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Montevideo, July 26th 2017 - 04:26 UTC

World Bank praise for Latam countries pursuing counter-cyclical fiscal policies

Wednesday, April 19th 2017 - 21:12 UTC
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Carlos Vegh, WB Chief Economist for Latin America and the Caribbean explains the trap of fiscal pro cyclicality, leading to higher public debt and fiscal deficits Carlos Vegh, WB Chief Economist for Latin America and the Caribbean explains the trap of fiscal pro cyclicality, leading to higher public debt and fiscal deficits

In a positive development, today more than ever before, Latin American and Caribbean countries are pursuing counter-cyclical fiscal policies - spending more in bad times and saving in good times, according to a new World Bank semiannual report for the region.

 “Leaning against the wind: Fiscal policy in Latin America and the Caribbean in a Historical Perspective”, argues that the transformation is significant for a region that has often pursued pro-cyclical spending – increasing the risks of overheating economies during boom times and making recessions deeper during the bad times.

According to the Consensus Forecasts, Gross Domestic Product in the region is expected to grow by 1.5% this year and 2.5% in 2018, putting an end to six years of an economic downturn, including recession over the past two years. If they materialize, recoveries expected in Brazil and Argentina will largely fuel the return to growth in the region. Mexico’s growth is expected to hover at around 1.4%, while Central America and the Caribbean will maintain steady growth of around 3.8%.

However, the fiscal accounts of many countries have suffered due to the prolonged slowdown. As of 2016, 29 out of 32 countries were facing fiscal deficits, largely due to higher spending. The median gross debt for the region stands at 50% of GDP. Still - in a significant break with the past - many countries now find themselves in a better position to escape this difficult fiscal predicament, according to the report.

“Countries in Latin America and the Caribbean have traditionally been pro-cyclical, either because of political pressures to spend during good times or lack of access to international capital during bad times,” said Carlos Végh, World Bank Chief Economist for Latin America and the Caribbean. “As a result, they often found themselves caught in a fiscal procyclicality trap, leading to higher public debt and fiscal deficits as well as lower credit ratings that left them few options to turn things around.”

In response to the global financial crisis of 2008, the number of countries with a countercyclical fiscal policy increased from 10 to 45%t of the region’s economies. Countries such as Chile, Colombia, Costa Rica, El Salvador, Guatemala, Mexico, Paraguay, and Peru begun to increase public spending and/or lower taxes in an attempt to stimulate the economy. While such measures produced fiscal deficits, they were the result of a concerted effort to minimize the downturn.

On the other hand, countries that continued with pro-cyclical policies must now further consolidate their fiscal accounts to minimize the risks of deterioration in their credit ratings and an increase in borrowing costs, the report argues.

“While countries may still find it tempting to spend rather than save in the next boom cycle, the events of the last decade in fiscal policy give us hope that countries will play it safe instead and be prudent,” said Vegh. “In an external environment characterized by frequent shocks and volatility, such prudence will allow them to turn fiscal policy into instruments to help cope with the next downturn and preserve social gains.”

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