Recent developments

GDP growth in Latin America and the Caribbean came in at 5.7 percent in 2007, up from 5.6 percent in 2006.
The current growth spell marks the first time in nearly three decades that growth has exceeded 5 percent for two consecutive years, and the first time since the early 1970s that GDP gains have eclipsed 4 percent for four consecutive years.

In 2007 the large regional economies, Argentina, Brazil, and Chile, achieved growth rates well above the 5 percent mark (8.7 percent, 5.4 percent, and 5.1 percent, respectively), while Mexican GDP expanded at a 3.3 percent pace.
Smaller economies in Central America and the Caribbean also performed well during the year (see the table below).

This strong performance underscores the view that growth in the region has become more resilient and is better positioned to weather the unfolding slowdown in the United States.
Although a favorable external environment has played a role in the improved regional performance, stronger domestic fundamentals have been just as important.

Indeed,  as the figure on  page 3 of this regional outlook highlights, capital formation has made a stronger contribution to growth during the most recent growth spell than during the two previous episodes in the mid-1980s and early 1990s.
Higher investment activity has been underpinned by a number of factors, including improved macroeconomic stability.

A major factor has been improved effectiveness of central banks in controlling inflation and in anchoring expectations to a stable, low level of inflation. In some countries, this development has been recently translated into lower real interest rates.
In turn, the continued strong pace of new investments bodes well for future growth, mainly through faster improvements in productivity.

In fact, this positive spillover to productivity can already be detected in recent data: for a group of countries including Brazil, Chile, Colombia, Panama, and Peru, growth rates in total factor productivity during 2001–06 ranged from 1.25 to 2.25 percent a year, well above historic averages.
In another group of countries, however, including the Dominican Republic, El Salvador, Honduras, and Mexico, productivity growth has been sluggish or even negative.

Financial stability has played a key role in supporting growth in recent years and is likely to help mitigate a portion of the contagion effects of the U.S. slowdown in 2008–09.

In contrast with previous episodes of financial market instability in high-income countries, increases in sovereign bond spreads for Latin American countries have been fairly muted during the current credit squeeze (see figure on  page 3 of this regional outlook).
This regional performance masks divergent behavior of two groups of countries.

A first group, comprised of Argentina, Bolivia, the Dominican Republic, Ecuador, and República Bolivariana de Venezuela, has experienced a sharper rise in the spread, showing a convergence toward the junk bond market.
A second group, including Colombia, El Salvador, Panama, Peru, and Uruguay, has shown reduced spread movements and seems to be joining the solid investment-grade group of Brazil, Chile, and Mexico.

Additionally, capital inflows have not reversed but remained buoyant, suggesting the region’s financial markets may be providing diversification benefits for investors.
Moreover, stocks of international reserves are large, and foreign debt continues to decline, limiting the region’s vulnerability to terms-of-trade shocks and to a sudden stop in capital flows.

In contrast with this positive backdrop, a number of concerns are emerging.
The surge in domestic demand has reduced excess capacity in many of the region’s economies and, together with rising food and energy prices, has resulted in increasing inflation.

Central banks have responded promptly in several countries: Brazil has suspended the easing of its monetary policy; Chile, Colombia, and Peru have raised their policy rates; and Mexico is holding its rates at a high level.
Elsewhere, inflation problems have caused social and political unrest, as in the case of Haiti, or have been addressed with the use of unorthodox policy measures, such as widespread price controls in Argentina and República Bolivariana de Venezuela.

Between 2006 and 2007, the region’s current account surplus decreased from 1.7 percent of GDP to 0.5 percent.
Surpluses have narrowed in Argentina, Brazil, Peru, and República Bolivariana de Venezuela, while deficits have widened in Colombia and Mexico.

Part of the narrowing of the region’s current account surplus is tied to shrinking goods surpluses, a consequence of imports growing at a markedly faster rate than exports.
But lower growth in remittance inflows also contributed.

Declining activity in the U.S. construction sector, where a large share of migrant workers is employed, explains the slowing of remittance incomes.
And though contagion from the U.S. credit freeze-up has not sharply affected bond spreads in the region, broader financial markets have shown some weakness.

Equity markets have recorded losses during the first quarter of 2008.