Latin America Copes with Volatility, The Dark Side of Globalization 2012 Spring Meetings IMF-World Bank Chief Economist Office Latin America and the Caribbean The World Bank Washington, DC 18 April 2012 1
LAC was bumping against capacity constraints after a strong recovery in the aftermath of the global crisis 12.0% Real GDP Growth Forecast Around The World Annual Real GDP Growth Rate, Weighted Average 45,000 % Growth Rate 10.0% 8.0% 6.0% 4.0% 2.0% 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 GDP Per Capita PPP (2010) 9% 8% 7% 6% 2011e 2012f Forecasts Across LAC Counrties 0.0% High Income South Africa Europe & Central Asia Latin East Asian America & Tigers Caribbean India 0 5% 4% 3% 2% 1% 0% Jamaica El Salvador Trin. & Tob. Guatemala Nicaragua Mexico Brazil LAC Argentina Costa Rica Bolivia Ecuador Paraguay Venezuela Chile Uruguay Colombia Dom. Rep. Peru China Panama 2010 2011e 2012f GDP Per Capita PPP (2010) 2
In addition, financial turbulence ignited in Europe in the second half of 2011 contributed to LAC s deceleration 5.5% LAC-7 2012 GDP Growth Forecasts Evolution 5.0% 4.5% 4.0% 3.5% 3.0% LAC7 - Foreign Agents LAC 7 - Domestic Agents Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 LTRO marked a turning point => probability of tail-risk event dimmed This created breathing room for troubled Euro Zone countries to tackle their deep structural challenges 3
Reduced probability of a tail-risk event combined with low rates in rich countries is unleashing a search for yield US$ Millions 5,000 4,000 3,000 2,000 1,000 0-1,000-2,000 Proxied By Mutual Fund Flows -3,000-4,000-5,000 Total (Equity + Bonds) LTRO I Equity Funds Bond Funds Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Increases in capital flows to LAC, especially of portfolio flows, add tensions to macroeconomic management: Keeping inflation expectations anchored in the face of economic overheating; Avoiding an excessive appreciation of the currency in a context of high but volatile commodity prices and capital flows. 4
The only certainty in LAC s path is uncertainty Mood swings and market fickleness characterize the current juncture Disproportionally large reactions to news can create sudden waves of optimism or pessimism 1400 1200 1000 Sovereign CDS for Selected European Countries In Basis Points Ireland+Portugal France UK Spain Italy 50 45 40 S&P 500 and VIX Index 1500 1450 1400 1350 800 600 35 30 25 1300 1250 1200 400 200 0 20 15 10 1150 1100 1050 1000 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 VIX Index Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 S&P500 VIX Index S&P 500 5
The focus of the report LAC s quest is to: Reap the benefits of integration (increase long-term growth and generate greater social equality) While cushioning the effects of external volatility, the dark side of globalization This report focuses on: 1. The nature of the financial volatility Very different financial globalization process today relative to the 80s and 90s 2. Landscape of vulnerabilities in LAC to external shocks Becoming more integrated (hence, more exposed) need not imply being more vulnerable 6
Two-way flows characterize the new financially globalized world Chile Brazil 30 25 Net Capital Flows Capital Inflows by Foreigners 10 8 20 Capital Inflows by Residents 6 15 10 5 0-5 Capital Flows as % of GDP 4 2 0-2 -4-10 -6-15 -8-20 -10 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2002 2004 2006 2008 Capital Flows as % of GDP In the 80s, gross and net flows were similar as domestic investors played a very small role. Starting in the 90s, gross flows have dwarfed net flows Marked differences in the composition of gross flows by both foreigners and residents across LAC countries 7
International asset management industry is playing an increasingly important role in financial globalization They are very large players: Vanguard alone manages approximately US$1.7 trillion through mutual funds. A 1% increase in allocation (about $17 billion) to, for example, Colombia represents about 6% of Colombia s GDP; roughly the same amount of all gross capital inflows the country received from foreigners during the entire year of 2010. Asset managers amplify fluctuation and are pro-cyclical through herding behavior focused on short-term returns Exit vs. monitoring Performance compensation as a poor substitute to skin-in-the-game Mark-to-market valuation 8
Asset managers have treated LAC better this time around 10 Russian Default Eastern Europe Asian and Russian Crises 40 Latin America Portfolio Weight 8 6 35 30 Thai Devaluation 4 25 Jun. 96 Oct. 96 Feb. 97 Jun. 97 Oct. 97 Feb. 98 Jun. 98 Oct. 98 Feb. 99 Jun. 99 Oct. 99 Feb. 00 Jun. 00 Oct. 00 Feb. 01 Jun. 01 Oct. 01 Jun. 96 Oct. 96 Feb. 97 Jun. 97 Oct. 97 Global Financial Crisis Feb. 98 Jun. 98 Oct. 98 Feb. 99 Jun. 99 Oct. 99 Feb. 00 Jun. 00 Oct. 00 Feb. 01 Jun. 01 Oct. 01 16 Eastern Europe 25 Latin America 14 24 Portfolio Weight 12 10 8 23 22 21 20 6 Lehman Brothers 19 4 Jan. 06 May.06 Sep. 06 Jan. 07 May.07 Sep. 07 Jan. 08 May.08 Sep. 08 Jan. 09 May.09 Sep. 09 Jan. 10 May.10 Sep. 10 Jan. 11 May. 11 Sep. 11 18 Jan. 06 May.06 Sep. 06 Jan. 07 May.07 Sep. 07 Jan. 08 May.08 Sep. 08 Jan. 09 May.09 Sep. 09 Jan. 10 May.10 Sep. 10 Jan. 11 May. 11 Sep. 11 9
However, global factors have gained importance vis-à-vis domestic factors, especially in times of turmoil 100% Equity Returns and the VIX Average R-Squared from Country Regressions 90% Early Period (2000-2005) 80% 70% Late Period (Jan-05 to Jul-08) Crisis (Aug-08 to Apr-09) Percent 60% 50% 40% 30% 20% 0.100 0.050 MSCI Latam w.r.t VIX and S&P500: VIX Coefficient Robust standard errors in parentheses Sep2006-Jul2008 Aug2008-May2009 Jun2009-Apr2010 May2010-current 10% 0% Equity Foreign Exchange CDS Spreads 0.000-0.050-0.100-0.056 (0.0263) -0.174-0.012-0.042 (0.019) (0.021) -0.150-0.200 (0.073) Coefficient of VIX 10
Still, good policies matter, a lot in fact! Policies matter: At longer horizons, well-managed countries attract greater investment flows When tensions subside, countries with a strong set of policies are able to recover fast and are better placed to reap the benefits of global integration Both of these points are illustrated through LAC s performance in the aftermath 2008 global crisis No local financial crisis Consolidation of sound macro-financial policy frameworks and the associated build-up of buffers allowed the use of counter-cyclical policies A safer integration into the global financial system reduced the downside associated with greater financial integration There is, however, still large heterogeneity in the region. 11
A Landscape of Vulnerabilities across LAC Countries Important distinction: exposure vulnerability Our four layer approach: Define external shocks ( what-if approach) Analyze exposure to each of these shocks Assess the capacity of policy response when facing these external shocks Overall examination of vulnerability to external shocks Given non-linearities in today s globalized world, we provide a qualitative assessment of exposures and vulnerabilities across LAC countries A few caveats: A tsunami (i.e. a very large) external shock can overwhelm even the best macropolicy response capacity The focus is restricted to external shocks, self-inflicted shocks can still arise from unstable and un-viable domestic macroeconomic policies 12
High Ability to Respond High Exposure Slowdown to the US and Europe Mexico External Shocks Slowdown in China and/or a decline in Commodity Prices Brazil, Chile, Colombia, Paraguay, Peru, and Uruguay Increased Risk Aversion Brazil, Chile, Colombia, Mexico, Uruguay and Peru High Ability to Respond Moderate Exposure Brazil and Peru.... Low Exposure Argentina, Bolivia, Chile, Paraguay, and Uruguay Barbados, Bahamas, Belize, Dom. Rep., ECCU, El Salvador, Guyana, Jamaica, and Mexico Argentina, Belize, Bolivia, ECCU, Ecuador, El Salvador, Guatemala, Guyana, Paraguay, and Venezuela Low Ability to Respond Moderate Exposure.. Honduras.. 13
Thank you 14
Unit Labor Costs in Europe 120 115 110 105 France Germany Spain Italy Ireland Greece Unit Labor Costs in Europe Index base 100 = 2005, Seasonally Adjusted 100 95 90 85 80 Q1-2000 Q3-2000 Q1-2001 Q3-2001 Q1-2002 Q3-2002 Q1-2003 Q3-2003 Q1-2004 Q3-2004 Q1-2005 Q3-2005 Q1-2006 Q3-2006 Q1-2007 Q3-2007 Q1-2008 Q3-2008 Q1-2009 Q3-2009 Q1-2010 Q3-2010 Q1-2011 15
Risks and Volatility in Financial Markets Around The World Global EZ US LAC CDS: ARG,VEN CDS: IT Countries EMBI LAC Currencies: IT Countries MSCI Latam (Volatility) CDS Banks High Yied Spread TED Spread VIX Index S&P 500 (Volatility) One Year Imp. Vol. ATM EURUS CDS Banks CDS GIIPS CDS France, Germany, UK STOXX (Volatility) FTSE Global CRB Index Risks And Volatility in Financial Markets Around The World Heat Map 2008 2009 2010 2011 2012 16
250% Global Financial Crisis: Long Term 200% 150% 100% 50% 0% -50% -100% 60% 40% Global Financial Crisis: Short Term -150% -200% Saudi Arabia Colombia Hong Kong Chile Indonesia India Average 2011 vs. Avg 2007 Thailand Poland China Brazil South Africa Korea South Taiwan Mexico Philippines Russia Turkey Hungary Egypt Israel 20% 0% -20% -40% -60% -80% -100% Average Sep08-Dec08 vs. Avg Jan08-Apr08 Chile Czech Republic South Africa Israel China Hong Kong Turkey Philippines Mexico Taiwan Korea South Brazil Malaysia Thailand Indonesia Russia Argentina Pakistan Egypt Austria 17
Stress in the Banking Systems of the Developed World 400% 350% 300% Libor - OIS Spreads in the US and Europe In percent LTRO I Libor - OIS Spread (USD) Libor - OIS Spread (EUR) 160 140 120 S&P Financial Index and IShares MSCI Financial CDS Banks EUR (rhs) CDS Banks EEUU (rhs) S&P Financial Ishares MSCI Europe Financials 400 350 300 250% 200% 150% Index base 100 =Jan - 11 100 80 60 250 200 150 100% 40 100 50% 20 50 0% 0 0 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 In Basis Points 18
Exposure to a Slowdown in the US and Europe 100% 2010 Share of Total Exports to the US and UE15 90% 80% 70% 60% 50% 40% 30% 20% 10% Grenada Barbados Dominica Mexico St. Kitts and Nev. St. Lucia Dom. Rep. St. Vinc. and Gren. TTO Venezuela Belize Costa Rica Colombia Ecuador Panama Peru Brazil Chile Uruguay Paraguay Argentina Bolivia Jamaica Nicaragua Guatemala Guyana Honduras Salvador Haiti 0% 0% 5% 10% 15% 20% 25% Received Remittances in % GDP 19
Exposure to a Slowdown in China and/or a Decline in Commodity Prices 25% 20% 2009 Chile High Exposure Moderate Exposure Low Exposure Share of Exports to China 15% 10% 5% Panama Peru Brazil Costa Rica Uruguay Argentina Venezuela Jamaica Dom.Rep. Mexico Honduras Guatemala Nicaragua El Salvador Ecuador Bolivia Colombia Paraguay 0% 0% 20% 40% 60% 80% 100% Share of Commodity Exports 20
Exposure to Increases in Risk Aversion 12% 2010 Chile FDI and Portfolio Flows from Foreigners as a percent of GDP 10% 8% 6% 4% 2% Argentina Bolivia Paraguay Peru Uruguay Mexico Dom. Rep. Costa Rica Colombia Brazil Jamaica Venezuela Ecuador 0% 0% 10% 20% 30% 40% 50% 60% 70% 80% Cross Border Banking Flows as a percent of GDP 21
Typology of Countries according to their Exposures to Shocks Slowdown in the US and Europe Belize Dominica Guatemala Honduras Nicaragua St. Kt. &Nev. St. Lucia St. Ven. & Grens. Dominican Rep. Jamaica Mexico Caribbean Offshore Centers Costa Rica Ecuador Trin. and Tob. Venezuela Colombia Panama Decrease in Commodity Prices/ Slowdown in China Brazil Chile Uruguay Argentina Bolivia Peru Increase in Risk Aversion 22
23