Confronting the Global Crisis in Latin America: What is the Outlook? Coordinators

Confronting the Global Crisis in Latin America: What is the Outlook? Policy Trade-offs May for 20, Unprecedented 2009 - Maison Times: Confronting de l Amérique the Global Crisis Latine, America, ParisIADB, 2009 (A. Izquierdo & E. Talvi, coordinators) Coordinators Alejandro Izquierdo, IADB Ernesto Talvi, CERES

OUTLINE I. Latin America and the Global Crisis: Predominant Views II. Macro Dynamics in Latin America Under Two Hypotheses on the Global Economy III. Policy Trade-offs for Unprecedented Times: A Liquidity Approach

LATIN AMERICA AND THE GLOBAL CRISIS: PREDOMINANT VIEWS As a result of the global crisis Latin America suffered a drastic deterioration in the external environment:

External Factors: Industrial Countries Growth (GDP, real terms) United States Japan 102 101 100 Peak May-08 Forecast Trough 102 100 98 Peak May-08 Forecast Trough 99 98 Current Forecast 96 94 Current Forecast 97 96-3.5% 08.II 08.III 08.IV 09.I 09.II 09.III 92 90-9.7% 08.I 08.II 08.III 08.IV 09.I 09.II 09.III 09.IV EU-15* Industrial Countries Source: JPMorgan 102 101 100 99 98 97 96 Peak May-08 Forecast -3.9% Current Forecast Trough 08.II 08.III 08.IV 09.I 09.II 09.III 09.IV * EU-15 includes Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovenia and Spain. 103 102 101 100 99 98 97 96 95 Peak -4.3% May-08 Forecast Current Forecast Trough 08.I 08.II 08.III 08.IV 09.I 09.II 09.III

2001 2002 2003 2004 2005 2006 2007 2008 2001 2002 2003 2004 2005 2006 2007 2008 2001 2002 2003 2004 2005 2006 2007 2008 External Factors: Commodity Prices Oil (1991-1997 Average = 100) Food (1991-1997 Average = 100) Metals (1991-1997 Average = 100) 750 650 550 450 350 250 150 Variation Dec.01 Jul.08: +616% US Financial Crisis 725 373-68% 228 91-97 Average 190 170 150 130 110 90 Variation Dec.01 Jun.08: +133% US Financial Crisis 123-30% 177 91-97 Average 123 340 310 280 250 220 190 160 130 100 Variation Dec.01 Mar.08: +282% US Financial Crisis -46% 313 91-97 Average 158 50 70 70 Source: IMF

Jan-07 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 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 The End of the Panglossian Period: International Financial Conditions Corporate Bond Spreads (Latin CEMBI; 01-Jan-07 = 100) Corporate Bonds: Issuance (LAC-7, billions of USD) 900 800 Jan-07 Jan.07- May.08 CEMBI 221 87 Variation in bps Jun.08- Mar.09 Total 516 603 06-Mar-09 824 25 20 21.2 700 600 15 500 400 10 300 200 5 100 2.5 0 0

Jan-07 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 Jan-07 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 External Factors: International Financial Conditions Sovereign Bond Prices (EMBI+, Latin EMBI and US AA Corporates; Bond Price Equivalent*, 01-Jan-07 = 100) Sovereign Bond Spreads (EMBI+ and Latin EMBI; Spreads, Basis Points) 105 1000 100 95 EMBI+ US AA Latin EMBI 900 800 700 Latin EMBI EMBI+ Jan-07 186 170 Variation in bps Phase 1 Phase 2 Total 67 401 468 71 448 519 06-Mar-09 654 689 90 600 85 500 80 Jan.07- May.08 % Variation Jun.08- Mar.09 Total 400 Latin EMBI 75 Latin EMBI EMBI+ AA -1.0.-0.6 0.5-18.4-18.0-6.4-19.2-18.4-5.9 300 200 EMBI+ 70 100 65 0 *Assumes a coupon of 11% and a 10Y maturity.

Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 External Factors: International Financial Conditions 100 Sovereign Bonds: Issuance (LAC-7, billions of USD) 97.8 65% Sovereign Bonds: Maturity (LAC-7, issuances with maturity less than 1 year, % of total issuance) 63.3% 90 60% 55% 80 50% 70 45% 40% 60 56.6 35% 50 30% 28.6% 25% 40 20% LAC-7 is the simple sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

1991 1993 1995 1997 1999 2001 2003 2005 2007 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Latin America: Fiscal Balance and Public Debt Fiscal Balance in Latin America (LAC-7; Overall Balance, % of GDP) Public Debt in Latin America (LAC-7; Public Debt, % of GDP) 2.0% 1.5% Russian Crisis Beginning of 2000s Boom US Financial Crisis 1.5% 52% 50% 50% Russian Crisis Beginning of 2000s Boom 52% US Financial Crisis 1.0% 48% 0.5% 46% 0.0% 44% -0.5% 42% -1.0% 40% -1.5% 38% -2.0% -2.5% 36% 34% 33% 35% -3.0% 32% -3.5% 30% LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 From All That Glitters Observed and Structural Public Debt (LAC-7, in % of GDP) 55% 90s Boom Russian Crisis Current Boom 50% 50% 52% Observed Debt 47% 45% Structural Debt 44% 40% 35% 37% 33% 30% LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Latin America: International Liquidity Indicators 450 400 International Reserves in Latin America (LAC-7, in billions of USD) Russian Crisis Beginning of the Boom US Financial Crisis 447 1.8 1.7 Liquidity Indicators in Latin America (LAC-7*, International Reserves to External Public Debt Amortizations in the next twelve months plus Central Bank Short Term Liabilities) Russian Crisis Beginning of the Boom US Financial Crisis 1.8 350 1.6 300 1.5 250 275 1.4 200 174 1.3 150 100 147 1.2 1.1 50 1.0 1.0 0 0.9 LAC-7 is the simple sum (*average) of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Latin America: Financial Dollarization Public Debt Dollarization in Latin America (LAC-7; Foreign Currency Debt, % of Total Debt) Credit Dollarization in Latin America (LAC-7; Bank Credit in Foreign Currency, % of Total Credit) 65% 65% Beginning of 2000s Boom 55% Beginning of 2000s Boom 60% 50% 50% 45% 55% 40% 50% 35% 45% 30% 40% 35% 25% 20% 23% 35% 15% 30% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 10% LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. For bank credit figures, LAC-7 excludes Brazil, Colombia and Venezuela.

LATIN AMERICA AND THE GLOBAL CRISIS: PREDOMINANT VIEWS As a result of the global crisis Latin America suffered a drastic deterioration in the external environment However, Latin America has very strong fundamentals to withstand the worsening of global conditions and thus better equipped to pursue countercyclical monetary and fiscal policies to mitigate the impact of adverse external shocks

Interest Rate Exchange Rate Latin America: Monetary and Fiscal Policy Response Monetary Policy (LAC-7*, Interbank interest rate and Nominal Exchange Rate, in % and Sep-15-08=100) 126 Fiscal Stimulus Announcements in Latin America (% of GDP) 9.9% 9.7% 122 ON - BUDGET OFF BUDGET TOTAL Revenue-side Expenditure-side 9.5% 118 Argentina 5.1 0.2 1.1 6.4 9.3% 114 Brazil Chile 0.3 1.0 0.1 1.1 3.3 0.7 3.6 2.8 9.1% 110 Mexico Peru 0.5 0.0 1.0 1.4 0.0 1.1 1.5 2.5 8.9% Exchange Rate 106 Source: Credit Suisse 8.7% Interest Rate 102 8.5% Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 98 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. *Excludes Argentina and Venezuela

Dec-96 Mar-97 Jun-97 Sep-97 Dec-97 Mar-98 Jun-98 Sep-98 Dec-98 Mar-99 Jun-99 Sep-99 Interest Rate Exchange Rate Monetary and Fiscal Policy Response: Russian Crisis vs. Current Crisis Monetary Policy (LAC-7*, Interbank Interest Rate and Nominal Exchange Rate, in % and Jul-98=100) Fiscal Policy (LAC-7, Structural Fiscal Balance, % of GDP) 40% 118 0.0% 38% 116-0.5% 36% 114 34% 32% Interest Rate 112 110-1.0% -1.5% -1.2% 30% 28% 108 106-2.0% 26% 104-2.5% 24% 22% 20% Exchange Rate Jul-98 Aug-98 Sep-98 102 100 98-3.0% -3.5% -3.2% Russian Crisis LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. *Excludes Argentina and Venezuela

LATIN AMERICA AND THE GLOBAL CRISIS: PREDOMINANT VIEWS However, Latin America has very strong fundamentals to withstand the worsening of global conditions and thus better equipped to pursue countercyclical monetary and fiscal policies to mitigate the impact of adverse external shocks As a result, the recession in 2009 will be relatively deep but short lived, the region will return to positive growth in 2010

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Market Forecasts: Economic Performance (LAC-7; real GDP, annual variation) 7% Russian Crisis Beginning of the Current Boom Forecasts* 6% 5% 91-97 Growth Average : 4.6% 03-06 Growth Average: 5.6% 4.9 % Apr-08 Forecast 4% Average 71-06: 3.4% 3% 3.0 % 2% 1% 0% -1% -2% 98-02 Growth Average : 0.7% US Financial Crisis -0.9 % Current Forecast LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. *Source: JPMorgan

ROADMAP To assess the predominant view on the region in the face of the global crisis, we proceed as follows: i. Go beyond a snapshot of the region and see the motion picture right to the end, tracing the macrodynamics under alternative hypotheses on how the global recovery unfolds ii. Develop a simple framework emphasizing liquidity issues as a key element in evaluating the region s risks and policy trade-offs

Hypotheses on the Global Economy

Two Hypotheses on the Global Economy Industrial Countries Growth EXTERNAL FACTORS Commodity Prices International Financial Conditions 109 107 G7 Industrial Production (2006 = 100) V-Shaped Peak Mar-08 Trough Jun-09 P-to-T -4.3% Recovery* Sep-10 L-Shaped Mar-08 Jun-09-4.3% Dec-13 135 125 Global Commodity Price Index (2006 = 100) V-Shaped Peak Jun-08 Trough Jun-09 P-to-T -47.3% Recovery* Sep-10 L-Shaped Jun-08 Jun-09-47.3% Dec-13 700 600 Sovereign Bond Spread V-Shaped Scenario (EMBI +, bps) L-Shaped Scenario 105 103 Pre-Crisis Levels V-Shaped Scenario 115 105 V-Shaped Scenario 500 400 Pre- Asian Crisis Levels 101 95 Pre-Crisis Levels 300 V-Shaped L-Shaped 99 97 L-Shaped Scenario 2006 2007 2008 2009 2010 2011 2012 2013 85 75 L-Shaped Scenario 2006 2007 2008 2009 2010 2011 2012 2013 200 100 Trough Jun-07 Peak Jun-09 T-to-P 512 Recovery* Sep-10 Jun-07 Jun-09 512. Dec-13 2006 2007 2008 2009 2010 2011 2012 2013 Source: Own calculations based on WEO and JPMorgan*, Oct-08. Source: IMF and Bloomberg* Source: JPMorgan for Bond Spreads G7 is the PPP-weighted average of the Canada, France, Germany, Italy, Japan, United States, UK *Recovery to Dec-06 levels *Recovery to Pre-Asian crisis levels *Recovery to pre-crisis levels of output

Economic Performance

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Economic Fluctuations in Latin America: The Role of External Factors * (LAC-7; real GDP, annual growth rate) External Factors 10% Tequila Crisis Asian / Russian Crises Dot-Com Crisis Beginning of the Boom Growth in Industrial Countries 8% 6% Actual 4% Commodity Prices 2% 0% International Financial Conditions -2% -4% Fitted -6% LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. * Izquierdo, A., Romero, R. and Talvi, E. (2008): Booms and Busts in Latin America: The Role of External Factors, IADB and CERES Working Paper

Economic Activity Under Two Hypotheses on the Global Economy Economic Activity (LAC-7 GDP, 2006 = 100) GDP Growth (LAC-7, annual growth rate) 125 7% 120 V-Shaped L-Shaped Peak Dec-08 Dec-08 Trough Sep-09 Dec-10 P-to-T -3.9% -5.1% Recovery* Mar-11 Dec-13 6% 5% 2003-2007 Avg.: 5.8% 115 Pre-Crisis Levels V-Shaped Scenario 4% 3% 1991-2007 Avg.: 3.3% 110 2% V-Shaped 2009-13 Avg.: 1.9% 105 L-Shaped Scenario 1% 0% L-Shaped 2009-13 Avg.: 0.1% 100-1% -2% V-Shaped Scenario L-Shaped Scenario 95 2006 2007 2008 2009 2010 2011 2012 2013-3% 2006 2007 2008 2009 2010 2011 2012 2013 *Recovery to pre-crisis levels of output LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

Fiscal Position

Fiscal Position Under Two Hypotheses on the Global Economy Fiscal Revenues (LAC-7, 2008 = 100) Interest Payments (LAC-7, % of GDP) Primary Expenditure (LAC-7, 2008 = 100) 105 105 V-Shaped L-Shaped Peak 2008 2008 Trough 2010 2011 P-to-T -7.2% -13.5% Recovery* 2012 n.a. 105 4.3% 3.8% V-Shaped L-Shaped Trough 2008 2008 Peak 2012 2013 Δ T-to-P 0.4% 1.8% Recovery* n.a. n.a. 4.1% 100 101 96 100 V-Shaped Scenario 95 3.3% L-Shaped Scenario 95 93 2.8% 2.6% 90 92 2.3% V-Shaped Scenario 85 87 L-Shaped Scenario 2006 2007 2008 2009 2010 2011 2012 2013 86 1.8% 2.3% 2006 2007 2008 2009 2010 2011 2012 2013 80 2006 2007 2008 2009 2010 2011 2012 2013 *Recovery to pre-crisis levels of output LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

Fiscal Position Under Two Hypotheses on the Global Economy: Are Debt Dynamics Sustainable? Fiscal Balance (LAC-7, % of GDP) Public Debt (LAC-7, % of GDP) 2% 1.6% 53% 1% 0.3% 48% 49% 0% L-Shaped Scenario -1% V-Shaped Scenario 43% -2% -3% -4% L-Shaped Scenario -2.6% -3.7% 38% 33% V-Shaped Scenario 34% -5% -5.0% 28% 27% -6% 2006 2007 2008 2009 2010 2011 2012 2013 23% 2006 2007 2008 2009 2010 2011 2012 2013 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

Liquidity Indicators

Liquidity Indicators: A Simple Analytical Framework Liquidity Indicators Debt Amortization Profile Definition B t ST ILR t = R t B ST t+1 where ILR t = International Liquidity Ratio in t R t = International Reserves in t B ST t+1 = Public Debt Amortizations in t+1 1 2 3 4 5 t

Liquidity Indicators: A Simple Analytical Framework ILR Dynamics Debt Amortization Profile R t B t ST B ST t+1 ILR with no Financial Precarization 0 1 2 3 4 t 1 2 3 4 5 6 t

Liquidity Indicators: A Simple Analytical Framework ILR Dynamics Debt Amortization Profile R t B t ST B ST t+1 ILR with no Financial Precarization Precarization Effect ILR with Financial Precarization Precarization Effect 0 1 2 3 4 t 1 2 3 4 5 t

Liquidity Indicators: A Simple Analytical Framework ILR Dynamics Debt Amortization Profile R t B t ST B ST t+1 Precarization Effect Fiscal Effect Fiscal Effect Precarization Effect 0 1 2 3 4 t 1 2 3 4 5 t

Liquidity Indicators: A Simple Analytical Framework ILR Dynamics R t B ST t+1 R t B ST t+1 Precarization Effect Effective Level of Reserves (R ) Degree of intervention in the FX market Degree of liquidity assistance to the corporate and banking sector Willingness to use reserves for public debt repayments Fiscal Effect Effective Level of Reserves Effect 0 1 2 3 4 t

Liquidity Indicators: A Simple Analytical Framework R t B ST t+1 ILR Dynamics Determinants of ILR Dynamics Initial level of public debt R t B ST t+1 Precarization Effect Effective level of international reserves Time profile of debt amortizations Fiscal Effect Effective Level of Reserves Effect Dynamics of fiscal deficit and public debt (which will depend on the initial fiscal deficit and the policy response) 0 1 2 3 4 t

Liquidity Indicators: A Simple Analytical Framework R t ST B t+1 ILR Dynamics Country 1 Conclusions The likelihood of a liquidity crisis as determined by ILRs will depend on external factors (i.e. duration of the global crisis) and idiosyncratic factors (i.e. determinants of ILRs dynamics) Threshold Liquidity Crisis Country 2 0 1 2 3 4 t Not every country may hit a critical threshold in the relevant period of the global crisis and for those that do, they will not do so at the same time. Liquidity crises, if they occur, will be sequential rather than simultaneous Liquidity problems may evolve gradually but materialize suddenly when a critical threshold is hit. Therefore, problems may not be evident until it is too late

Liquidity Indicators Under Two Hypotheses on the Global Economy 200% ILR Dynamics: Precarization and Fiscal Effects (LAC-7) Normal International Financial Conditions 180% 160% 140% 120% V - Shaped Scenario 100% 80% L - Shaped Scenario 60% 40% Sudden Stop 20% 0% 2009 2010 2011 2012 2013

Liquidity Indicators Under Two Hypotheses on the Global Economy ILR Dynamics Under V-Shaped Scenario (LAC-7) ILR Dynamics Under L-Shaped Scenario (LAC-7) 190% 180% 170% 160% 180% 170% 160% 150% 150% ILR 1 140% ILR 1 140% 130% 130% 120% 120% ILR 2 110% ILR 2 110% 100% 100% 90% 90% 2009 2010 2011 2012 2013 80% 2009 2010 2011 2012 2013 ILR 1 t = Reserves t / Public Debt Amortizations t+1 ILR 2 t = Reserves t / (Public Debt Amortizations t+1 + Short Term Private External Debt Amortizations) LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP.

MACRO DYNAMICS IN LATIN AMERICA UNDER TWO HYPOTHESES ON THE GLOBAL ECONOMY CONCLUSIONS Under a V-shaped global recovery, the dynamics of key macro fundamentals suggest that the predominant views on the region are largely correct Under the L-shaped scenario, the region could experience negative growth in 2009 and 2010 and average growth will be close to zero in the next five years A key feature of this scenario is that the deterioration in fundamentals, i.e., fiscal, banking and liquidity indicators, is gradual and therefore problems may not become evident until it is too late It is crucial to anticipate gathering problems early on to act in a timely fashion, and to design a set of policies that prevent countries from entering into financially fragile territory

CONFRONTING THE GLOBAL CRISIS IN LATIN AMERICA: POLICY TRADE OFFS Under precarious access to credit markets liquidity considerations become paramount The benefits of alternative policies should be primarily weighed against their immediate impact on the international liquidity ratios (ILRs) of a country and how they affect the likelihood of a liquidity crisis and a severe output contraction

Confronting the Global Crisis in Latin America: Policy Trade Offs EXPANSIONARY FISCAL POLICY Mitigate Recessionary Pressures Trade - Off Weaken Liquidity Position GDP ILR GDP with expansionary policy and no liquidity crisis GDP with no policy ILR with no policy Threshold ILR with expansionary policy GDP with expansionary policy and liquidity crisis Threshold -1 0 1 2 3 t 0 1 2 3 4 t

Policy Proposals

POLICY PRINCIPLES: MAIN GOALS Anticipate gathering problems early on to act in a timely fashion Design a set of policies that prevent countries from entering into financially fragile territory that might expose them to a liquidity crisis and a major economic collapse

Jan-07 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 Jan-07 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 US 10Y BBB POLICY PRINCIPLES: CONSTRAINTS Sovereign and Corporate Bonds in US (US 10y T-Bonds and US BBB Corporate, Yield in %) Sovereign and Corporate Bonds in LAC (Latin EMBI and Latin CEMBI, Yield in %) 5.5 10.5 13 5.0 10.0 9.5 12 4.5 US 10Y 9.0 11 4.0 8.5 10 8.0 3.5 7.5 9 3.0 7.0 6.5 8 Latin CEMBI 2.5 6.0 7 2.0 BBB 5.5 6 Latin EMBI Source: Bloomberg

POLICY PROPOSALS THE ROLE OF MULTILATERALS Precarious access to credit markets for many emerging market governments calls for multilaterals to step in and play a key role as a lenders (and borrowers)-of-last resort, akin to the role that credible governments, such as the US government, play domestically The question then is not whether multilaterals should play a key role in the current crisis, but which is the most effective way to channel their intervention and at what financial cost

POLICY PRINCIPLES 1. Strengthen the role of multilateral institutions. Multilateral support will be vital under precarious access to credit markets. 2. Move away from short-term financing. Multilaterals should avoid short-term emergency financing and only consider medium to long-term financing in order to partially complete markets in terms of maturities. 3. Redefine the emphasis of multilateral support. Multilaterals should not only provide medium to long-term financing for fiscal stimulus when fiscal sustainability is not at stake but more importantly, they should provide for long-term refinancing of maturing debt obligations. 4. Ensure that countries work towards sustainable fiscal policy while strengthening social protection. Multilateral support should be complemented with incentive-compatible conditionality, to ensure fiscal sustainability and strengthen social protection.

ILR Dynamics Under Alternative Policies (LAC-7, L-Shaped Scenario, ILR 2 ) Refinancing Public Debt Stocks vs. Financing Fiscal Deficits 125% 120% 115% Normal International Financial Conditions 110% 105% 100% 95% 90% 85% 80% Precarization of Flows and Stocks Full Financing of Flows and Precarization of Stocks 75% 2008 2009 2010 2011 2012 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. ILR 2 t = Reserves t / (Public Debt Amortizations t+1 + Short Term Private External Debt Amortizations)

Full Financial Support à la US: Financial Costs (LAC-7, millions of dollars) Table 1. Full Financial Support by Multilaterals: Financial Costs (LAC-7, in millions of dollars) 2009 2010 2009-2010 Public Debt Amortizations 227,903 173,857 401,760 Domestic 194,084 155,458 349,542 External 33,818 18,399 52,218 Fiscal Deficit Financing 97,319 138,926 236,245 Passive Fiscal Deficit 79,515 118,127 197,642 Geithner s Proposal * 17,804 20,799 38,603 Total Borrowing Requirements 325,222 312,783 638,005 * Assuming full impact of Keynesian multiplier on output and revenues LAC-7 is the sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. Source: Own calculations based on National Sources Scenario of deficit support and minimum rollover support to sustain liquidity ratios above 1: US$ 470 billion. Scenario a la Guidotti-Greenspan (public and private external obligations only): US$ 453 billion

ILR Dynamics Under Alternative Policies (LAC-7, L-Shaped Scenario, ILR 2 ) 125% 120% 115% Normal International Financial Conditions 110% 105% 100% 95% 90% 85% 80% 75% Precarization of Flows and Stocks Full Financing of Flows and Partial Financing of Stocks Full Financing of Flows and Precarization of Stocks 2008 2009 2010 2011 2012 Scenario of deficit support and minimum rollover support to sustain liquidity ratios above 1: US$ 470 billion. Scenario a la Guidotti-Greenspan (public and private external obligations only): US$ 453 billion LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America s GDP. ILR 2 t = Reserves t / (Public Debt Amortizations t+1 + Short Term Private External Debt Amortizations)

Confronting the Global Crisis in Latin America: The Role of Multilaterals Financial Support - Long term financing - Emphasis on refinancing public debt amortizations Multilaterals Conditionality Set targets to ensure a consistent macro framework emphasizing the dynamics of fiscal deficits and public debt, while engaging in social protection policies (expenditure switching or expenditure increasing)

CLOSING REMARKS A strategy by the IMF and multilaterals that only pays attention to financing countercyclical fiscal policies is incomplete and ignoring the impact of expansionary policy on liquidity ratios can be a costly mistake. It is necessary that lender (and borrower)-of-last-resort functions, similar to those that governments perform in developed economies, be recreated for LAC by multilateral institutions, so that liquidity concerns are kept at bay.

CLOSING REMARKS This strategy has three basic requirements: i. a strengthening of the resources of multilateral institutions to allow them to act with a scale commensurate to the tasks at hand ii. an appropriate division of labor between the IMF and MDBs: - Setting targets for a consistent macroeconomic framework should be primarily the role of the IMF - MDBs should work on the design of optimal expenditure composition policies or expenditure increasing policies when feasible that maximize the impact on long-term development and poverty alleviation iii. a careful country-by-country analysis that determines the optimal amount of liquidity support cum fiscally sustainable combinations of expenditure policies

FULL REPORT AVAILABLE AT: http://www.iadb.org/res/pub_desc.cfm?pub_id=b-635 Coordinators Alejandro Izquierdo, IADB Ernesto Talvi, CERES Confronting the Global Crisis in Latin America: What is the Outlook? May 20, 2009 - Maison de l Amérique Latine, Paris