Nicolás Eyzaguirre

Western Hemisphere DepartmentInternational Monetary Fund

BrazilMay 12, 2011

Latin America: Managing Abundance

Presentation Outline

1. Global baseline

2. Risks to global outlook

3. Implications for Latin America. How is Latin America different from other Emerging Market Economies?

4. What are the policy options? Importance of initial conditions and country-specific circumstances

1. Global baseline: High commodity prices and ...

Strong growth in emerging economies, particularly in Asia ...

... should keep commodity prices high for an extended period

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-8

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0

4

8

12

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-8

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4

8

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2006:Q1 2007:Q1 2008:Q1 2009:Q1 2010:Q1 2011:Q1

Emerging economiesWorldAdvanced economies

Real GDP Growth (Percent change, SAAR)

Source: IMF World Economic Outlook.

0

50

100

150

200

250

0

100

200

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400

500

1980 1985 1990 1995 2000 2005 2010 2015

Oil 1/Metals (right axis)Food (right axis)

Real Commodity Prices(Index, 1995 = 100)

Source: IMF, Global Assumptions.1/ Simple average of spot prices of U.K. Brent, Dubai Fateh, and West Texas Intermediate crude oil.

... easy financing conditions for an extended period

Weak U.S. recovery and need for fiscal consolidation ...

... should keep monetary policy rates low for some time

United States: Federal Deficits and Debt

2005 2007 2009 2011 2013 20150

25

50

75

100

-12

-6

0

6

12

Federal deficit (percent of GDP, fiscal years; left axis)

Federal debt held by the public (percent of GDP, f iscal years; right axis)

Source: Office of Management and Budget and Fund s taff calculations.

Note: Projections assume full implementation of policies under Staff's macroeconomic assumptions. 0

1

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5

6

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Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

FRBFed funds futures (On February 18, 2011; percent)Fed funds futures (On May 4, 2011; percent)

United States: Federal Funds Rate (in percent) 1/

Source: Bloomberg, LP.1/ Projections implied by futures contracts

Unusually easy conditions and improved prospects in EMs are leadingto a surge in capital flows

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30

35

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1986 1991 1996 2001 2006 2011

Real Fed funds rate Jan-Apr 2011 real Fed fundsVIX index (right scale)Jan-Apr 2011 VIX (right scale)

Episodes of Easy External Financial Conditions

Source: Haver Analytics.

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100

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400

500

1990 1994 1998 2002 2006 2010Source: IMF staff calculations.Note: 2007 value exceeded US$ 1000 billion.

Non-FDI Capital Inflows to Emerging Market Economies(Billions of U.S. dollars)

Prolonged oil shock with impact on global growth and price of other commodities

Early tightening of global financial conditions: U.S. political deadlock on fiscal consolidation coupled with strong recovery in private demand

2. Alternative scenarios: New tail risks have emerged

Scenario A. Deep and prolonged oil shock: would lower global growth as well as the price of other commodities

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Oil Metals (rhs)

First Oil Crisis(December 1972=100)

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8

-12 -6 0 6 12 18 24 30 36

Global Growth

number of monthsSource: World Economic Outlook and Fund staff estimates.

Scenario B. Earlier tightening of U.S. monetary policy: stronger recovery of U.S. private demand and lack of fiscal consolidation

There is still lots of pent-up private demand

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1995 2000 2005 2010

Private Durable ConsumptionPrivate Fixed Investment (right side)

United States: Private Investment and Durable Goods Consumption (in percent of GDP)

Source: BEA and Fund staff calculations.

Defense and other security

24%

Social Security

20%

Medicare and

federal Medicaid

21%

Other mandatory

15%

Net interest

6%

Nonsecurity discretionary

14%

Composition of Federal Spending

Sources: U.S. Office of Management and Budget; and IMF staff calculations.

Reaching political consensus on fiscal consolidation will be challenging

0.0 0.2 0.4 0.6 0.8 1.0

Brazil, Chile, Colombia, Mexico, Peru and

Uruguay

Australia, Canada, New Zealand, Norway,

and Sweden

Other

China, Indonesia, Malaysia, Philippines,

South Korea, and Thailand

Chinn & Ito Index, 2008(Means, higher indicates greater openness)

Source: Chinn & Ito, 2009. Source: Schindler, 2009.0.0 0.2 0.4 0.6 0.8 1.0

Brazil, Chile, Mexico, Peru and Uruguay

China, Indonesia, Malaysia, Philippines,

South Korea, and Thailand

Australia, Canada, New Zealand, Norway,

and Sweden

Other

Schindler Index, 2005(Means, higher indicates greater openness)

3. Implications for Latin America: Capital accounts are significantly more open than in other emerging market economies ...

Current accounts are in deficit, and widening

Currencies are more flexible and reserves are smaller

... current accounts are in deficit and currencies are flexible

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Dec-10

Dec-10Aug-08

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Sep-05 Sep-05

Gross reserves (ratio to GDP)²R

eal e

ffect

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exch

ange

rate

¹ Emerging Latin America

Emerging As ia

Note: Weighted averages of 15 Lat in American and 10 As ian economies.¹Index 2005=100. ²Gross international reserves as a s hare of 2006–08 average GDP.

Emerging Latin America and Asia: Real Exchange Ratesand Reserves, 2005–10

¹ Output minus domestic absorption in percent of output, at constant (2005) prices.

External Balances in Emerging Market Economies,2005–10

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Out

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Current account balance (percent of GDP)

Latin America Emerging As ia

2005

2010

2005

2010

Latin America has historically been more sensitive to changes in external financing conditions ...

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LA5 ASIA Emerging Europe

MENA ACE4

Domestic Demand Growth in Episodes of Easy External Financing(Difference of growth rates relative to non-episode years)

... and fluctuations in commodity prices

Current Account Balance at Current and Constant 2005 Prices(percent in GDP)¹

¹ Simple average for Brazil, Chile, Colombia, Mexico and Peru.² Keeping terms of trade constant at 2005 levels and controling for the sensitivity of repatriation of profits and dividends to commodity prices.

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2006 2008 2010

CA, actual

CA, Fixed 2005 prices

LA5 (average)¹

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2006 2008 2010

CA, actual

CA, Fixed 2005 prices

Brazil

Brazil is likely more sensitive than others in the region

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2004 2005 2006 2007 2008 2009 2010 2011

Brazil Chile Mexico

EMBI Global Bond Spreads(basis points)

Brazil’s spreads have contracted far more since 2004

0 20 40 60 80

0 20 40 60 80

Chile

Brazil

Mexico

Dec. 2004 Dec. 2010

Private Sector Credit (Percent of GDP)

Source: National authorities and Fund staff estimates.

Bank credit started from a fairly low base

Do natural resources/capital inflows shocks cause... (Percent of total observations; number of observation in parenthesis)

(31)

(10)

(17)

(2)

(4)

(0)

(1)

(6)

0 25 50 75 100

... appreciation?

... lower net exports?

... factor reallocation?

... lower growth?

Yes No

Source: Magud & Sosa (2010).

What is key risk/concern for Latin America?

• Domestic demand boom

• Buildup of financial risks and excesses (credit boom, mismatches)

• How about risks to growth?

Unlikely that currency appreciation could bring a demand shortfall, recession

Dutch disease? conceptually, a relevant concern... but empirical evidence is weak

Impact of currency appreciation may depend on the relative size of the manufacturing sector (open question)

The share of Brazil’s manufacturing exports is larger than Chile’s (though smaller than Mexico’s)

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Brazil Chile Mexico

Manufacturing output (% of GDP,lhs)Manufacturing exports (% of total exports, rhs)

Relative Importance of Manufacturing Sector, 2010

Source: Haver Analytics, and IMF World Economic Outlook.

Need Action on multiple fronts (and at the same time):

• Shift macro policy to neutral or contractionary mode

• Protect exchange rate flexibility o FX intervention? Not too early.

• Macro-prudential policies (more work)

• Capital controls can be part of toolkit

• Tackle information gaps (corporate and housing sectors)

4. Policy Response

Don’t let fiscal policy feed the boomo Bring fiscal stance to neutral gear (reverse previous stimuli) o Limit spending growth to match structural revenue gains, not

boom gains Requires enhancing fiscal policy targets

o Reign in policy lending

Take advantage of greater currency flexibility o Demand booms are smaller where flexibility is greatero Net K inflows are not predetermined, but respond to domestic

policies Some currency “overshooting” is part of the solution Don’t intervene prematurely; intervention is more effective in

countries with closed capital account (i.e. Asia).

Fiscal and exchange rate policy

Strengthen macro-prudential policieso Continue working fast and build on earlier experience

o Need broad oversight and targeted interventions

o Open issues: calibration (trial and error required); effectiveness (circumvention); consistency (with traditional policies).

Consider capital controls (if macro and financial policies are insufficient to contain risks)o Controls should be on the table, given high openness and exceptional

global setting

o For effectiveness, be comprehensive (not selective)

Complementing toolkit

Demand booms and financial excesses—not currency appreciation per se—are the main risks.

Take advantage of exchange rate flexibility to mitigate inflows—avoid intervening prematurely.

Enhance fiscal policy targets: simple nominal targets on fiscal balances guarantee procyclical responses.

Strengthen and develop new macroprudential policies.

Marginal/temporary reductions in openness can be justified in some cases.

5. Key Takeaways