IMF Sees Latin America Facing a Range of Challenges from Global Crisis

The Fund’s latest baseline projection is for a modestly lower growth outlook for Latin America and the Caribbean at 4.5 percent in 2011 and 4 percent in 2012, down 0.1 percentage point from the forecast published in June.

“We still have as our baseline a situation in which both global liquidity and commodity prices will remain, as we have called them, the double tailwinds for the region,” said Nicolás Eyzaguirre, director of the IMF’s Western Hemisphere Department. “However, these will be somewhat weaker than in the recent past.”

Noting the fluid situation in markets, the report notes that downside risks to the baseline are potentially severe. The lack of a definitive solution to the crisis in Europe could worsen confidence and global credit market conditions, with spillovers to emerging markets. A recession in advanced economies could hit commodity prices, with significant negative effects on commodity exporters. But there are upside risks as well: a quick resolution of European stresses and a better outlook for global growth could reignite strong capital inflows, bringing back overheating risks.

“In the past, when the rich world had a cold, this region would catch pneumonia. Right now, the situation seems reversed: advance economies have pneumonia, but the region will likely only have a cold. Of course, a cold still has to be treated,” Mr. Eyzaguirre said. “In this complicated environment, Latin America and the Caribbean should generally stay the course of their present policies, including a nimble monetary stance, rebuild fiscal buffers, and stand ready to adjust if global winds change.”

Different Realities across the Hemisphere

In South American countries with more robust growth, overheating dangers have lessened but have not fully disappeared, particularly where output is above potential and domestic demand remains strong. Nevertheless, countries with credible monetary policy frameworks, and where inflation expectations are well anchored, could pause in the tightening cycle. If downside risks materialize, monetary policy should be the first line of defense. Meanwhile, the gradual fiscal consolidation should continue, to create room for maneuver to counter a more serious downturn, and preserve hard-won fiscal credibility. In addition, macro-prudential policies remain an important part of the policy toolkit.

Countries with strong economic linkages to the United States, like Mexico and much of Central America, face a somewhat weaker outlook, the report notes. Because their fiscal situation has been stretched, policies should focus on reducing public debt to pre-crisis levels.

For Caribbean countries, which have started recovering from a long and protracted recession, the outlook continues to be constrained by high debt levels and weak tourism flows from advanced economies. Countries must focus in bringing down high debt levels, as well as addressing financial sector vulnerabilities.

The Impact of Commodities

The Regional Economic Outlook analyses Latin America’s vulnerability to a commodity price bust and the policies that could mitigate it. On average, the region is as dependent on commodities today as it was 40 years ago, the report notes. Accordingly, faltering global demand could deliver a blow to the region’s terms of trade.

In Chapter 3, the report concludes that appropriate policies can play an important role in mitigating the economic impact of commodity shocks: Countries with strong policies—exchange rate flexibility if dollarization is low, along with sound external and fiscal positions—particularly during the boom phase of the commodity price cycles, fare better. This underscores the need to rebuild policy buffers, to better position the region to weather any sharp declines in commodity prices

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