THE FISCAL IMPACT OF THE INTERNATIONAL FINANCIAL CRISIS ON LATIN AMERICAN AND CARIBBEAN ECONOMIES 1

Transcription

1 Insiuional Capaciy and Finance Secor THE FISCAL IMPACT OF THE INTERNATIONAL FINANCIAL CRISIS ON LATIN AMERICAN AND CARIBBEAN ECONOMIES Technical Noe Ocober 2008 This Technical Noe was prepared by Vicene Frees and Luiz Villela in he Fiscal and Municipal Managemen Division (FMM), Insiuional Capaciy and Finance Secor (ICF) of he Vice-Presidency of Secors and Knowledge (VPS). The findings, inerpreaions, and conclusions expressed herein are hose of he auhors and do no necessarily reflec he views of he Iner-American Developmen Bank.

2 ABSTRACT The main objecive of his Technical Noe is o provide a simple framework o deermine he shor-erm fiscal impac of he inernaional financial crisis on Lain American and Caribbean (LAC) counries, i.e., fiscal financing needs/gap by counry (or fiscal liquidiy impac). In addiion, i will provide a framework o evaluae fiscal susainabiliy by counry (or fiscal solvency impac). In boh cases, and depending of he paricular counry under analysis, ransmission mechanisms (variables) will be idenified, and sensiiviy analysis will be carried ou o deermine he robusness of heir impac. Given ha LAC economies are quie heerogeneous, he sandard framework will require adjusmens o reflec each individual case under analysis. The Noe also proposes o sar he analysis on hose counries wih relaively weakes iniial condiions as defined by counries wih primary and overall fiscal deficis. 2

3 Curren Siuaion In Flux The global financial crisis is sill unfolding, and financial markes remain fragile and volaile. A his poin, i is no ye clear wha will be he final impac on he real global economy. However, here is a general consensus ha a global economic slowdown is highly likely, resuling from he financial disress alongside wih commodiy price changes and sluggish expor markes, despie he coordinaed effors o sabilize he global financial marke. I is well known ha in advanced counries, he crisis has been driven by a loss of confidence and rus, wih he effecs spreading o consumers and firms, which had so far weahered he recen price hikes in oil and commodiies well bu were now experiencing sharply slowing demand. Wih regard o emerging economies, despie heir cooling momenum, hey are expeced o provide a source of resilience, benefiing from produciviy growh and improved policy frameworks. However, he longer he financial crisis lass, he more he emerging economies' growh is likely o be affeced. Wih respec o LAC region, more specifically, i is expeced o deal wih he curren global shocks beer han in previous crises reflecing he progress many counries have made in improving heir macroeconomic fundamenals over he pas decade. However, here is consensus among forecasers and economiss ha he global credi freeze/crunch, a slowdown (if no recession) in he USA and commodiy-price declines will ake a oll on he resource-rich region nex year regional growh forecas is now around.5%, down from abou 3.5% before he crisis. In addiion, here are sill a number of furher downside risks. Commodiy prices remain elevaed bu could fall furher in line wih he experience in previous global downurns. Lower food and fuel prices would bring welcome relief for some counries, in paricular low-income commodiy imporers in Cenral America and many Caribbean counries, bu for he region as a whole, srong commodiy prices have been a major facor in bolsering fiscal and exernal posiions and driving growh in recen years. A furher sharp fall would have considerable adverse implicaions for he region's fiscal and exernal posiions. In many counries of he region he fiscal siuaion will likely come under sress a a ime when here will be increased need o mainain a safey ne for hose low-income households who would be affeced by he slowdown. Regarding he slowdown in he USA, i is clear ha Mexico's growh is going o be hi and he counries in Cenral America are he mos exposed o he reducion in demand aking place in he USA. In addiion, here are significan wealh effecs across he region ha will affec consumpion and invesmen, and hus economic growh. For example, Brazil s sock marke was down significanly las week (50% from his year s high) and is currency has suffered is deepes declines since he naion s 999 economic meldown. Mexico burned abou 0% of is inernaional reserve las week rying o slowdown he drop in he pesos. 3

4 The currency s fall (by 6% his monh so far) has exposed currency mismaches in balance shees (of even blue chips companies), weakening heir posiion o access o credi. Fiscal Impac Poenial Transmissions In general, he fiscal impac of he financial crisis will be boh on revenues and expendiures. On revenues, here are wo main channels (i) GDP growh and (ii) price of commodiies. In mos counries he evoluion of heir GDP has a significan effec on heir fiscal revenues. In some of hem, highly dependen on royalies and axes on commodiies, he price of hose commodiies has an independen and direc fiscal impac. LAC counries are quie heerogeneous and no serious assessmen can be done of he coninen vulnerabiliies o he curren crisis by bundling all is counries ogeher. We could, however, idenify channels hrough which he crisis may affec all of hem albei wih more or less virulence. Fiscal balance is achieved when counries are able o raise enough revenues o cover heir fiscal expendiures (above he line equilibrium) and, a leas, obain enough financing o cover he ineres coss of heir public deb in order o avoid is unsusainable expansion, i.e., explosion. So, o ensure fiscal susainabiliy, counries mus achieve a high enough level of primary balance ha will warran a sable or declining rajecory of he deb-o-gdp raio. The primary balance is affeced by public secor expendiures, including deb ineres paymens, and revenues. The financing o cover shorfalls in primary balance and o susain a non-explosive public deb will depend on he access o boh domesic and foreign financial markes and of he credibiliy of he counry s macroeconomic policies, paricularly fiscal policies. In addiion o fiscal policies, primary balance and deb financing are affeced by real GDP growh and prices including changes in he overall price level (inflaion), exchange and ineres raes. The crisis will affec all of hese variables. On revenue, he basic sources of governmen revenues are axes, boh indirec and direc, as well as rens from sae monopolies such as oil and minerals. Tax revenues in he region could be roughly divided as 60% from sales (indirec) and 40% from income (direc), including payroll, and boh sources of revenues are highly posiively correlaed wih income his however varies from counry o counry. Reducion in aggregae demand abroad (e.g., USA and Europe) would likely resul in fewer expors, affecing profis and income ax revenue. For LAC counries imporing oil and some basic commodiies, he price reducion would be posiive bu would resul in less indirec ax revenues. For he ones overly dependen on oil and commodiies expors for direc governmen revenues, price and quaniy reducions could have a significan impac. The 4

5 overall effecs of he crisis on rade balance will vary from counry o counry, depending, among oher hings, on heir foreign rade srucure and foreign exchange regime. On expendiure, he flexibiliy o ighen he bel and adjus for hard imes will depend on he proporion of enilemens or oher measures o reduce expenses in he budge. In many counries, here is much earmarked expendiure, be i o social secors (e.g., healh, educaion or pensions) or o subnaional governmens. The lower he curren balance (difference beween curren revenues and expendiures), here will be less flexibiliy o adjus. Depending on he duraion and inensiy of he crisis, here will be increased pressure for governmens o exend heir social safey ne acions o miigae he adverse effecs on he poores segmens of sociey. On public deb, he mos obvious implicaion of he crisis will be growing difficulies in is financing. Therefore, whenever possible, increased primary balances should be sough o reduce he deb financing requiremens. For counries wih weak economic and poliical insiuions, he safe level of he ne public deb o GDP raio is likely o be low. If here is a hisory of sovereign defaul, he safe level of public deb is likely o be even lower. Weak borrowers will have o generae larger and earlier primary surpluses han more credi-worhy borrowers. Counries ha made more use of hard currency borrowing during normal imes are now in disadvanage during his period of financial urmoil. As indicaed above, he crisis will impac on he region s GDP and revenues (as hey are posiively correlaed), and consequenly on he fiscal sance of LAC counries. Some of he poenial channels and impacs on GDP (and revenue) include: Expors and erms of rade. A world-wide economic slowdown or recession will impac LAC counries by affecing heir expors (quaniies and prices) and by cuing liquidiy (financing balance of rade deficis.) Counries ha will suffer more will be counries wih significan commodiies expors (for example Argenina, Bolivia, Ecuador, Mexico, Peru, and Venezuela) and counries wih significanly negaive balance of rade. Remiances. This is an imporan source of income for some LAC counries (e.g., Cenral American Counries, Ecuador and Mexico) and hose counries will see remiances significanly reduced. Ineres rae. They will increase and reduce borrowing from banks, no only invesmen bu working capial may be affeced. LAC counries may face significan increases in he cos of issuing new deb eiher fresh or o resrucure old deb. 5

6 Exchange rae. Due o uncerainies, he demand for US dollar may increase leading o currency depreciaion (e.g., Mexico). Dollarized economies such as Ecuador, Panamá and El Salvador will be direcly affeced, reducing heir compeiiveness. Demand for money. The GDP conracion can be exacerbaed if here is an incremen in demand for money leading o conracion in aggregae demand. Moreover, in a conex of exchange rae depreciaion and higher ineres raes, counries wih weak banking sysems (e.g., Bolivia, Guaemala) may experience banking disress or crisis, requiring addiional fiscal resources o sabilize he banking sysem. Unexpeced depreciaion will impac banks nonperforming porfolio in dual currency, highly dollarized economies (e.g., Bolivia, Paraguay, and Peru) Fiscal Liquidiy and Susainabiliy Analysis Proposal The complexiy of he global financial crisis, is repercussions on financial markes and economies (as indicaed above), ogeher wih iniial condiions of macroeconomic policies, including fiscal posiion and he ype of fiscal policies (pro- or couner- cyclical) in LAC counries, call for ackling, firs, he counry s financing needs. Thus, his Noe proposes o proceed calculaing/esimaing he gap, by counry, as follows: PB: Primary Balance (Before Crisis) Plus or Minus Changes en PB (Afer Crisis) Plus or Minus Xs (Oher Flows-Before Crisis, i.e., Fund Accumulaions, Oher Savings, Exraordinary Flows) Pus or Minus Changes in X (Afer Crisis) Minus Amorizaions = Ne Financing Needs Minus Idenified Sources of Financing (Bonds, Loans) = Ne Financing Gap The financing needs and gaps should be esimaed for a leas wo years ino he fuure. In addiion, a sensiiviy analysis should be carried ou o deermine how hese variables will vary wih changes in he underlined componens (e.g., how sensiive is PB o changes in revenues resuling from changes in GDP). We will compare, conras hese esimaed gaps wih ohers available in he marke, including IMF s and World Bank s. Secondly, he analysis should include, by counry, he susainabiliy of he fiscal pah. This will be based on susaining a feasible deb-o-gdp raio pah over ime 2. More specifically, i will be based on (for deails see Annex): 2 See for example The Economics of he Governmen Budge Consrain, 990 by Easerly and Fisher or Some Thoughs on he Role of Fiscal Policy in Sabilizaion and Srucural Adjusmens 6

7 S (r n)b Where: S: Primary Balance (Surplus) as a proporion of GDP, which denoes he excess of revenues over non- ineres expendiures; r is he real ineres rae. n: he growh rae of real GDP; and b: is he oal (domesic and foreign currency-denominaed) deb as a share of GDP Thus, according o his formulaion, if he real ineres rae is, say, 8 percen, he real growh rae 5 percen and he deb o GDP raio fify percen, hen a primary surplus of 2.5 percen of GDP could sabilize he deb-o-gdp raio. In oher words, if he oucome of he curren unfolding financial crisis affecs eiher or boh he ineres rae or he GDP growh, he fiscal policy response o ensure a susained deb-o-gdp raio will have o be cenered in an increased primary balance. The susainabiliy analysis should include a pah overime o ensure he deb o GDP raio is non-explosive. As in he liquidiy impac (financing needs), a sensiiviy analysis should carried ou o deermine how hese variables will vary wih changes in he underlined componens. We will also compare and conras hese analyses wih ohers available in he marke, including IMF s and World Bank s analyses. Iniial Condiions Iniial fiscal condiion of each individual counry will be of criical imporance o asses how and if he counry will successfully weaher he sorm. Among he iniial condiions are he exisence of primary and overall fiscal balance, he size of inernaional reserves, he size of he public deb and how much is foreign denominaed, he dependency of commodiy prices and he fiscal elasiciy relaive o GDP changes. I s proposed he financing needs and susainabiliy analysis sar wih counries wih he weakes iniial condiion (as measured by primary and overall fiscal deficis, prior o he crisis). The able below summarizes some he key macro-fiscal indicaors ha will have o be moniored in order o indicae he capaciy of each paricular counry o face he challenges of he curren financial crisis and make he necessary fiscal adjusmen o ensure fiscal susainabiliy. in Developing Counries, 990 by Willem Buier, as well as he recen Fiscal Susainabiliy, 2004, by he same auhor. 7

8 Some Key Indicaors for Iniial Condiions and Fiscal Impac Revenues Expendiures Deb Exernal Exposure Curren T/GDP Ineres paymen/g Primary balance/gdp Exchange rae regime (fl. fx mix,$) Terms of rade Personnel / G or R Toal balance/gdp Reserves/fx deb Taxes on Impors Enilemens / G Toal D/GDP Reserves / M Taxes on Expors Deb service/g or R Fx D/GDP Remiances/M or X Commodiies expor revenues K expendiures/g Domesic D / GDP Diversificaion X GDP growh Inflaion Domesic ineres rae Concenraion rade parners Average D paymen period (years) Annex: Fiscal Susainabiliy Analysis Curren accoun / GDP FDI/oal invesmens Ne foreign asses Dependency on food/oil impors The global economic recession and financial crisis will have impacs on he boh he fiscal posiion and he exernal curren accoun of LAC. We will focus primarily in he former, using he fiscal susainabiliy equaion. More specifically, for a given definiion of he public secor, le GDP be he economy s gross domesic produc (GDP) in period, D be he ne sock of public secor deb, PS he public secor s primary surplus, X he amoun of seignorage financing, g he (consan) rae of growh of GDP, and i he (consan) average ineres rae on public secor deb. In he sandard framework for he analysis of deb susainabiliy 3, he increase in deb is a funcion of he level of deb muliplied by he ineres rae, and of he governmen s primary surplus adjused for seignorage financing of he budge. This is expressed as: 3 See, for example, The Economics of he Governmen Budge Consrain, 990 by Easerly and Fisher 8

9 D = D = id PS X For consisency wih he analysis conduced in oher Chapers, our definiion of governmen is he Consolidaed Public secor. Since in Colombia direc Cenral Bank financing of he fiscal defici has been phased ou and insiuional arrangemens are such ha he independence of he Cenral Bank is credible, we assume in our projecions ha he likelihood ha he governmen would resul o inflaionary financing of he defici is negligible. However, he balance of he Cenral Bank is included above he line (as a governmen revenue iem direcly included in he calculaion of he primary surplus), as is done in oher Chapers. In his case, he increase in he deb sock can be simplified o: D + D = id PS Rearranging erms and dividing boh sides of he equaion by GDP + = ( + g) GDP, we obain: D + GDP + + i = + g D GDP + g PS GDP D + To simplify his expression, deb-o-gdp and primary-surplus-o-gdp raions are expressed in lower case: d += + i d + g + g ps This difference equaion describes he behavior of he deb-o-gdp raio given consan ineres and GDP growh raes, and given a sequence over ime of primary surpluses. I can be shown ha if: v + g Lim v = 0 + d v i holds, hem he deb-o-gdp raio is no explosive. Applying his condiion o he difference equaion given above, yields: 9

10 d = + + i + g i v ps v This saes ha o avoid a no explosive deb-o-gdp raio, he public secor mus generae a sequence of primary surpluses (relaive o GDP) such ha he ne presen value of he sequence is worh al leas as much as he deb-o-gdp raio a ime. If we furher assume ha fuure primary surplus-o-gdp raios are consan and making use of esablished resuls on he summaion of sequences, i can be shown ha: ps = (i g)d The expression can be inerpreed as saying ha a sable deb-o-gdp raio is obained when he raio of he primary surplus o GDP is equal o he difference beween he ineres rae and he economy s rae of growh, muliplied by he curren deb-o-gdp raio. 0