Monday, May 25, 2009

Latin America – Present and Future

An interesting debate is taking place on where Latin America is headed and about the growth prospects for this region. In 2003-2008, Latin American growth was 5% - the highest in decades. This year the region will enter a recession and we are forecasting growth to reach -2% for the Latin America. However, almost the whole world will experience negative growth in 2009. The question to be explored here is if Latin countries will continue to grow at 5% rate after 2009 or will countries be unable to keep high growth rates in the near future. Has something fundamentally changed in Latin America - in terms of policies, reforms and productivity trends - that will lead to permanently higher growth? Or is the recent experience all cyclical and driven by positive external fundamentals that are likely to be temporary (high global growth, low global interest rates and temporarily high commodity prices)?

One prominent view is that Latin America has entered a secular "New Paradigm" of high growth where macro stabilization, structural reforms, moderate pragmatic governments and good external conditions reinforce each other in a virtuous circle of permanently higher growth. According to this new paradigm, most Latin American countries have achieved investment grade status, are experiencing lower sovereign spreads and are absorbing increasing amounts of capital inflows.

In the recent past, we had a second strand of the debate that argued that what is happening in Latin markets is primarily due to “good luck”, that is due to the positive external scenario. In brief, there are two views on the debate: a) There is a secular change and new paradigm of long run growth in the region; b) Important reforms have occurred but the region has not fully turned the corner and external conditions have helped. The growth in the Latin American region is cyclical and due to positive external conditions

The prospects for Latin American depend both on internal and external factors. For what concerns the internal factors, there are some positive developments but there are also some negative factors and vulnerabilities that are source of concerns.
The positive developments - that suggest that Latin America may have changed course and be on a much better economic trajectory - are the following: Some of the factors of macro and financial fragility that caused previous crises have improved. Most of the countries in the region now run current account surpluses reducing the risk of "sudden stops"; foreign reserves are increasing, short term foreign currency debts are somewhat reduced and external financing needs seem manageable, thus reducing the risk of liquidity runs; no major Latin economy has had a financial crisis since 2002; fiscal policy has improved with large primary balances that are stabilizing the public debt dynamics; inflation rates are low and central banks becoming more independent; structural reforms are continuing even if at a pace that is not ideal. On the external front, however, the scenario is mixed. On the US side, things are rather bleak. The country is experiencing the worst recession since the great depression. This will force an adjustment of American living standards. Consumption will have to decrease and savings will go up. The twin deficits dynamics (current account deficit and public deficit) will have to come to an end. The world will have to stop financing the American bonanza. On the other hand, on the Chinese side, we have a situation where China is still growing very fast and thus demanding the commodities produced by the region. It remains to be seen whether or not China will be able to support the former virtuous circle of growth, spreads reduction and capital inflows.

What about the potential internal vulnerabilities? An important problem among Latin American countries is the fact that permanent increases in long-run potential growth require high investment rates. However, investment rates are relatively low in the region. Also, while most of the required investments may derive from the private sector, Latin America also badly needs public investments (in infrastructures, transportation systems and more broadly in education, health and other social services) that need to find appropriate ways to be financed. In this regard the current account surplus are reflecting a fall in investment rates as much as an increase in savings rates. In other words, a current account surplus means that the savings are greater than investment. One way of achieving a sustainable growth path is to have high investment levels. This, however, requires current deficits. In turn, when current account deficits are explained by greater investment rates (and financed by an increase of FDI) rather than an increase in fiscal deficits then, the risk of a sudden stop is decreased. In this context, the capital inflows that are now flowing to the region and leading to a build-up of low yielding reserves should, over time, finance the necessary investment boom that would be accompanied by a return to current account deficits.

In conclusion, policies have somewhat improved in Latin America: macro stabilization, moderate structural reforms and policy pragmatism are emerging. It is too early to say that the whole region has entered in a new paradigm for the entire region especially because there are some success stories but policy improvement has been more impressive on the macro side and less impressive on the structural side. What is impressive is that in times of stress, as the ones we are currently living, Latin America has not only survived but has outpaced other emerging regions like the Baltics and the whole Eastern Europe, for example.

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