Latin America in 2009: Confronting the impact of the global crisis
by Pamela Cox
World Bank Vice President for Latin America and the Caribbean
Woodrow Wilson International Center
Thursday, February 5, 2009
Colleagues and friends of the Woodrow Wilson International Center,
Ladies and gentlemen,
I would like to thank the Woodrow Wilson International Center for this invitation and the opportunity to address critical issues affecting development trends in Latin America & the Caribbean.
Today, I am going to focus on how the global crisis is affecting the region, both through the real economy and the financial sector, how the de-coupling theory-–so popular last year—melted away; and how the region can protect the social gains achieved from more than 5 years of sustained growth; and, how Latin America can prepare itself for recovery and future growth.
A globalized crisis hitting Latin America
It is not news that we are in the midst of a severe global economic crisis. If you read the front pages of world newspapers, it is also not news that there is no clear roadmap on how to tackle this crisis.
How much fiscal stimulus is enough? What do we do about toxic assets? Indeed, the one answer seems to be increased reliance on the State in ways unthinkable years ago.
Economists searching for answers have looked backward to the 1980s, 1970s and even to the 1930s in search of guidance. But the types of problems we are confronting now are very different and it is not clear how we will emerge. Some say let’s go back and look at the books. Others say it is time to throw the books away.
All economies throughout the world have been hit. Economic news from the United States to Europe; from China to Brazil, relentlessly recount the difficulties faced by dozens of governments, hundreds of markets, thousands of businesses and millions of hardworking people.
This time around, however, the crisis did not erupt in emerging economies. And, this time, Latin America was not the epicenter as the crisis was sparked in developed countries. Nevertheless, the region is profoundly affected, and is grappling with contracting global demand, declining exports, and restricted access to capital flows.
The end of a virtuous cycle
The crisis has brought to a screeching halt more than 5 years of sustained economic growth —averaging 5% per year--fueled in part by the adoption in Latin America of responsible macro and fiscal policies, and in part by the boom in commodity prices.
Before the downturn, for the first time in 30 years, several countries were able to make significant progress in reducing poverty and inequality. For Brazil, Chile, Argentina, El Salvador, Colombia, amongst others, poverty reduction was achieved in part due to the fiscal space provided by improved macroeconomic policy. This allowed more intelligent social spending focused on those who needed it most; budget surpluses; never-before-seen increases in international reserves; a more attractive investment environment; and lower inflation rates.
Indeed it seemed as if the region had finally “taken off” on the growth path, following the model of the Asian tigers.
Those who know Latin America know that the region is no stranger to financial shocks: LAC suffered severe financial crises in the 1970s, 1980s, 90s and during 2001-02. People in the region know too well the pain of loosing savings or other assets; banks collapsing; dramatic depreciation of the local currencies; and the resulting poverty, unemployment, and negative growth.
But this time around, Latina America was not hit in the same way and many thought that it was de-coupling from advance economies.
A decoupling that was not
From August 2007, when the subprime crisis erupted, to mid 2008, when commodity prices began to fall, there was a sense that the region would weather the global crisis relatively unscathed.
While the subprime crisis roiled the economies of the industrialized world, the economic outlook for Latin America and the Caribbean was not bleak. Currencies were strengthening, the central banks continued to accumulate reserves, levels of direct foreign investments were maintained while portfolio capital inflows rose. Growth prospects for 2008 were revised upwards, and Peru and Brazil joined the “investment grade” club of countries.
The reason behind the existence of this oasis in the midst of the crisis was the boom in commodity prices, --for some economists another bubble--which more than offset the negative impacts of the financial turmoil and the economic slowdown in many developed countries.
The link between Latin American growth cycles and commodity price cycles is powerful. According to our research, more than 90% of the region’s population depend one way or the other on commodity exports.
But by mid 2008, as commodity prices began collapsing, the decoupling theory melted away. Commodity prices were now moving adversely for Latin America, reinforcing (rather than offsetting) the trend coming from the global slowdown and financial turmoil. After Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, a “perfect storm” took shape and the region was brought into full synchronization with the global downward spiral. The impact was clear:
- The region’s stock markets fell sharply as investors’ risk priorities changed
- Currencies depreciated (40% in Brazil, almost 30% in Chile)
- Commodity prices plunged and are now at January 2007 levels (50% price decrease from the 2008 peak)
- Remittances flows contracted significantly, with particularly strong negative effects in Mexico, Central America and the Caribbean. (6% decline in the last quarter of 2008)
- Households, companies and governments all started to feel the effects of the credit crunch.
Nearly all countries in the region have felt the impacts, although in different ways:
- Mexico and Central America will risk suffering the most from a long recession in the U.S as their economic and trade relations are closely tied to the U.S economy. Mexico, for example, will probably experience negative growth in 2009.
- In South America, the explosion of the commodity bubble is hitting Brazil very hard; Argentina also affected, has witnessed the nationalization of the pension system as a way of maintaining fiscal balance.
- Oil exporting nations such as Venezuela and Ecuador will need to adjust spending to the short fall of revenues as the result of the drop in international oil prices. (from $160 to around $40 per barrel).
- Less affected will be those countries that have managed to save during the good times, and those with more diversified markets and stronger ties with Asian economies (Chile, Colombia and Peru).
- Overall, countries with autonomous central banks, with inflation targeting regimes, and solid fiscal processes are better positioned.
- In September 2008 the consensus forecast for Latin America was 3.7% growth for 2009. By January 2009, by contrast, the consensus forecast envisioned only an anemic 1% growth, which is aligned with downward revisions of global growth. What a difference a quarter can make!
2009: New challenges, new opportunities to protect social gains
Though the current crisis has highlighted the need to regulate markets better, we also need to remember that some of the countries in the region will be able to withstand this crisis better than in the past because they have been implementing for years prudent macro and financial policies, including stronger financial sector regulation.
Nevertheless, policy makers will face significant challenges managing the short-term difficulties of the crisis while also maintaining conditions for long-term growth.
The current global financial crisis must not become a human and social crisis, and therefore, timely and decisive actions are imperative to protect the social gains made in Latin America and the Caribbean during recent years.
So what should governments do under these unique circumstances?
- First, the region needs to increase well targeted support to the most vulnerable through a social protection package. This package should ensure broad access to health insurance services, protect public spending on key areas such as nutrition and vaccines, and provide additional targeted cash support. Many countries in the Region have well targeted social protection networks, such as Brazil with the “Bolsa Familia,” Mexico with “Oportunidades,” with similar programs in El Salvador, Panama, Jamaica, and Colombia. These programs are now being expanded to mitigate some of the worst effects of the economic slow down that are yet to come. The World Bank has actively supported targeted social programs and today provides over US$ 2 billion to implement Conditional Cash Transfers initiatives in the region.
- Second, and for those countries that have the fiscal space, temporary financing of the emerging deficits is crucial to avoid unduly cutting expenditures on social protection, health, education and vital infrastructure. Where savings or prudent borrowing from multilaterals permit, well-designed increases in expenditure may be appropriate, including to close the gaps in human and physical capital while boosting domestic demand. Multi-billion stimulus packages have been set in motion in Argentina, Brazil, Mexico and Chile, with the objective of investing in infrastructure, protecting jobs, credit facilitation and the promotion of consumer spending.
- Third, governments could make a difference by moving fast towards an active labor market policy through job creation measures such as public works programs, initiatives in support of self-employment and enterprise development. Together with retraining and training programs for the unemployed and wage and employment subsidies, these measures will have not only a direct human effect but will contribute to the economic recovery.
- Fourth, the region needs to keep strengthening policies aimed at the longer term and at the eventual recovery; otherwise the gains of the last few years will be lost. Countries that are better able to manage the dangers posed by the crisis, while seizing its opportunities, will be better positioned to resume rapid growth and gain a larger presence in world markets. This means, for example, continued investments in trade facilitation, quality of education, and logistics.
- Fifth, most countries in the Americas are still committed to open trade and the upcoming Summit of the Americas will be an excellent opportunity to reconcile regional interests with the common goal of expanding economic relations that are mutually beneficial for all countries in the Western Hemisphere. Indeed, crises often present opportunities for government to deal with “sacred cows”.
- Finally, the effectiveness of governments and institutions in using scarce resources will play a crucial role in weathering the storm.
Governments could take advantage of the present crisis to review their policies on “universal subsidies”, which are subsidies that are going not only to the poor but to the middle class, and to a large degree, to the well-off. Why should the state subsidize water and sanitation, education services, gasoline or electricity for those who can afford it?
With political will, and the crisis may help on this, an overhaul of the “free for all” subsidies system could result in substantial savings that could then be used for targeted safety net programs and economic stimulus. The region annually spends between 5-10% of GDP on subsidies. Approximately 1/3 of this is captured by the top income earning 20% of the population. This would be enough to triple (or more) direct transfer programs for the poor.
To move this agenda forward, leadership will be crucial, especially in the context of a very dynamic political year.
In 2009 we will witness presidential elections in Panama, El Salvador, Chile, Uruguay, Ecuador, Bolivia and legislative contests in Argentina and Mexico. Bolivia is reforming its Constitution after President Morales recently won a referendum and in two weeks Venezuelans will decide if presidential terms limits will be abolished.
It is precisely during this crisis and in defining political junctures, that leadership in maintaining a sound economic management combined with an emphasis in protecting recent social gains will be needed to cushion the external shock and facilitate the resumption of growth once the storm has passed.
Emerging economies as part of the solution
A global crisis demands global solutions. We therefore must recognize that there will be no solution to this world-wide economic crisis if the point of view and concerns of developing countries are not taken into account.
The G20 leaders agreed that emerging and developing country economies such as Mexico and Brazil should have a seat at the table together with developed countries, as all are part of the solution. We support this path and we welcome this initial step toward a new multilateralism.
As World Bank President Robert Zoellick recently said “responsible globalization, with inclusivity and sustainability should take precedence over the enrichment of a few.”
World Bank’s response
But what is the World Bank Group doing during this unprecedented crisis? We are increasing financial support throughout the developing world, including lending for middle income countries ($100 billon total from 2009 to 2011) grants and concessional lending for low income nations and loans for the private sector through our private sector arm, the International Finance Corporation (IFC).
Through the International Bank for Reconstruction and Development (IBRD) we made new commitments in Latin America of up to $13 billion for the fiscal year ending June 2009, more than doubling our regular lending volume. These additional resources are critical to sustain jobs and social gains, boost ongoing public sector programs and inject liquidity into countries where needed.
This is a time to act and responsible leadership is crucial. Latin America will be part of the global solution if it is aimed at creating a global fair environment that provides opportunities for all.
I am confident that the same strong leadership that made possible the robust growth and the social progress achieved in recent years, will continue to develop in this critical time for the benefit of millions of Latin Americans.