| October 8, 2008. Countries across Latin America and the Caribbean are feeling the effects of the global financial crisis as credit contracts, demand for exports declines, and commodity prices fall, resulting in a deterioration of terms of trade, according to Augusto De la Torre, the chief economist for the Bank’s Latin American and Caribbean region. De la Torre added that while the region as a whole is better prepared than in the past, due to robust growth in the last 5 years (average of 5%) and the implementation of sound macro and fiscal policies, the unprecedented magnitude of the crisis and fear and uncertainty surrounding its scope and impact mean that the region, like the rest of the world, will not go unscathed. “Since our previous outlook for Latin America and the Caribbean in April, 2008, the external environment has deteriorated significantly,” De la Torre announced at a press conference today. “Three inter-related global shocks are hitting the world economy: the financial crisis, the slowdown in growth, and changes in international relative prices (notably, a weakening of commodity prices). These shocks are becoming larger, increasingly reinforcing each other and spreading rapidly around the world, although their relative importance for different countries continues to evolve.” De la Torre said Latin America has witnessed a large declines in stock price indexes, and significant currency adjustments—with the latter in large part associated with the unwinding of previous speculative short-run positions (the so-called “carry trades”). External borrowing costs have increased sharply, particularly for Latin firms but also for Latin sovereigns. The average EMBI spreads for Latin corporates and sovereigns rose to 578 and 603 basis points, respectively, as of October 7, 2008. He cautioned, however, that the deterioration in risk premiums is occurring from a historically low level of spreads, high equity prices, appreciated currencies, and record capital inflows, and that these effects are less pronounced in Latin America than in other emerging regions. Additionally, other key financial indicators do not appear to have worsened yet: Foreign Direct Investment (FDI) inflows to the region have remained high according to the latest estimates and local currency debt and interbank markets have remained relatively well behaved across most countries. Rising concerns on the cyclical impacts of the global slowdown Nevertheless, given the continuing unfolding of the global crisis, local financial conditions need to be closely monitored. De la Torre said the likely stagnation of growth in the rich countries and sharp deceleration in emerging economies in Asia will adversely affect LAC growth. The main channel will be the decline in the world’s demand for LAC exports. Falling remittances (significant in Central America, Caribbean and Mexico) weakening commodity prices, higher borrowing costs, and the lag from tight monetary policy that LAC countries have pursued to curb inflation also will exacerbate the situation. Economic growth in LAC is expected to slow from 5.6 percent in 2007 to an estimated 4.6 percent in 2008 and to between 2.5 and 3.5 percent in 2009. Although the slowdown in LAC will be greater than previously expected, the decline will occur from a relatively high growth trend achieved in recent years. Countries with a diversified trade —such as Argentina, Peru, and Brazil—will see a somewhat mitigated and delayed impact, given robust growth in China. The countries that are likely to perform better will be those that have in the past managed to reduce vulnerabilities, increase investment rates, diversify export markets, and restore productivity growth. Commodity price changes will have different effects across LAC countries Softer commodity prices due to the global economic slowdown will deteriorate the terms of trade of the region as a whole, as Latin America is a net commodity exporter. Over 90 percent of the region’s GDP and population reside in net commodity exporting countries. This follows a prolonged period where the same countries benefited significantly from the commodity price boom. Meanwhile, approximately half the countries in the region, mainly located in Central America and the Caribbean, are net commodity importers. For them, the recent downturn in the international prices of fuels, industrial metals, and cereals will provide some relief. Unfortunately, in many cases, this relief is offset by falling remittances inflows and stagnating economic growth. At the same time, the fall in international prices of foods and fuels is helping reduce the inflation pressures to which they formerly contributed. The shocks are much larger and the outlook is significantly bleaker De la Torre said that while there is great uncertainty on the ultimate consequences of the global shocks on the LAC region, downside risks have widened, forcing a reconfiguration of policy challenges and priorities. While inflation expectations have begun to decline, at the same time, policy concerns over the financial turmoil and growth slowdown have moved to center stage. The ability of Latin American countries to respond to these deteriorating circumstances will depend on the extent of their financial and real vulnerabilities. De la Torre said authorities will be faced with the decision of whether and when to ease monetary policy, and the answer will depend in part on the inflation level and the amount of stress on financial systems and currencies. |
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