MercoPress. South Atlantic News Agency

IMF Says Latam Recovering Faster than Expected but With “Bubble” Risks

Nicolas Eyzaguirre, Director of the IMF’s Western Hemisphere Department during the launching of the report in Montevideo

The recovery in Latin America and the Caribbean is advancing faster than anticipated but at different speeds across countries, the International Monetary Fund (IMF) said in its latest Regional Economic Outlook-Western Hemisphere report, which was launched Tuesday in Montevideo, Uruguay.

However, the report also warns that faster-than-forecast recovery from the global financial crisis requires “careful” macroeconomic measures to avoid the emergence of bubbles, already with some incipient signals in several countries.

According to the report, growth continues to gather momentum in the region, driven primarily by a strong rebound in private consumption and improved external conditions. For 2010, regional GDP is expected to grow by 4%, after contracting by 1.8% in 2009. But the report sees marked differences in the outlook across countries.

“Overall, we expect a good performance for the Latin America and Caribbean economies in 2010,” said Nicolas Eyzaguirre, Director of the International Monetary Fund (IMF) Western Hemisphere Department. “But within that regional picture, countries with strong ties to global financial markets are likely to stage a more vigorous recovery, helped by their access to ample external financing and by strong prices for their commodity exports. On the other hand, some of the smaller economies will experience more sluggish growth, and some of those will even contract. Accordingly, policy approaches will have to vary considerably to ensure a sustainable recovery across countries.”

For the purpose of analyzing the regional outlook, the report divides LAC countries into four groups:

1. countries that are exporters of commodities and have full access to global financial markets (including Brazil, Chile, Colombia, Mexico and Peru);
2. other commodity exporters;
3. commodity importers that rely heavily on foreign tourism (mainly Caribbean countries);
4. other commodity importing countries (including many in Central America that rely on remittances from workers abroad).

For commodity exporting countries, the challenge is how to best manage the upswing in the business cycle amid very favourable external conditions. As economic activity recovers, and inflation and output gaps close, there will be a need to phase out macroeconomic policy stimulus, starting with the fiscal side, especially where private demand is gaining strong momentum.

For some of the other commodity exporting countries, a key policy challenge will be to break from past patterns of fiscal pro-cyclicality as government revenue rises along with commodity export prices.

For many commodity importing countries, where the room for macroeconomic stimulus has been almost depleted, the remaining space should be prudently saved and replenished if possible to address potential downside risk scenarios.

In tourism dependent countries where activity has been hurt by weak employment conditions in the advanced economies, the policy focus should be on easing hardships on the poor and maintaining macroeconomic stability.

As for the United States and Canada, with recovery under way, the near term policy focus is turning toward exit strategies. Stimulus is appropriately being maintained to support growth. But for the United States attention will soon need to turn to getting fiscal imbalances under control. In particular, crafting a strong medium-term consolidation strategy to underpin confidence in fiscal sustainability will be essential.

The report looks in depth at the challenges arising from the return of favourable external financial conditions, analyzing how economies in Latin America and other regions responded to similar conditions in the past. Episodes of cheap and abundant external financing raise the risk of a boom-bust cycle, since they can lead to surges in domestic demand and credit, as well as asset price bubbles and larger current account deficits.

“The arrival of easy external financial conditions is good news overall for emerging economies,” said Mr. Eyzaguirre. “But these temporary episodes come with risks that need to be managed. It’s important not to let easy conditions trigger too-rapid growth of demand and credit, in new booms that could end badly later.”

The report concludes that averting such risks depends on policies. “An important message of our analysis is that policies can either mitigate or amplify the eventual risks associated with easy external financing,” said Mr. Eyzaguirre. “So the decisions taken by policymakers right now are very important to avoiding trouble later.”

The situation calls for a set of policy responses, Mr. Eyzaguirre said. “The priorities are to allow significant flexibility of the exchange rate, to maintain fiscal discipline and to use fiscal policy to lean against excessive demand growth, and to use macro-prudential policies to keep financial systems stable.” If these approaches together turn out to not be sufficient, he noted, adding carefully designed taxes on capital inflows may help on a temporary basis.