LAC Treads a Narrow Path to Growth: The Slowdown and its Macroeconomic Challenges Washington, DC April 14, 2015 Chief Economist Office Latin America and the Caribbean Region
I. What happened?
The deceleration was unexpectedly large and abrupt LAC: Actual vs Forecast Real GDP Growth for 2014 GDP Growth and Forecasts by Region Notes: ECA excludes Russia. Sources: Consensus Forecasts and national sources
albeit not uniformly distributed GDP Growth Estimates and Forecasts Notes: Countries in red have suffered a large negative terms of trade shock, countries in black have suffered a moderate negative terms of trade shock, countries in green have suffered a positive terms of trade shock. Sources: March 2015 Consensus Forecasts.
LAC deceleration went in tandem with the big China cycle, yet in an amplified way LAC, China, and U.S. Growth, and Commodities Sources: Bloomberg and national sources
The external cycle explains most of LAC s growth fluctuations but not the mean LAC s Growth Largely Explained by External Factors LAC s Growth Variance Decomposition G7 YoY Growth 25.8% China YoY Growth 29.7% Commodities 3.8% US 10 Year Yield 0.1% Residual 40.6% Sources: Authors calculations from Bloomberg and national sources.
and changes in terms of trade explain much of the cross country growth variation LAC: Growth Deceleration and TOT Changes Sources: World Bank s GEM, IMF s WEO and March 2015 Consensus Forecasts.
Commodity prices play a key transmission role, particularly among commodity exporters LAC: Investment Contribution to GDP Growth Correlation between Stock Market Returns and CRB Commodity Index Sources: Authors calculations from Bloomberg and national sources.
The reconfiguration of external factors is here to stay; hence LAC is back to low growth LAC: Average Growth by Period and Forecast China s growth settling around 7 percent. G-7 s growth picking up, mainly due to the U.S. Yet, uncertainty still looms: The new equilibrium of commodity prices is hard to know Europe and Japan can drag G-7 s growth Notes: The 2015-2019 estimates assumes constant growth in China and LAC specific factors, and G7 GDP growth between 1.3 and 2.3 percent. Sources: Bloomberg, Consensus Forecasts, and national sources.
but the permanence of the shock is just sinking in for consumers and firms LAC Investment and Consumption in Three Acts: Changes in External Saving, Domestic Saving and Investment LAC: Issuance of Corporate Debt Securities by Currency Sources: IDB and IMF s IFS.
as well as for governments Revenue, Expenditure and GDP Growth Sources: IMF s IFS and national sources.
II. The policy response
Issues and responses depend on country characteristics and available instruments Terms of Trade Shock since 2011 Large Negative Shock Moderate Negative Shock Positive Shock Exchange Rate Flexibility Low Intermediate High Belize, Ecuador, and Bolivia Argentina, Guatemala, Jamaica, Paraguay, Trinidad & Tobago, and Venezuela Brazil, Chile, Colombia, Mexico, and Peru El Salvador, Guyana, and Panama Honduras and Nicaragua Uruguay OECS Countries Costa Rica, Dominican Republic, and Haiti Sources: Authors elaboration.
Commodity exporting floaters and fixers face different problems in the transition Fixers: significant output problem No worries about inflation As long as exchange rate anchor holds no inflationary pressures Floaters: tension between inflation and output objectives Worries about inflation Pass-through problem leading to an expectations anchoring problem but large output loss No expenditure switching RER adjustment through deflation leading to a policy conundrum Major fiscal tightening to limit absorption or heterodox policies to facilitate expenditure switching? and smaller output loss Expenditure switching RER adjustment through nominal depreciations still leading to a policy conundrum Tighten monetary to control inflation or loosen monetary to limit downturn/speed up growth?
Floaters face inflationary pressures due to exchange rate response to falling ToT Change in the Terms of Trade and Nominal Exchange Rate The Rise of LAC s Pass-Through Sources: Authors elaboration from Bloomberg, DECPG, and national sources.
which limit their monetary policy space LAC Inflation Targeters ECA Inflation Targeters Sources: Authors elaboration from Bloomberg, DECPG, and national sources.
Hence, unlike during global crisis, there is no longer a divine coincidence Gap Relative to GDP Trend, Inflation Rate and Interest Rate Differentials between LAC and US Sources: Authors elaboration based on Bloomberg and national sources.
There is not much room on the fiscal side either: sustainability has worsened Primary Balance Sustainability Index Notes: The primary sustainability index depends on assumptions about the primary balance, growth, debt, and the interest rate. Sources: Authors calculation from Bloomberg, IDB, and IMF s WEO.
in part due to the widening fiscal deficits Sources: IMF s WEO.
It seems that fiscal expansion was not transitory in most of LAC. Fiscal Accounts in LAC Sources: IMF s WEO.
and the growth in public spending has been mostly consumption-oriented Change in Public Investment and Other Public Spending, 2007-2014 Sources: Authors calculation from IDB and national sources.
Does the inability to engage in transitory spending reflect a small government syndrome Expenditure Gaps Simple Averages by Region Sources: Authors calculation from WEO.
resulting from limited resource (tax) mobilization? Revenue Gaps Simple Averages by Region Sources: Authors calculation from WEO.
The evidence points the other way: bigger governments spent more LAC: Public Expenditure Sources: Authors calculation from WEO.
It is therefore time for LAC to widen its macro policy maneuvering space Conventional means Building monetary space through credibility (+ broader bands?) Building fiscal space through strengthened specialized instruments (buffers, automatic stabilizers, etc.) But key lesson: countercyclical differs from transition smoothing! Non-conventional means: higher saving should also help Monetary Fiscal Less inflationary pressures on NT sector => less bumping against ceiling? More local currency domestic debt issuing capacity Higher fiscal multipliers? (less crowding out, less Ricardian equivalence)
In addition to helping widen the policy space, higher saving would help boost growth Savings, Real Exchange Rates, and Growth II I National Saving Gap 0.2 0.8 5.7-0.7 Over-saving Undervalued Overvalued Under-saving 0.2 6.8 0.4 1.0-0.6-0.7 2.8 3.7 III IV Sources: Authors from de la Torre and Ize (2015). Real Exchange Rate Gap Country Rating Growth Inflation
Unfortunately, LAC tends to under-save; some countries much more than others Savings: LAC Relative to Other Regions Savings Across LAC Countries Sources: Authors from de la Torre and Ize (2015).
China s switch toward consumption should help LAC in this regard, but only at the margin China s saving decline => saving increase for ROW (given world investment) Less external funding More investment opportunities China: GDP and Demand Component Growth More LAC saving => more competitive RER => higher growth Back-of-envelope estimate 10% reduction in China saving => 0.5% increase in LAC growth
Concluding thoughts LAC needs to face the permanence of the shock Cannot finance its way out It confronts the region with its traditional low-growth syndrome LAC needs to rebuild its macro policy maneuvering space Commodities => LAC faces periodic RER re-equilibrating adjustments Hence, LAC needs more transitional maneuvering space, not just countercyclical policy capacity Raising saving is an important part of the answer It should help LAC grow faster and broaden the policy maneuvering space It cannot (nor should it) be done overnight but it should already color LAC s policy agenda and priorities