Economic growth in much of Latin America remains strong, propelled by rising commodity prices, easy financing conditions, and stimulative policies. Growth exceeded 6% in 2010, and while it is projected to moderate to about 4¾% in 2011, the IMF says countries should remove the policy stimulus on a timely basis.
In its Regional Economic Outlook for the region, issued this week in Mexico City, the IMF said that the region continues to grow at a robust pace, led by rapidly expanding domestic demand.
“The main economic risk in the case of Latin America is complacency,” said Nicolás Eyzaguirre, head of the IMF Western Hemisphere Department. “The region is growing a bit beyond its possibilities so if it does not begin to put the brakes on and continues at this pace, economies could eventually overheat,” he added.
Within Latin America and the Caribbean, economic performance will be less uneven in 2011. South America’s commodity exporters will continue to lead the expansion, though there are signs that the recovery is finally gaining some traction in economies with closer real links to advanced economies, mainly Central America and the Caribbean, where recovery has lagged.
According to the report, overheating risks stand out in much of Latin America. Growth remains above trend and domestic demand has been growing even faster, pushed not only by unprecedented favorable external conditions but also by economic policies that have been quite stimulative and are only gradually normalizing. Early signs of overheating pressures and possible excesses are appearing in several areas:
• Inflation is rising in much of the region. Many central banks have been raising interest rates, but more rate hikes will be needed to contain demand pressures and limit spillovers from higher food and fuel prices into core inflation and expectations.
• Current account deficits are widening in many countries. Even in those benefiting from higher commodity export prices, import growth has been outpacing exports. While current account deficits are not yet excessive, their movement in that direction will need to slow. Fiscal policy can contribute in this regard, particularly through slowing the growth in public expenditure.
• Credit is accelerating in many countries. While banking systems seem to remain sound, vigilance is needed as leverage and external exposure is increasing in some countries.
• External borrowing by corporations is up and some assets are looking pricy. Countries should continue to adopt and strengthen prudential policies, although these cannot substitute for having suitable monetary and fiscal policies in place.
Countries in Central America and the Caribbean experiencing weaker growth will also need to proceed carefully, the report warned. These countries should focus on rebuilding the policy buffers used during the recent global recession to better prepare themselves in case of another shock. In Central America, where output gaps are closing, priorities should shift towards strengthening the business climate and institutions, which are known to be weak.
In much of the Caribbean, where public debt is very high, fiscal policy will need to continue consolidating to ensure economic stability and set the stage for higher and more sustainable growth in the future.
Finally rising global prices of commodities, especially food, pose an important social challenge across the region. This applies even to countries that are net exporters of commodities and food, the report said.
To protect the poor, IMF says, policies should focus on scaling up proven social safety net programs, such as targeted income transfers, school lunches, and child nutrition programs.
Generalized price subsidies should be avoided as these measures are often very costly and regressive, and can turn out to be permanent—requiring large adjustments to other parts of the budget.
The expansion of safety nets should take place within the established budget envelope, in some cases to avoid stimulating demand (South America), while in other cases to rebuild the policy buffers (Central America and the Caribbean).