Shockwaves from the North: Latin America and the External Deterioration Annual Meetings of the IMF and World Bank Washington, DC October 2008 Chief Economist Office Latin America and the Caribbean Region The World Bank 1
Outline Global shocks a perfect storm? Worsening and spreading of U.S. financial crisis, weakening commodity prices, sharper economic slowdown Big uncertainty: transmission around the world Transmission channels Financial contagion Remittances Commodity prices Interrelated External demand LAC perspective and policy challenges 2
The deteriorating external environment 3
The trigger of the U.S. financial crisis Toxic subprime loans, imploding housing markets US House Prices and Real Estate Loans S&P/ Case Shiller Indices and Stock of Real Estate Loans 300 250 Price variation since the peak Miami 33.5% Las Vegas 34.3% S&P Case Shiller 10 21.1% Miami 4,000 3,500 3,000 Case Shiller Indexes 200 150 100 Las Vegas 2,500 2,000 1,500 in billion 50 S&P/Case Shiller 10 Real Estate Loans (rhs) 1,000 500 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 0 The S&P/Case Shiller 10 index is a composite index of housing prices in 10 U.S. metropolitan areas. Source: Bloomberg. 4
The severity of the U.S. financial crisis Colossal accumulation of credit losses, and counting Cumulative Bank Writedowns and Credit Losses vs. Capital Raised in billions of U.S. dollars 800 750 700 650 600 550 500 450 400 350 300 250 200 150 100 50 0 Insurance Companies and Hedge Funds Writedowns and Credit Losses Capital Raised Prior 3Q 07 4Q 07 1Q 08 2Q 08 3Q 08 Note: The figures reported above do not include Freddie Mac an Fannie Mae. Source: Bloomberg. 5
The severity of the U.S. financial crisis Assets of failed institutions represent 40% of GDP, so far Closed Institutions Assets (in billion of dollars) Ameribank 0.1 ANB Financial 2.1 Douglass National Bank 0.1 First Heritage Bank 0.3 First Integrity Bank 0.1 First National Bank of Nevada 3.4 First Priority Bank 0.3 Hume Bank 0.0 IndyMac Bank 32.0 Integrity Bank 1.1 Lehman Brothers 691.0 Silver State Bank 2.0 The Columbian Bank and Trust 0.8 Washington Mutual 307.0 Total 1,040.1 Intervened Institutions Assets (in billion of dollars) = 40% of US 2007 GDP AIG 1,060.0 Fannie Mae 882.0 Freddie Mac 794.0 Merrill Lynch 1,020.0 Wachovia 782.0 Total 4,538.0 6
The intractability of the U.S. financial crisis Confidence erosion despite massive government support Liquidity and Solvency Interventions LoLR Liquidity Injections (USD 145 bn)* FED doubled its cash auctions to banks to up to USD 900 bn Solvency and Quasi Solvency Support Deposit Insurance Fund use (USD 7.2 bn) Bear Stearns bad asset purchase (USD 30 bn) Freddie and Fannie conservatorship (?) AIG long term loan (USD 85 bn) Guarantee on money market funds (USD 50 bn) TARP (USD 700 bn) Fund to purchase commercial paper (?) *Net interbank liabilities to monetary authority Q2.2008 7
The intractability of a spreading credit crisis Unyielding money markets dislocation in the U.S. & Europe 3.5 Interbank Markets TED spread, in percentage points 3.0 United States 2.5 2.0 1.5 1.0 Euro Area 0.5 0.0 Japan Jan 06 Mar 06 May 06 Jul 06 Sep 06 Nov 06 Jan 07 Mar 07 May 07 Jul 07 Sep 07 Nov 07 Jan 08 Mar 08 May 08 Jul 08 Sep 08 TED Spread: 3 Month LIBOR minus T bill rate. Source: Bloomberg 8
The intractability of the U.S. credit crisis Virtual freezing of commercial paper market Asset Backed Commercial Paper Outstanding and 30 day ABCP Yield CP in billion of US$ and rates in percentage points 840 820 Outstanding Maturity Distribution of AA asset backed CP 1 9 days 9+ days 2008* 73.4% 26.6% August 08 67.6% 32.4% September 08 84.2% 15.8% 4.5 4.0 800 * Data through October 6 30 day ABCP Yield 3.5 780 3.0 760 740 2.5 720 2.0 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Oct 08 Source: Bloomberg and Federal Reserve 9
The intractability of the U.S. financial crisis Unprecedented contraction in consumer credit 30,000 Total Consumer Loans Owned and Securitized Monthly variation in million of dollars, seasonally adjusted 25,000 20,000 15,000 10,000 5,000 0 5,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 10,000 Source: Bloomberg and Federal Reserve 10
The perniciousness of the U.S. financial crisis It is infecting the real economy in the USA U.S. Economic Indicators Total Employment and YoY variation of Consumer Confidence and Vehicle Sales 30% 147000 20% Total Employment (rhs) 146500 10% 146000 0% 10% 20% Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Vehicle Sales Oct 07 Jan 08 Apr 08 Jul 08 145500 145000 in thousands 30% Consumer Confidence 144500 40% 144000 50% 143500 60% 143000 Source: Bloomberg 11
Amidst rising uncertainty, a sharper global slowdown is now envisaged 12.60 11.60 2006 2007 2008 2009 Recent Growth and Forecast for 2008 and 2009 annual GDP real growth rate, in % 10.60 9.60 8.60 7.60 7.5 6.60 5.60 4.60 3.60 2.60 1.60 0.60 0.40 0.1 0.2 US EURO China Japan 0.4 Lowest forecasts for 2009 (in black dots) are taken from Consensus Forecasts. Source: Consensus Forecasts 12
Commodity prices are moving now in the same direction as finance and growth, downward 450 Commodity Prices Oil WTI in current US$ Wheat, Copper and Soybean are Index numbers: 01/01/05=100 150 400 Wheat 140 130 350 120 300 110 250 Copper 100 90 200 80 150 100 Soybean Petroleum (rhs) 70 60 50 50 40 Jan 05 Mar 05 May 05 Jul 05 Sep 05 Nov 05 Jan 06 Mar 06 May 06 Jul 06 Sep 06 Nov 06 Jan 07 Mar 07 May 07 Jul 07 Sep 07 Nov 07 Jan 08 Mar 08 May 08 Jul 08 Sep 08 Source: Bloomberg 13
Financial contagion effects 14
LAC has been caught in the global selloff of stocks But fall is less pronounced than in Asia and Eastern Europe Stocks in Emerging Markets Index number Jan 06=100 240 230 220 210 200 190 180 170 160 Asia 150 140 130 120 LAC Eastern Europe 110 100 90 S&P 80 Jan 06 Mar 06 May 06 Jul 06 Sep 06 Nov 06 Jan 07 Mar 07 May 07 Jul 07 Sep 07 Nov 07 Jan 08 Mar 08 May 08 Jul 08 Sep 08 LAC: Argentina, Brazil, Colombia, Chile, Mexico. Eastern Europe: Czech Republic, Hungary, Poland and Russia. Asia: China, Hong Kong, India, Indonesia, Malaysia, Philippines and Thailand. Source: Bloomberg 15
Latin currencies are adjusting sharply, following a prolonged period of appreciation Performance of Selected LAC Currencies Unit of local currencies vis a vis US dollar. Index 100=Jul2006 110 105 PER ARG BRA CHI COL MEX 100 95 90 85 80 75 70 65 Jul 06 Sep 06 Nov 06 Jan 07 Mar 07 May 07 Jul 07 Sep 07 Nov 07 Jan 08 Mar 08 May 08 Jul 08 Sep 08 Source: Bloomberg 16
Latin firms are facing a steep rise in FX borrowing costs, though less than firms in Eastern Europe 1200 Corporate EMBI & U.S. High Yield Bond Spread in basis points 1000 High Yield 800 600 Eastern Europe 400 200 Latin Asia 0 Jan 04 Aug 04 Mar 05 Oct 05 May 06 Dec 06 Jul 07 Feb 08 Sep 08 Source: Bloomberg US Credit Suisse High Yield Spread, JP Morgan CEMBI Global: Corporate Emerging Markets Bond Index. 17
Risk premiums for Latin sovereigns have risen but have remained well below junk bond spread (level & volatility) 1200 Latin America EMBI & U.S. High Yield Spreads in basis points US High Yield Spread 1000 800 600 LAC EMBI Spread 400 200 ASIA EMBI Spread 0 Jan 04 Jul 04 Jan 05 Jul 05 Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Source: Bloomberg US Credit Suisse High Yield Spread, Latin America JP Morgan EMBI Global. 18
Behind the Latin EMBI average, countries can be classified into three groups High EMBI Spread LAC countries in basis points Medium EMBI Spread LAC countries in basis points Low EMBI Spread LAC countries in basis points 1400 1300 1200 Arg Ecu Belize Ven Rep. Dom. 550 500 Pan SLV Per TTO Col Bra Uru 500 450 Mexico Chile 1100 450 400 1000 900 800 400 350 350 300 700 300 600 500 400 250 200 250 200 300 150 150 200 100 100 100 0 Jan05 Jul05 Jan06 Jul06 Jan07 Jul07 Jan08 Jul08 50 Jan05 Jul05 Jan06 Jul06 Jan07 Jul07 Jan08 Jul08 50 Jan05 Jul05 Jan06 Jul06 Jan07 Jul07 Jan08 Jul08 Source: Bloomberg Latin America JP Morgan EMBI Global 19
depending on the behavior of their EMBIs relative to the spreads of U.S. high yield bonds 1200 1000 excluding Argentina* Latin EMBI & U.S. High Yield Spreads in basis points LAC Low EMBI spread LAC Medium EMBI spread LAC High EMBI spread High Yield Spread 800 600 including Argentina* 400 200 0 Jan 04 Jul 04 Jan 05 Jul 05 Jan 06 Jul 06 Jan 07 Jul 07 Jan 08 Jul 08 Source: Bloomberg US Credit Suisse High Yield Spread, Latin America JP Morgan EMBI Global. 20
Local interbank markets in LAC remain well behaved, so far Interbanks Markets in Selected LAC Countries Spread between 1 month Interbank rate and Policy Rate 4.0 3.5 3.0 2.5 2.0 1.5 US TED 1.0 Mexico* 0.5 Chile 0.0 0.5 1.0 Source: Bloomberg 21 Jan 06 Mar 06 Apr 06 May 06 Jun 06 Jul 06 Aug 06 Sep 06 Oct 06 Nov 06 Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07 Jul 07 Aug 07 Sep 07 Oct 07 Nov 07 Dec 07 Jan 08 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Percentage points Jul 08 Aug 08 Sep 08 Brazil Colombia
Remittances 22
Remittances represent 10 20 percent of GDP in 8 Caribbean and Central American countries 30% Remittances to LAC in 2006 (Remittances inflows as % GDP ) 25% 20% 15% 10% 5% 0% HND GUY HTI JAM SLV NIC GTM DOM ECU BOL BLZ GRD PRY MEX COL CRI PER DMA VCT PAN KNA URY BRA ARG LCA SUR VEN CHL LCRCE calculations. Source: Migration and Remittances. Factbook 2008 World Bank 23
Troubles in originating countries have led to a sharp fall in the growth rate of remittances to the region Remittances to Latin America annual variation, 3 month moving average 30% 25% Mexico Ecuador El Salvador Guatemala Dom. Rep. Jamaica 20% 15% 10% 5% 0% 5% 10% Jan 06 Feb 06 Mar 06 Apr 06 May 06 Jun 06 Jul 06 Aug 06 Sep 06 Oct 06 Nov 06 Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07 Jul 07 Aug 07 Sep 07 Oct 07 Nov 07 Dec 07 Jan 08 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 Source: Central Banks of corresponding countries 24
Commodity prices and inflation 25
Despite marked asymmetries in TOT effects across countries, gains have dominated until recently Terms of Trade for Selected LAC countries change between 2002 2007 in % VEN CHL PER BOL COL ECU LAC BRA ARG PAR MEX HTI SLV GT PAN NIC CRI HND URY DR # Countries GDP (current USD, bn) Pop. (mn) Winners 11 55% 2,760 95% 476 90% Lossers 9 45% 136 5% 55 10% Total 20 2,897 531 20% 0% 20% 40% 60% 80% 100% 120% LCRCE staff calculations. We use 2006 GDP (current US$) and population figures. Source: ECLAC. 26
But terms of trade effects seem to be turning the corner, reversing winning and losing sides Terms of Trade 2002.Q1=100 135 130 LAC 7 Central America 125 120 115 110 105 100 95 90 2002.Q1 2003.Q2 2004.Q3 2005.Q4 2007.Q1 2008.Q2 Source: WDI 27
Reflecting the previous sharp rise in food & fuel prices, inflation rose in the region but not evenly across countries 16 Consumer Price Inflation in LAC annual variations, in % 14 12 10 8 25 75 percentile range 6 4 Median 2 0 Jan 05 Feb 05 Mar 05 Apr 05 May 05 Jun 05 Jul 05 Aug 05 Sep 05 Oct 05 Nov 05 Dec 05 Jan 06 Feb 06 Mar 06 Apr 06 May 06 Jun 06 Jul 06 Aug 06 Sep 06 Oct 06 Nov 06 Dec 06 Jan 07 Feb 07 Mar 07 Apr 07 May 07 Jun 07 Jul 07 Aug 07 Sep 07 Oct 07 Nov 07 Dec 07 Jan 08 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 LAC: Bolivia, Brazil, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Mexico, Panama, Peru, Trinidad y Tobago, Uruguay and Venezuela LCRCE staff calculations. Source: National data sources and Bloomberg. 28
The good news is that inflation expectations have begun to yield in several countries 6.5 Expected Inflation for the next 12 months 6.0 Colombia 5.5 in percentage points 5.0 4.5 4.0 Chile Mexico Brazil 3.5 3.0 Oct 07 Nov 07 Dec 07 Jan 08 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Expected Inflation as reported by central banks surveys. Source: Bloomberg National Authorities 29
not least because of tight monetary policy, but also due to weaker commodity prices and lower growth prospects Monetary Policy Rates in % Monetary Policy Rates in % 18 9 16 BRAZIL 8 MEXICO 14 7 CHILE 6 12 5 PERU 10 8 ARGENTINA COLOMBIA 4 3 6 2 US 4 Jan 06 Jun 06 Nov 06 Apr 07 Sep 07 Feb 08 Jul 08 1 Jan 06 Jun 06 Nov 06 Apr 07 Sep 07 Feb 08 Jul 08 Source: Bloomberg National Authorities 30
However, the taming of inflation is proceeding unevenly across Latin countries Change in Inflation Rates percentage change 30 May June July August September 20 10 0-10 -20-30 DECELARATING MIXED ACCELERATING PAR CHL COL HON GUA PER BOL URU BRA PAN ECU JAM ELS VEN NIC MEX CR TTO LCRCE Staff calculations based on Bloomberg and National Authorities 31
External demand effects 32
Latin countries can hardly break free from the cyclical deceleration in global growth 10.0 9.0 8.0 2006 2007 2008 2009 Recent Growth and Forecast for 2008 and 2009 annual GDP real growth rate, in % 7.0 6.0 5.9 5.0 4.0 4.0 3.0 2.0 1.0 2.5 3.0 3.2 1.3 2.5 0.0 Argentina Brazil Chile Colombia Mexico Peru LAC The global slowdown, higher costs of finance, weaker commodity prices, and the lagged effect of monetary tightening all point to a sharper deceleration Lowest forecasts for 2009 (in black dots) are taken from Consensus Forecasts, World Bank and Citibank. Sources: Consensus Forecasts, ECLAC and World Bank 33
Fortunately, Latin America as a whole is decelerating from a relatively high trend growth 7% 6% Cyclical adjusted Growth in Latin America and High Income Countries Trend growth computed using the band pass filter High Income Latin America 5% 4% 3% 2% 1% 0% 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 The trend growth of real GDP growth is computed using the band pass filter (Baxter and King, 1999). LCRCE staff calculations. Source: WDI World Bank; National Authorities. 34
yet growth vulnerability varies considerably across Latin countries 1400 EMBI spread (basis points) as of 10/07/08 1200 1000 800 600 400 200 JAM BLZ MEX SLV ECU DOM URY BRA CHL ARG VEN COL PER PAN 0 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 Index of growth performance (0 1) The index of growth prospects combines information on annual variation of the investment to GDP ratio, annual average growth in GDP and TFP over the period 2003 7. The median of the growth prospects index for the entire LAC sample is 0.5. LCRCE Staff calculations based on Bloomberg, WDI and ECLAC 35
LAC perspective and policy challenges 36
LAC: a better built boat facing a nastier storm Overall, LAC is less vulnerable to macro financial shocks than before and this is due to fundamental improvements but vulnerability to shocks varies considerably across countries in the region LAC enters the cyclical downturn from a higher trend growth but growth vulnerability is heterogeneous across countries The fall in commodity prices hurts LAC, a net commodity exporter but it is a relief for the small Central American and Caribbean countries which are nonetheless hurt by lower remittances 37
Key policy challenges for the short run Monetary policy: whether and when to ease Will depend on having truly tamed the inflation threat and on the degree of financial stress Fiscal policy: weathering the revenue contraction Will depend on availability of self insurance buffers, degree of expenditure rigidity, and room to borrow prudently Financial policy: learning from the U.S. financial crisis Will depend on institutional strength, leadership and coordinating capacity of relevant agencies 38
Thank you 39