How Nasty will the External Environment Get? Global Scenarios for LAC RTM Retreat Washington, DC 2 November 2011 Chief Economist Office Latin America and the Caribbean The World Bank 1
Rising Global Uncertainty and Risks 2
The European Epicenter Reversal of fortune! Argentina Venezuela Ukrain Kazakhastan Tukey Phillipines Indonesia Colombia Panama Peru Vietnam Brazil Russia Romania South Africa Bulgaria Mexico Croatia Thailand Hungary Korea Malaysia Chile Poland Italy Greece Ireland Slovak Rep Portugal Spain Belgium France Germany Sweden Global Sovereign CDS 31-Dec-2007, in basis points 0 500 1000 1500 2000 Greece Venezuela Portugal Argentina Ireland Ukraine Hungary Italy Croatia Vietnam Spain Romania Bulgaria Turkey Belgium Poland Kazakhastan Russia Indonesia Phillipines South Africa France Peru Brazil Mexico Colombia Thailand Slovak Rep Panama Korea Malaysia Chile Germany Sweden Global Sovereign CDS 16-Sep-2011, in basis points 0 1000 2000 3000 4000 5000 6000 Source: Bloomberg 3
The European epicenter One currency, 17 sovereign debt issuers 25% 20% 15% 10% 5% Spreads Over German Bonds In % Official Launch of the Euro Portugal Greece Ireland France Italy Spain 0% -5% Mar-93 Apr-94 May-95 Jun-96 Jul-97 Aug-98 Sep-99 Oct-00 Nov-01 Jan-03 Feb-04 Mar-05 Apr-06 May-07 Jun-08 Jul-09 Aug-10 Sep-11 Source: Bloomberg 4
The European epicenter Structural heterogeneity and the CGD trap 200 Unit Labor Costs in Europe Index base 100 = q1-2000 Germany 180 Italy Portugal 160 Greece France 140 120 100 Spain 20.0% 15.0% Debt Sustainability in Europe Theoretical vs Actual Primary Balance Actual Theoretical 80 10.0% 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 % of GDP 5.0% 0.0% -5.0% -10.0% Greece France Ireland Portugal Italy Spain Source: EuroStats and Bloomberg. For panel B, the theoretical primary balances is calculated using the last observation of the nominal interests rates on 10ys bonds, and assuming a long term inflation and growth of 1.5% and 2%, respectively. 5
The European epicenter Is a Euro in an Italian bank the same as a one in a German bank? 130 European Banks Bloomberg Europe Banks Index base 100 = Jan-11, CDS in bps 350 120 300 Index base 100 = Jan-11 110 100 90 80 70 60 50 Jan-11 Jan-11 Jan-11 Bloomberg Europe Banks Index Markit itraxx Europe Financial CDS Index (rhs) 250 200 150 100 50 0 400.0% 350.0% 300.0% 250.0% Libor - OIS Spreads in the US and Europe In percent Libor - OIS Spread (USD) Libor - OIS Spread (EUR) 200.0% 150.0% 100.0% 50.0% 0.0% Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Feb-11 Feb-11 Mar-11 Mar-11 Apr-11 Apr-11 May-11 May-11 Jun-11 Jun-11 Jul-11 Jul-11 Aug-11 Aug-11 Aug-11 Sep-11 Sep-11 Oct-11 Oct-11 bps Notes: In panel B the LIBOR OIS is the difference between LIBOR and the overnight indexed swap (OIS) rates. Source: Bloomberg 6
The US epicenter Feeble growth prospects: Keynes vs. Fischer 135 US Economic Activity GDP Index base 100 = Iq - 2003 130 125 2003-2007 trend Index base 100 = Iq - 2003 120 115 110 105 100 95 90 Mar-03 Nov-03 Jul-04 Mar-05 Nov-05 Jul-06 Mar-07 Nov-07 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 ISM Index 70 60 50 40 30 20 Industrial Production and ISM Index Industrial Production (YoY %) 10.0% 5.0% 0.0% -5.0% -10.0% Industrial Production (YoY) 10 ISM Index -15.0% 0-20.0% Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Series2 Sources: Consensus Forecasts (October 2011) and Bloomberg. 7
The US Epicenter Downgraded but still the safe haven ( exorbitant privilege ) Gold and US T10 2011 2000 Gold 4.0% 1900 1800 US T10 (rhs) 3.5% USD 1700 1600 1500 1400 3.0% 2.5% 2.0% Percent 115 110 Japan US-EUR UK Currencies: 2011 Index base 100 = 1-Jan-2011 Brazil 1300 105 1200 1.5% Jan-11 100 95 90 Dec-10 Jan-11 Mar-11 Apr-11 May-11 Jan-11 Jun-11 Feb-11 Jul-11 Feb-11 Aug-11 Mar-11 Mar-11 Apr-11 Apr-11 Sep-11 May-11 May-11 May-11 Jun-11 Jun-11 Jul-11 Jul-11 Aug-11 Aug-11 Sep-11 Source: Bloomberg 8
Short-run scenarios 1. Continued real de-coupling 2. A great global re-coupling 9
Real cyclical de-coupling has been a salient feature of the post-crisis global economic landscape 120 115 110 105 Crisis World Industrial Production Index Apr-08 = 100 Advanced Economies Emerging Economies 100 95 90 85 100% 80% Contribution to World Economic GDP as a % of World GDP increase (PPP) 8% 11% 8% 8% 7% 8% 80 Jan-06 Aug-06 Mar-07 Oct-07 May-08 Dec-08 Jul-09 Feb-10 Sep-10 Apr-11 60% 34% 44% 57% 40% 20% 51% 38% 27% 0% 1996-2001 2001-2006 2009-2011 Others Other Advanced Economies EM - 20 Euro (15)+US+Japan+Canada+UK Note: The group of developed countries refers to OECD countries excluding Turkey, Mexico, Republic of Korea, and Central European countries. Source: CPB (Netherlands Bureau for Economic Policy Analysis). 10
For LAC it has been a decade of trend decoupling also 7.0% 6.0% 5.0% Cyclical Adjusted Growth High-Income Latin America 4.0% 3.0% 2.0% 1.0% 0.0% 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Average TFP growth per year Avg 61-70 Avg 71-80 Avg 81-90 Avg 91-00 Avg 01-08 Avg 61-08 LAC 7 1.9% 0.4% -2.0% 0.2% 1.0% 0.3% Non - LAC 7 1.1% 0.5% -2.0% 0.1% 1.2% 0.2% Argentina 1.3% -0.2% -2.5% 2.0% 1.4% 0.4% Brazil 2.9% 3.2% -3.3% -1.7% 0.5% 0.3% Chile 1.5% 0.5% -0.5% 2.9% 0.5% 1.0% Colombia 1.4% 1.0% -1.3% 0.0% 1.3% 0.5% Mexico 2.0% 0.3% -0.9% -1.6% 0.3% 0.0% Peru 2.4% -0.2% -3.8% 0.5% 2.9% 0.4% Venezuela 2.1% -2.1% -1.6% -0.5% 0.2% -0.4% EAP 3.1% 2.1% 2.3% 1.3% 2.0% 2.2% China -0.5% 0.9% 1.6% 3.4% 6.2% 2.3% United States 0.9% -0.4% 1.1% 1.0% 0.6% 0.6% Japan 6.7% 1.1% 1.4% -0.7% 0.9% 1.9% Notes: In Panel B, High Performance EAP includes Korea Rep., Taiwan, Hong Kong, and Singapore; Low Performance EAP includes Indonesia, Philippines, Thailand, and Malaysia; LAC includes the following countries: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Uruguay, Venezuela, Bolivia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Jamaica, Nicaragua, Panama, and Paraguay. The weightsare calculated using the2007 nominal GDP. Source: Penn World Tables. 11
much is due to the China connection 0.8 0.6 Output Co-Movement Between LAC and China 20 years rolling correlation of the Real GDP Growth Brazil Chile Colombia Mexico Peru Argentina Panama Dom. Rep. 0.4 0.2 0.0-0.2-0.4-0.6 1980 1984 1988 1992 1996 2000 2004 2008 0.9 0.8 0.7 0.6 0.5 0.4 Industrial Production: Latin America w.r.t Asia, US and Europe Asia US Europe 0.3 0.2 0.1 0-0.1-0.2 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11 Notes: In both panels, the coefficients were estimated using the percentage variation of industrial production against the percentage variation in industrial production in Asia, US and Europe. In Panel A the coefficients are associated to the following regression IP Latam=a+b1*IP(US)+b2*IP(Europe)+b3*IP(Asia). In Panel B, the coefficients are associated to IPLAC 6=a+b1*IP(US)+b2*IP(Europe)+b3*IP(Asia). LAC 6 includes Argentina, Brazil, Chile, Colombia, Peru and Mexico. One st.dev. in dashed lines. Sources: World Bank. 12
Financial coupling, however, is intensifying along a trend! 120 Stocks Markets 2011 In USD, Index base 100 = Jan - 2011 110 100 90 80 70 60 Japan S&P 500 Brazil Germany UK France Jan-11 Feb-11 Feb-11 Mar-11 Mar-11 Apr-11 Apr-11 May-11 May-11 Jun-11 Jun-11 Jul-11 Jul-11 Aug-11 Aug-11 Aug-11 Sep-11 Sep-11 Oct-11 Oct-11 Nov-11 Percent 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Emerging Market Asset Returns and Common Factors Average R-Squared from Country Regressions Early Period (2000-2005) Late Period (Jan-05 to Jul-08) Crisis (Aug-08 to Apr-09) Equity Foreign Exchange CDS Spreads Source: Bloomberg 13
The financial stress we are living in 90 80 Tranquil Sep2006-Jul2008 VIX Index 70 60 50 40 30 Aug2008-May2009 Jun2009-Apr2010 May2010-Current Lehman Brothers QEI Flash Crash/PIGS US Downgrade Japan 0.3 VIX Kernel Densities 20 10 0 Jackson Hole (QEII) Aug-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Density 0.25 0.2 0.15 0.1 Tranquil Sep2006-Jul2008 Aug2008-May2009 Jul2009-Apr2010 May2010-Current 0.05 0 10 13 15 18 20 23 26 28 31 34 36 39 42 44 47 50 52 55 58 60 63 66 68 71 73 76 79 VIX Source: Bloomberg 14
is hitting LAC assets, but much less virulently than in the Lehman aftermath, so far 30.0% 20.0% 10.0% Elasticity of MSCI Latam w.r.t. VIX Weekly Sep2006-Jul2008 Aug2008-May2009 Jun2009-Apr2010 May2010-Sep2011 MSCI Returns 0.0% -10.0% -20.0% y = -0.1688x + 0.0087-30.0% y = -0.5596x + 0.0061 y = -0.1729x + 0.0067 y = -0.1449x + 0.0015-40.0% -40.0% -20.0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% VIX Returns EMBI Latam Returns 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Elasticity of Latam Sovereign Bond Spreads w.r.t. VIX Weekly Sep2006-Jul2008 Aug2008-May2009 Jun2009-Apr2010 May2010-Sep2011-10.0% y = 0.237x + 0.0019 y = 0.5306x + 0.0079-20.0% y = 0.1641x - 0.0091 y = 0.1917x + 0.0034-30.0% -40.0% -20.0% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0% VIX Returns Notes: VIX returns are calculated as the percentage variation of the VIX index. Both the MSCI Latam returns and VIX returns are weekly returns. The Latam Sovereign Bond spreads returns are the EMBI Latam index (weekly) retunrs. 15
Benign scenario: real decoupling continues If China s growth rate and commodity prices remain high Wheat, Copper and Soybean, Index 01-Jan-05=100 400 350 300 250 200 150 100 50 Commodity Prices Oil WTI in Current US$, Wheat, Copper and Soybean: Index base Jan-05=100 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Oct-11 150 130 110 90 70 50 30 Oil WTI, Current US$ 400 350 300 250 200 150 100 50 0-50 -100 Gross Capital Inflows to LAC-7+URY Countries US$ Millions, Annual Flows Gross Inflows Non-FDI Gross Inflows FDI Mar-02 Aug-02 Jan-03 Jun-03 Nov-03 Apr-04 Sep-04 Feb-05 Jul-05 Dec-05 May-06 Oct-06 Mar-07 Aug-07 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 16
TOT dominates over other external factors for LAC 0.5% 0.0% LAC6+URY: Impact of a 2008 Crisis-like Event Percentage points of GDP growth Countries with strong policies*= -0.47% 0.1% -0.5% -1.0% -1.5% -1.5% -1.3% -2.0% -2.5% -1.8% Countries with weak policies**= -6.1% -3.0% ToT VIX World GDP Growth US T10 *"Strong Policies" With floating exchange rate regime, 15 percent dollarization and balanced primary fiscal accounts **"Weak Policies" With de-facto crawling band (narrower than +/-5 percent), 30 percent dollarization and primary balance of -2 percent of GDP Notes: LAC6+URY :Argentina, Brazil, Chile, Colombia, Mexico, Peru and Uruguay. Assumes shocks of (i) 40 percent drop in all commodity prices, leading to a -2.8 percentage points of GDP terms of trade shock (based on LA7's average net commodity exposure); (ii) a slowdown in global growth of 3.3 percent; (iii) a fall of 137 basis points in the US 10-year T-bond yield; and (iv) an increase of 14 points in the VIX. These assumptions are broadly consistent with developments during the 2008 09 crisis. Source: IMF s WEO (Sep-2011) 17
Forecasts are being revised downward world-wide, but so far seem to be assuming a benign scenario 10% GDP Growth Forecasts Evolution Forecasts for 2012 9% 8% 7% January 2011 October 2011 6% 5% 4% 3% 2% 1% 0% EEUU EuroZone China Latin America South East Asia Eastern Europe Source: Consensus Forecasts (2011) 18
LAC was already expected to decelerate, and downward revisions have not been large, so far 9.0% 8.0% 7.0% Actual Growth and Growth Forecast: LAC Countries Weighted Averages for LAC 2011 2012 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Trin. & Tob. Jamaica El Salvador Guatemala Venezuela Brazil Mexico Costa Rica Nicaragua LAC Bolivia Ecuador Dom. Rep. Paraguay Colombia Uruguay Chile Peru Argentina Panama 19
Bad scenario: a global downward re-coupling In this scenario, major tail risks materialize and another great recession ensues All transmission channels would be activated Terms of trade External demand for LAC exports of goods and services Remittances Financial channels LAC countries that have the greatest shock absorption capacity are not necessarily those with the greatest growth potential Mexico versus Argentina 20
Bad scenario: a global downward re-coupling Lines of defense in shock absorption Robust monetary policy frameworks in LAC, mostly Shock absorption via e-rate flexibility/monetary policy independence Rate increases over the past 15 month gives the region room to maneuver How good are LAC s fiscal buffers? Comfortable public debt situation but insufficient fiscal flexibility Much less space among Central American and Caribbean countries How good are LAC s financial system buffers? Strong capital and liquidity positions, except in the Caribbean Have systemic risks been brewing in the past year or so? How good are LAC s social safety nets? Ability to scale up social assistance programs vary widely in the region Social insurance frameworks are the weak link 21
Thank you 22
LAC s success A decade of high growth and progress in social equity 7% 6% 5% 4% 3% 2% 1% Cyclical-adjusted Growth in Latin America and High-Income Countries Trend growth computed using the band-pass filter High-Income Latin America Moderate Poverty Rate US$ 4 a Day 45 40 35 30 25 20 Per Capita GDP Growth and Poverty LAC Countries Poverty Headcount GDP Per Capita 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 GDP Per Capita US Dollars 0% 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 1994 1996 1998 2000 2002 2004 2006 2008 2010 Costa Rica Dominican Republic Colombia Uruguay Honduras Bolivia Chile El Salvador Argentina Panama Latin America Mexico Brazil Peru Paraguay Gini Coefficient Cumulative Change From 2009 to 1995-0.1-0.05 0 0.05 0.1 LAC: Expanding Middle Class Source: LCSPP based on Socio-Economic Database for Latin America and the Caribbean (CEDLAS and The World Bank). 23
LAC s uneven success Mutating regional heterogeneity 170 160 150 Slow-Growth Countries within LAC GDP Index 2002 = 100 Actual Potential 170 160 150 Medium-Growth Countries within LAC GDP Index 2002 = 100 Actual Potential 140 140 130 130 120 120 110 110 100 100 90 90 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 170 160 150 High-Growth Countries within LAC GDP Index 2002 = 100 Actual Potential 140 130 120 110 100 90 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: Potential GPD is computed as the average rate of growth between 2007 and 2003. Simple averages are used to construct the composite. The categorization of each group is as follow: Slow-growth are those countries that showed a less than 3.5% in their 2011-2008 GDP real growth rate; Medium-growth are those between 3.5% and 10%: High-growth are those with 10% or more. For 2011 we used the last available forecast (Consensus Forecast June-2011). Sources: Consensus Forecast (June 2011); WEO (April 2011). 24
LAC s uneven success Where you are matters less than to whom you are connected Cumulative Number of countries Mean growth 2003-2007* Mean Growth 2003-2011 Mean Growth 2008-2011** Max. 2008-2011 Min. 2008-2011 Low growth 13 4.4% 2.3% -0.3% 3.3% -12.3% Medium growth 7 4.4% 3.5% 2.4% 7.9% 4.1% High growth 12 5.4% 5.2% 4.9% 18.8% 10.0% Total 32 4.8% 3.7% 2.2% 18.8% -12.3% * This is the measure used to construct the "Potential GDP" ** This is the measure used to define the classification as "Low", "Medium" and "High". Low growth (<4%): St. Kitts and Nevis, Antigua and Barbuda, Grenada, Barbados, Jamaica, Bahamas, Venezuela, Trinidad and Tobago, St. Vincent and the Grenadines, El Salvador, St. Lucia, Dominica and Mexico Medium growth (4%-10%): Honduras, Belize, Haiti, Nicaragua, Guatemala, Costa Rica and Ecuador High growth (>10%): Chile, Colombia, Brazil, Guyana, Bolivia, Suriname, Paraguay, Dominican Republic, Peru, Argentina, Uruguay and Panama Sources: World Bank s World Development Indicators WDI (December 2010), IMF's World Economic Outlook WEO (April 2011), and Consensus Forecasts (June 2011) Latest available forecasts. Potential GDP is calculated computing the annual average real growth rate for the 2002-2007 to 2007 GDP. Weighted averages (2007 Nominal GDP in USD Billions). 25
VIX dominates stock market co-movement in crisis times 0.100 0.050 0.000-0.050-0.100-0.150-0.200 MSCI Latam w.r.t VIX and S&P500: VIX Coefficient Robust standar errors in parentheses -0.056 (0.0263) -0.174 (0.073) -0.012 (0.019) Coefficient of VIX Sep2006-Jul2008 Aug2008-May2009 Jun2009-Apr2010 May2010-Sep2011-0.059 (0.025) MSCI LatAm Returns = a+b1*vix+b2*s&p500 1.800 1.600 1.400 1.200 1.000 0.800 0.600 0.400 0.200 0.000-0.200 MSCI Latam w.r.t VIX and S&P500: S&P500 Coefficient Robust standar errors in parentheses (0.212) (0.195) 1.012 1.197 (0.132) 1.353 Coefficient SP500 Sep2006-Jul2008 Aug2008-May2009 Jun2009-Apr2010 May2010-Sep2011 (0.213) 0.719 Notes: The coefficient showed in both panels are associated to the following regression MSCI Latam returns=a+b1*vix returns+b2*s&p500 returns. 26