The New Face of LAC and Challenges Ahead: Capital Inflows and Commodities

11

The New Face of LAC and Challenges Ahead:The New Face of LAC and Challenges Ahead:Capital Inflows and CommoditiesCapital Inflows and Commodities

Augusto de la Torre

XXI Seminario Anual CIES 2010XXI Seminario Anual CIES 2010Lima, PerúLima, Perú

17 de diciembre del 201017 de diciembre del 2010

Chief Economist OfficeChief Economist OfficeLatin America and the CaribbeanLatin America and the CaribbeanThe World BankThe World Bank

AgendaAgenda

LAC breaking with the past: financially globalized yet resilient Resilience through the cycle

Driving forces of resilience and performance Policy-related and exogenous

Policy challenges Dealing with frothy capital inflows Harnessing benefits/avoiding risks of natural resource abundance

2

LAC breaking with the past: LAC breaking with the past: financially globalized yet resilientfinancially globalized yet resilient

3

Defining and measuring Defining and measuring resilienceresilience

Definition – resilience is the ability to: Withstand the initial external shock Engineer a fast and strong recovery Conduct counter-cyclical policies in bad and good times

Measurement – indirectly, through an outcome variable (GDP) that actually reflects a combination of factors … Size of the shock Degree of exposure to the shock Extent of resilience per se (“relative” resilience)

… which we sort out through econometric techniques and using appropriate comparators

4

Exposure to the shock: degree of financial globalizationExposure to the shock: degree of financial globalization

5Note: Financial openness is the amount of inflows and outflows of capital as a percentage of GDP. In this graph, Central America excludes Panama (an outlier due to its condition as offshore financial center). Source: IMF’s BOP

0

2

4

6

8

10

12

14

16

18

20

Other South Am. Countries

Central Am. + Dom. Rep.

Caribbean LAC-6 + URY

Per

cent

age

of G

DP

Financial Openess (Flows)Simple Averages

Exposure to the shock: degree of trade opennessExposure to the shock: degree of trade openness

6Note: Trade openness is the sum of exports and imports as a percentage of GDP. Source: IMF’s WDI

0

20

40

60

80

100

120

LAC-6 + URY Other South Am. Countries


Caribbean

Per

cent

age

of G

DP

Trade OpennessSimple Average

Resilience: benchmarking LAC through the cycleResilience: benchmarking LAC through the cycle

Resilience in the downturn: not worse than the Asian TigersResilience in the downturn: not worse than the Asian Tigers Downturn was highly synchronized around the globe LAC was not immune, but its growth collapse (6.5 pp) was comparable to that

of the East Asian Tigers and significantly smaller than that of ECA (13 pp) Within LAC, the collapse was largest where trade openness is highest – the Caribbean (8.7 pp)

-- and smallest in the less financially globalized countries of South America (6.2 pp)

Resilience in the rebound: fast and strong growth recoveryResilience in the rebound: fast and strong growth recovery LAC’s recession was shorter compared to previous crises and the MIC average

Brazil led the LAC pack: industrial production started to recover in 3 months! Strong recovery: like other non-ECA MICs, LAC’s GDP in 2010 will be above its

2008 level (ECA: 1.7% below; HICs: 0.2% below) LAC’s GDP will be closer to potential than the East Asian Tigers (who have higher potential) Brazil, Peru, Argentina, Uruguay, Panama, and Dominican Republic lead the LAC pack

7

2009 growth collapse: LAC no worse than the East Asian 2009 growth collapse: LAC no worse than the East Asian Tigers, but particularly bad for the CaribbeanTigers, but particularly bad for the Caribbean

8Notes: Growth collapses are defined as growth in 2009 minus growth in 2007. Country groupings are simple averages. Haiti is not included among Caribbean countries. Source: IMF's WEO (October 2010)

-18%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

An

t &

Bar

b

Gre

nad

a

Ven

ezu

ela

Par

agu

ay

Mex

ico

Pan

ama

Co

sta

Ric

a

Tri

n &

To

b

Ho

nd

ura

s

Per

u

El S

alv

ado

r

Arg

enti

na

LA

C

Bra

zil

Ch

ile

Gu

atem

ala

Co

lom

bia

Do

m R

ep

Uru

gu

ay

Nic

arag

ua

Jam

aica

Gu

yan

a

Do

min

ica

Su

rin

ame

Ecu

ado

r

Bel

ize

Bo

liv

ia

Per

cen

tag

e P

oin

ts

GDP Growth CollapsesAcross LAC Countries

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

ECA South Africa

HIC East Asian Tigers

LAC China India

Per

cen

tag

e P

oin

ts

GDP Growth CollapsesAcross Regions

-9.0%

-8.5%

-8.0%

-7.5%

-7.0%

-6.5%

-6.0%

-5.5%

-5.0%

Caribbean Central Am. + Dom. Rep.


Per

cen

tag

e P

oin

ts

GDP Growth CollapsesWithin LAC Regions

Resilience: benchmarking LAC through the cycleResilience: benchmarking LAC through the cycle

Resilience in the downturn: not worse than the Asian TigersResilience in the downturn: not worse than the Asian Tigers Downturn was highly synchronized around the globe LAC was not immune, but its growth collapse (6.5 pp) was comparable to that

of the East Asian Tigers and significantly smaller than that of ECA (13 pp) Within LAC, the collapse was largest where trade openness is highest – the Caribbean (8.7 pp)

-- and smallest in the less financially globalized countries of South America (6.2 pp)

Resilience in the rebound: fast and strong growth recoveryResilience in the rebound: fast and strong growth recovery LAC’s recession was shorter compared to previous crises and the MIC average

Brazil led the LAC pack: industrial production started to recover in 3 months! Strong recovery: like other non-ECA MICs, LAC’s GDP in 2010 will be above its

2008 level (ECA: 1.7% below; HICs: 0.2% below) LAC’s GDP will be closer to potential than the East Asian Tigers (who have higher potential) Best performers are the financially globalized commodity exporters like BRA, PER, and URU

9

Size and duration of downturn: LAC better than its past Size and duration of downturn: LAC better than its past and ahead of the MIC average and ahead of the MIC average

10Notes: In the figures, period T stands for the Peak year in GDP business cycles. The sample of LAC countries includes: Argentina, Brazil, Chile, Colombia, Costa Rica, Ecuador, Mexico, Peru, and Venezuela. Sources: Calderón and Servén (2010), EIU, Haver Analytics, LAC Central Banks and Statistical Offices.

-4.5

-3.5

-2.5

-1.5

-0.5

0.5

T-8

T-6

T-4

T-2 T

T+

2

T+

4

T+

6

T+

8

Gro

wth

Rat

e (%

)

Latin America & the Caribbean

Historic cycle

Current cycle

-4.5

-3.5

-2.5

-1.5

-0.5

0.5

T-8

T-6

T-4

T-2 T

T+

2

T+

4

T+

6

T+

8

Gro

wth

Rat

e (%

)

Middle Income Countries

Historic cycle

Current cycle

-4.5

-3.5

-2.5

-1.5

-0.5

0.5

T-8

T-6

T-4

T-2 T

T+

2

T+

4

T+

6

T+

8

Gro

wth

Rat

e (%

)

High Income Countries

Historic cycle

Current cycle

Cyclical Growth Dynamics in a Comparative SettingCyclical Growth Dynamics in a Comparative Setting

Heterogeneity across LAC countries in terms of the length Heterogeneity across LAC countries in terms of the length of the recession (based on IP indexes)of the recession (based on IP indexes)

11Sources: World Bank’s Global Economic Monitor (Oct 2010).

0

2

4

6

8

10

12

14

16

18

Brazil Argentina Peru Uruguay MexicoVenezuela Chile Colombia

Num

ber o

f mon

ths

Speed of RecoveryMonths between peak and trough in IP Indexes

Strength of the recovery: LAC recovering potential output Strength of the recovery: LAC recovering potential output faster than the Tigers faster than the Tigers

12Notes: Trend GDP, used in Panels B and C, is defined as the GDP that each country would have attained if it had grown between 2008 and 2010 at the same pace as in between 2000 and 2007. Sources: Didier, Hevia, and Schmukler (2010).

-30%

-20%

-10%

0%

10%

20%

30%

Ant

. & B

arb.

Tri

n. &

Tob

.V

enez

uela

Gre

nada

Bel

ize

Hon

dura

sM

exic

oC

osta

Ric

aJa

mai

caE

l Sal

vado

rC

olom

bia

Nic

arag

uaC

hile

Gua

tem

ala

Ecu

ador

Dom

. Rep

.S

urin

ame

Par

agua

yB

razi

lP

anam

aD

omin

ica

Bol

ivia

Per

uG

uyan

aA

rgen

tina

Uru

guay

Per

cent

Expected GDP Levels Relative to Trend GDPLAC Countries

2010 2011

-20%

-15%

-10%

-5%

0%

5%

ECA HIC South Africa

East Asian Tigers

LAC China India

Per

cent

Expected GDP Levels Relative to Trend GDP

2010 2011

-5%

0%

5%

10%

15%

20%

25%

30%

35%

ECA HIC South Africa

LAC East Asian Tigers

India China

Per

cent

Expected GDP Levels in 2010 and 2011 Relative to GDP in 2008

2010 2011

Strength of the recovery: LAC growth in 2010 trails East Strength of the recovery: LAC growth in 2010 trails East Asia, but some LAC countries with Asian-like growth ratesAsia, but some LAC countries with Asian-like growth rates

13Country groupings are weighted averages. Haiti is not included among the Caribbean countries. Source: Consensus Forecasts (November 2010).

-6%

-4%

-2%

0%

2%

4%

6%

8%



Caribbean

2009 Real GDP Growth and Forecasts for 2010-11Annual GDP Real Growth Rate, Weighted Averages

2009 2010 2011

0%

2%

4%

6%

8%

10%

12%

HIC South Africa

ECA LAC East Asian Tigers

India China

GDP Growth Forecasts for 2010 and 2011Across Regions

2010 2011

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

Ant

. & B

arb.

Ven

ezue

la

Jam

aica

Gre

nada

El S

alva

dor

Tri

n. &

Tob

.

Dom

inic

a

Bel

ize

Gua

tem

ala

Ecu

ador

Hon

dura

s

Nic

arag

ua

Guy

ana

Cos

ta R

ica

Bol

ivia

Sur

inam

e

Dom

. Rep

.

Col

ombi

a

Mex

ico

Pan

ama

Chi

le

LA

C

Par

agua

y

Uru

guay

Bra

zil

Per

u

Arg

enti

na

GDP Growth Forecasts for 2010 and 2011Across LAC Countries

2010 2011

LAC: 2010 growth recovery has vastly exceeded LAC: 2010 growth recovery has vastly exceeded expectations… expectations…

14Source: Consensus Forecasts (March 2009 and November 2010).

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

South Africa

High Income

Europe & Central

Asia

China India Latin America & Caribbean

East Asian Tigers

Per

cent

age

Poi

nts

Difference in 2010 Growth ProjectionsNov-10 vs. Mar-09, Weighted Averages

3.1%

7.1%

5.7%8.4%

10.5%

3.9%

2.4%

Current growth rate projection for 2010

… … especially among the most financially globalized especially among the most financially globalized commodity exporting LAC countriescommodity exporting LAC countries

15Source: Consensus Forecasts (March 2009 and November 2010).

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

Other South Am. Countries


LAC-6 + URY

Per

cent

age

Poi

nts

Difference in 2010 Growth ProjectionsNov-10 vs. Mar-09, Weighted Averages

-1.2%

6.4%

3.5%

Current growth rate projection for 2010

Resilience: benchmarking LAC through the cycle (2)Resilience: benchmarking LAC through the cycle (2)

Shielding the poorShielding the poor While a year ago 10 million people were expected to fall into poverty ($4 a

day) in 2009, we now know (actual data) that only 2.1 million people did Poverty increased mainly in Mexico and some Central American Countries; it actually

continued to decline (at a lower rate) in Brazil, Peru, Uruguay

If poverty reduction is as elastic to growth as it was during the 2000-2007 expansion, 7 million Latinos will climb out of moderate poverty in 2010

Unexpectedly strong labor market performanceUnexpectedly strong labor market performance During 2009, the LAC unemployment rate increased much less than in ECA

and slightly more than in the East Asian Tigers ... ... the increase in unemployment given the decline in GDP was much milder

than in previous crises ... the trend towards labor market formalization was not reversed … … and all this despite constant or increasing real average wages

16

Shielding the poor: milder increase in poverty compared to Shielding the poor: milder increase in poverty compared to the past and heterogeneous effects within the regionthe past and heterogeneous effects within the region

Source: The World Bank, 2010. “Did Latin America learn to shield its poor from economic shocks?” Washington, DC: The World Bank, Latin America and the Caribbean Poverty Sector (LCSPP)

-8

-6

-4

-2

0

2

4

Andean Region Central America & Mexico

Cono Sur ExtendedP

erce

nta

ge P

oin

ts

Change in Moderate Poverty(US$ 4 a day)

2004 - 2005 2005 - 2006 2006 - 20072007 - 2008 2008 - 2009 2009 - 2010*

-4

-3

-2

-1

0

1

2

3

4

199

3 -

199

4

199

4 -

199

5

199

5 -

199

6

199

6 -

199

7

199

7 -

199

8

199

8 -

199

9

199

9 -

200

0

200

0 -

200

1

200

1 -

200

2

200

2 -

200

3

200

3 -

200

4

200

4 -

200

5

200

5 -

200

6

200

6 -

200

7

200

7 -

200

8

200

8 -

200

9

200

9 -2

010

*

Per

cen

tage

Po

ints

Change in Moderate Poverty(US$ 4 a day)

17

Resilience: benchmarking LAC through the cycle (2)Resilience: benchmarking LAC through the cycle (2)

Shielding the poorShielding the poor While a year ago 10 million people were expected to fall into poverty ($4 a

day) in 2009, we now know (actual data) that only 2.1 million people did Poverty increased mainly in Mexico and some Central American Countries; it actually

continued to decline (at a lower rate) in Brazil, Peru, Uruguay

If poverty reduction is as elastic to growth as it was during the 2000-2007 expansion, 7 million Latinos will climb out of moderate poverty in 2010

Unexpectedly strong labor market performanceUnexpectedly strong labor market performance During 2009, the LAC unemployment rate increased much less than in ECA

and slightly more than in the East Asian Tigers ... ... the increase in unemployment given the decline in GDP was much milder

than in previous crises ... the trend towards labor market formalization was not reversed … … and all this despite constant or increasing real average wages

18

Labor market performance: unemployment less responsive Labor market performance: unemployment less responsive to the downturn than previously in most of LACto the downturn than previously in most of LAC

19Note: Previous recession periods are: Argentina (1998.Q4 – 2002.Q2); Brazil (1997.Q4 – 1998.Q2); Chile (1998.Q3 – 1999.Q4); Colombia (1998.Q3 – 1999.Q4); Mexico (1995.Q1 – 1996.Q1), and Peru (1997.Q2 – 1999.Q1). Current recession periods are: Argentina (2008.Q3 – 2009.Q2); Brazil (2008.Q4 – 2009.Q2); Chile (2008.Q3 – 2009.Q3); Colombia (2008.Q3 – 2009.Q2); Mexico (2008.Q2 – 2009.Q2), and Peru (2008.Q2 – 2009.Q1). Source: LCRCE Staff calculations based on National Statistical Institutes data.

0.0

0.5

1.0

1.5

2.0

2.5

Argentina Brazil Chile Colombia Mexico Peru

Semi-Elasticity of Unemployment with Respect to GDP Growth

Previous recession Current Recession

Driving forces of resilience and performanceDriving forces of resilience and performance

20

Driving forcesDriving forces

Policy related Silent revolution in macro policy frameworks Safer international financial integration Diversification of export markets – the China connection!

Exogenous Terms of trade Return of risk appetite in financial centers

21

The driving forces: policy-drivenThe driving forces: policy-driven

Silent revolution in macro-financial policy frameworksSilent revolution in macro-financial policy frameworks In a break with history, what used to be shock amplifiers were turned into

cushions: currency, banking system, fiscal process … and this enabled counter-cyclical policies, particularly in monetary policy

and to a lesser extent in fiscal policy No financial crises at home this time around

22

Notes: Panel C reports the average quarterly variation (in percentage points of GDP) of the cyclically-adjusted primary balance of LAC-6 countries during the global downturn associated to the 2008 - 2009 financial crisis and during previous crisis. Negative (positive) values indicate an expansion (contraction) in discretionary fiscal policy. Sources: IMF’s “Fiscal Monitor: Navigating the Fiscal Challenges Ahead” (May 2010), ECLAC, and Bloomberg for Panels A and B; and LCRCE staff calculations based on Haver Analytics, Datastream in Panel C.

LAC breaking with history: countercyclical macro policy LAC breaking with history: countercyclical macro policy

23

-9%

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

Cos

ta R

ica

Arg

enti

na

Para

guay

Gua

tem

ala

Mex

ico

Tri

n. &

Tob

.

Uru

guay

Hon

dura

s

Bar

bado

s

Bra

zil

Peru

Dom

. Rep

.

Col

ombi

a

Jam

aica

Chi

le

Per

cent

age

Poi

nts

Monetary PolicyChanges in Monetary Policy Rates

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Argentina Brazil Chile Colombia Mexico Peru Dom. Rep.

Variation in the cyclically-adjusted primary surplus(in percentage points of GDP)

In previous crises

During current global crisis

0%

2%

4%

6%

8%

10%

12%

14%

16%

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

Monetary Policy RatesInflation-Targeting LAC Countries, in %

US Peru

Colombia

Chile

Brazil

Mexico

LAC and the East Asian Tigers: LAC and the East Asian Tigers: Flexible exchange rates cushioned the shock this time…Flexible exchange rates cushioned the shock this time…

24Notes: This figure depicts the behavior of the nominal exchange rate around crises episodes of external origin to the region in question. Sources: Didier, Hevia, and Schmukler (2010).

80

90

100

110

120

130

Sep-94 Oct-94 Nov-94 Dec-94 Jan-95 Feb-95 Mar-95

Inde

x Ju

l-97

= 1

00

East Asia & Pacific Previous Crisis

China Indonesia Korea, Rep. MalaysiaPhilippines Singapore Thailand

80

90

100

110

120

130

Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Inde

x Ju

l-97

= 1

00

East Asia & Pacific Current Crisis

China Indonesia Korea, Rep. MalaysiaPhilippines Singapore Thailand

80

90

100

110

120

130

Apr-97 May-97 Jun-97 Jul-97 Aug-97 Sep-97 Oct-97

Inde

x Ju

l-97

= 1

00

Latin America & Caribbean Previous Crisis

Argentina Brazil Chile ColombiaMexico Peru Venezuela Dom. Rep.

80

90

100

110

120

130

Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Inde

x Ju

l-97

= 1

00

Latin America & Caribbean Current Crisis

Argentina Brazil Chile Colombia

Mexico Peru Venezuela Dom. Rep.

… … not least because reduced currency mismatches helped not least because reduced currency mismatches helped dispel the “fear of floating” in most of LACdispel the “fear of floating” in most of LAC

0%

10%

20%

30%

40%

50%

60%

70%

80%

Corporate Banks

Corporate and Banks' Dedollarization in LAC

Source: Gozzi et al. (2009), IFS

Issues in Foreign Currency / Total Issues ForeignLiabilities / Broad Money

1990-1993

2006-2009

2001-20032006-2008

Note: GDP-weighted averages of the periodsnoted.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1998 2008 1998 2008 2002 2008

Mexico Colombia Brazil

Share of the Domestic and Foreign Public Debt in Total DebtSelected LAC Countries

Domestic Foreign

25Sources: Gozzi et al (2009), Reinhart, Rogoff and Savastano (2003), IFS.

LAC breaking with history: no systemic damage at homeLAC breaking with history: no systemic damage at home

26

Financial Crises Around the WorldFinancial Crises Around the World

The driving forces: policy-driven (2)The driving forces: policy-driven (2)

Safer international integration…Safer international integration… The region became a net creditor in debt and a net debtor in equity

… … in the midst of financial re-couplingin the midst of financial re-coupling While EM policy fundamentals boost economic resilience, they are not the

main drivers of financial asset performance EM asset returns have become more sensitive to common factors than to

differences in EM fundamentals The co-movement of asset returns across the world has increased over

time, reducing the gains of international portfolio diversification

27

LAC has migrated towards a safer form of integration into LAC has migrated towards a safer form of integration into international financial marketsinternational financial markets

-40%

-30%

-20%

-10%

0%

10%

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

Per

cen

t of

GD

P

A Safer Integration in LAC Finance

Net Debt Position vis-à-vis Rest of the World

Net Equity Position vis-à-vis Rest of the World

Net

Cre

dit

or

Net

Deb

tor

28Note: The net debt position (vis-à-vis ROW) is the sum of debt assets and reserves minus debt liabilities. In turn, the net equity position (vis-à-vis ROW) is the sum of net FDI assets and net portfolio equity assets. The sample ranges from 1990 to 2008. Source: Lane and Milesi-Ferretti (2007).

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Per

cent

of G

DP

A Safer Integration in PeruFinance

Net Equity Position vis-à-vis Rest of the World

Net Debt Position vis-à-vis Rest of the World

Net

Cre

dito

rN

et D

ebto

r


Safer international integration…Safer international integration… The region became a net creditor in debt and a net debtor in equity

… … in the midst of financial re-couplingin the midst of financial re-coupling While EM policy fundamentals boost economic resilience, they are not the

main drivers of financial asset performance EM asset returns have become more sensitive to common factors than to

differences in EM fundamentals The co-movement of asset returns across the world has increased over

time, reducing the gains of international portfolio diversification

29

The variance of EM asset return is increasingly explained The variance of EM asset return is increasingly explained by common factorsby common factors

30Notes: A principal component is estimated for returns on equities, on foreign exchange spot contracts, and on CDS sovereign spreads. Then, country-specific returns for each asset class are regressed on its associated PC1 in order to get an R-squared. The average R-squared is being reported for countries within each region. See Levy Yeyati (2010) for more details. Sources: Bloomberg.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Equity Foreign Exchange CDS Spreads

Per

cent

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)


Diversification of export marketsDiversification of export markets The share of the US and Europe in many LAC country exports has fallen, as

that of Asia has been rising

Real de-coupling from HIC and increased coupling with ChinaReal de-coupling from HIC and increased coupling with China Over time, economic activity in EMs has become less sensitive to economic

activity in HICs, and more sensitive to economic activity in China

31

The China connection: LAC countries has been sharply The China connection: LAC countries has been sharply intensifying trade and FDI links to Asia intensifying trade and FDI links to Asia

32Source: IMF’s Direction of Trade Statistics (DOTS).

0%

10%

20%

30%

40%

50%

60%

70%

80%

Su

rin

ame

Bar

bad

os

Jam

aica

Nic

arag

ua

Tri

n. &

To

b.

Ho

nd

ura

s

Gu

atem

ala

Mex

ico

Bah

amas

Gu

yan

a

Ecu

ado

r

Co

lom

bia

Bel

ize

Do

m. R

ep.

Bo

liv

ia

Par

agu

ay

Ecu

ado

r

Hai

ti

Pan

ama

Ven

ezu

ela

Uru

guay

Arg

enti

na

Bra

zil

Co

sta

Ric

a

Do

min

ica

Per

u

Ch

ile

Per

cent

LAC Exports to Selected Regions as % of total exports, 2008 data

EAP Euro Zone US

Real de-coupling: growth in EMs has become more Real de-coupling: growth in EMs has become more sensitive to China and less sensitive to the G-7sensitive to China and less sensitive to the G-7

LAC-7 CRB ChinaIndependent Variables: (1) (2) (3) (4) (5) (6) (7) (8)

0.432*** 1.636*** 0.988*** 1.936*** 0.960 0.052 0.327* 0.169(0.000) (0.000) (0.000) (0.000) (0.253) (0.592) (0.081) (0.435)0.146** -1.299*** -0.763*** -1.54*** 0.492** 0.487**(0.043) (0.000) (0.000) (0.000) (0.033) (0.039)

0.850*** 0.557*** 0.847*** 2.826*** 0.121* 0.050(0.000) (0.000) (0.000) (0.000) (0.067) (0.511)

0.420*** 0.174*** 0.535*** -0.153*** -0.223***(0.000) (0.006) (0.000) (0.005) (0.002)

0.091*** 0.060* 0.000 0.028*(0.000) (0.058) (0.000) (0.069)

0.013*** -0.023** 0.000 0.002(0.005) (0.012) (0.000) (0.611)

0.028*** -0.086*** -0.040*** -0.101*** -0.269*** 0.097***(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Observations 1357 1357 1357 264 63 64 264 264

R-squared 0.12 0.26 0.30 0.26 0.27 0.00 0.42 0.43

0.578*** 0.347*** 0.226*** 0.397*** 0.818*** 0.657***(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

1.270*** 0.731*** 1.382*** -0.054 -0.172(0.000) (0.000) (0.000) (0.579) (0.123)

α

G-7 + G-7, Late

China + China, Late

G-7

G-7, Late

China

China, Late

CRB

WTI

Emerging Markets Non-Euro Advanced EconomiesPanel Estimations Panel Estimations

33Notes: The late period goes from 2000 to 2009. Median sample estimations report the median values from country-by-country regressions. G-7 growth was computed as the average of individual growth rates weighed by the dollar GDP in the previous year. Non-Euro Advanced Economies include Australia, New Zealand, Norway, and Sweden. For panel regressions, ***,** and * denotes significance at a 1%, 5% and 10% respectively. P-values are reported in parentheses. Sources: IMF's IFS.

The co-movement of growth between LAC countries and The co-movement of growth between LAC countries and China has been clearly trending upward… China has been clearly trending upward…

34Source: National Authorities. Note: Solid colors reflect correlation values significant at a 10% confidence interval.

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1980 1984 1988 1992 1996 2000 2004 2008

Output Co-Movement Between LAC and China20 years rolling correlation of the Real GDP Growth

Brazil Chile Colombia

Mexico Peru Argentina

Panama Dom. Rep.

The driving forces: exogenous factorsThe driving forces: exogenous factors

Rebound in commodity pricesRebound in commodity prices Commodity prices started rebounding in Jan 09 and are at their 2007 level Asymmetric effects on the region (South America vs. Central America)

Pronounced move towards risk appetite in financial marketsPronounced move towards risk appetite in financial markets The comeback of risk appetite has contributed to strong capital inflows to

LAC, and intensified the strength of the recovery Capital inflows to the region in 2010 are already higher than those observed

in 2007

35

Commodity prices rebounded quickly, with asymmetric Commodity prices rebounded quickly, with asymmetric effects across the regioneffects across the region

36Source: Bloomberg.

30

50

70

90

110

130

150

50

100

150

200

250

300

350

Jan-05

May-0

5

Sep-05

Jan-06

May-0

6

Sep-06

Jan-07

May-0

7

Sep-07

Jan-08

May-0

8

Sep-08

Jan-09

May-0

9

Sep-09

Jan-10

May-1

0

Sep-10

Oil W

TI, C

urr

ent U

S$

Whea

t, C

opper

and S

oyb

ean, 01

-Jan

-05=

100

Commodity PricesOil WTI in Current US$, Wheat, Copper and Soybean: Index 01-Jan-05=100

Oil (rhs)

Copper

Wheat

Soybean

-40% -20% 0% 20% 40% 60% 80% 100% 120% 140%

HondurasDom. Rep.Dominica

NicaraguaCosta Rica

GuatemalaPanama

BrazilUruguay

MexicoArgentina

PeruColombia

Trin. and Tob.Paraguay

ChileEcuador

Bolivia

Cumulative Change in Terms of Trade

2008q4 - 2009q42001q4 - 2008q2

Around 93% of LAC’s population and 97% of its economic activity is in countries which

are net exporters….

The driving forces: exogenous factorsThe driving forces: exogenous factors

Rebound in commodity pricesRebound in commodity prices Commodity prices started rebounding in Jan 09 and are at their 2007 level Asymmetric effects on the region (South America vs. Central America)

Pronounced move towards risk appetite in financial marketsPronounced move towards risk appetite in financial markets The comeback of risk appetite has contributed to strong capital inflows to

LAC, and intensified the strength of the recovery Capital inflows to the region in 2010 are already higher than those observed

in 2007.

37

38Sources: Bloomberg

A swing from risk aversion to risk appetite is boosting A swing from risk aversion to risk appetite is boosting capital flows to EMscapital flows to EMs

0

10

20

30

40

50

60

70

80

90

100

Jan-

02

Jun-

02

Nov

-02

Apr

-03

Sep-

03

Feb-

04

Jul-

04

Dec

-04

May

-05

Oct

-05

Mar

-06

Aug

-06

Jan-

07

Jun-

07

Nov

-07

Apr

-08

Sep-

08

Feb-

09

Jul-

09

Dec

-09

May

-10

Oct

-10

VIXCBOE Volatility Index

Lehman

Citi's Memo Greece

-2

-1

0

1

2

3

4

5

6

Jan-

02

Jun-

02

Nov

-02

Apr

-03

Sep-

03

Feb-

04

Jul-

04

Dec

-04

May

-05

Oct

-05

Mar

-06

Aug

-06

Jan-

07

Jun-

07

Nov

-07

Apr

-08

Sep-

08

Feb-

09

Jul-

09

Dec

-09

May

-10

Oct

-10

Financial Conditions Indexes

United States Financial Stress

St Louis Federal Reserve Bank Financial Stress Index

Lehman

Citi's Memo Greece

Capital flows to LAC have surged in 2010 to levels higher Capital flows to LAC have surged in 2010 to levels higher than those observed in 2007than those observed in 2007

39Source: National BOP data. LAC-7 countries comprise Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.

Policy challenges Policy challenges (Assuming the HICs do not drag all down)(Assuming the HICs do not drag all down)

40

Capital inflows - where is the problem?Capital inflows - where is the problem?

Surging capital flows to LAC are a problem inasmuch as they entail: Distortions that give rise to global imbalances – an international coordination failure Mood swings/exuberance that underpin “frothy” and unduly volatile flows – a collective

cognition failure Potentially lasting impact on the LT growth and systemic stability of the recipient countries –

negative externalities

Uncoordinated responses to global imbalances and center-periphery asymmetries in output gaps…

…raise currency appreciation pressures in LAC more than otherwise…

FX intervention to resist currency appreciation is the dominant response in the larger LAC countries

Monetary policy is currently over-burdened

41

Capital inflows surge and global rebalancingCapital inflows surge and global rebalancing

42

HIC-EM asymmetry:output gap & inflation pressures

Interest rate differentials / risk appetite comeback

“Frothy” capital inflow surge to EMs

EM resistance to appreciation (to dollar depreciation)

Lower than otherwise interest rates in HICs QE2

• Global coordination failureGlobal coordination failure• What is good for a particular nation is not necessarily good for the worldWhat is good for a particular nation is not necessarily good for the world

Global imbalances

Currency appreciation pressures are already felt and Currency appreciation pressures are already felt and bound to intensify in several LAC countries…bound to intensify in several LAC countries…

43Note: The Exchange Market Pressure Index is the weighted average of year-on-year percentage changes in: (a) the nominal exchange rate of the local currency vis-à-vis the US dollar (such that an increase represents an appreciation of the LAC currency), and (b) the level of international reserves. The weights are given by the inverse of the annual standard deviation of the changes in the nominal exchange rate and the standard deviation of the changes in reserves. An increase in the Exchange Market Pressure index signals appreciation pressures and/or accumulation of reserves. Source: LCRCE Staff calculations based on IMF’s IFS. Figures updated until October 2010

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

Jan-

00

Sep-

00

May

-01

Jan-

02

Sep-

02

May

-03

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep-

08

May

-09

Jan-

10

Sep-

10

Brazil

Appreciation pressures Reserve Accumulation Exchange Market Pressure

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Jan-

00

Sep-

00

May

-01

Jan-

02

Sep-

02

May

-03

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep-

08

May

-09

Jan-

10

Sep-

10

Chile


-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

Jan-

00

Sep-

00

May

-01

Jan-

02

Sep-

02

May

-03

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep-

08

May

-09

Jan-

10

Sep-

10

Colombia


-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

Jan-

00

Sep-

00

May

-01

Jan-

02

Sep-

02

May

-03

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep-

08

May

-09

Jan-

10

Sep-

10

Mexico


-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Jan-

00

Sep-

00

May

-01

Jan-

02

Sep-

02

May

-03

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep-

08

May

-09

Jan-

10

Sep-

10

Peru


Policy options: two unpalatable corner solutionsPolicy options: two unpalatable corner solutions

Allow an overshooting appreciation of the nominal exchange rate until the interest rate differential reflects expected depreciation Pros: conceptually clean; consistent with low inflation target; and easy to implement,

at least technically Cons: (i) consumption feast now with adverse growth effects later (irreversiblilities

and non-fundamentals driven inflows) (ii) first-mover disadvantage: an even greater appreciation would be needed if the emerging country is the only one to do it (prisoner’s dilemma)

Lower policy interest rates until differential disappears and let inflation do the trick Pros: it would result in less real exchange rate overshooting (inflation adjusts sluggishly

compared to the nominal exchange rate) Cons: it would sacrifice 20 years of monetary virtuousness, with lasting adverse effects on

central bank credibility

44

First-best solution: tectonic change in policy mix First-best solution: tectonic change in policy mix

Loosen monetary to eliminate interest rate differential…

… and tighten fiscal and macro-prudential policies sufficiently to anchor inflation expectations

Macro-prudential policy To induce the internalization of risks both to the financial sector and the economy, thereby

affecting the business cycle itself Options: counter-cyclical provisions/capital; lower LTV ratios; tax on whole-sale ST funding;

tax on external & domestic credit; etc.

Pros: (i) gets individual country to its first-best (first mover advantage); (ii) increased inflows, if any, would tend to be of the good kind (FDI)

Cons: (i) self-defeating in the aggregate if everybody does it; (ii) major political economy constraints to implementation

45

The pragmatic hybrid solution can be improvedThe pragmatic hybrid solution can be improved

The hybrid approach – do a little bit of every thing according to what is politically and technically feasible … FX intervention; tolerance on inflation targets to dampen increases in interest rates;

controls on inflows; some taming of fiscal expansion; some macro-prudential

… can be improved by rebalancing in favor of fiscal and, especially, macro-prudential policies to relieve burden on central banks Fiscal policy has become pro-cyclical in many LAC countries during 2010 Macro-prudential – LAC is in a learning-by-doing mode

Pros: option value of wait and see; limit first mover disadvantage

Cons: larger scope for distortions/dead-weight losses associated with expanded use of macro prudential to compensate for insufficient fiscal

Some global coordination may be forthcoming (G20) and would help, but Further push is needed to ensure it happens and LAC should play a role in that push Even if happens, it would be insufficient to solve LAC’s policy mix problem

46

Can LAC break with its past and use its natural resources Can LAC break with its past and use its natural resources to turn the cyclical recovery into higher long-run growth?to turn the cyclical recovery into higher long-run growth?

47Source: Maddison (2009) and IFS’s WEO (October 2010)

0%

10%

20%

30%

40%

50%

60%

70%

80%

19

00

19

06

19

12

19

18

19

24

19

30

19

36

19

42

19

48

19

54

19

60

19

66

19

72

19

78

19

84

19

90

19

96

20

02

20

08

Relative GDP Per Capita of Selected Regions relative to the US

Asian Tigers/US

LAC/US

Gold Standard Period

Interwar Period Import Substitution

WashingtonConsensus

WashingtonDissensus

LostDecade

Peru/US

The latest commodity price boom has been unusually The latest commodity price boom has been unusually broad-based and long-lastingbroad-based and long-lasting

The most comprehensive in terms of the number of commodities it affected…

… and the number of countries it benefited

For LAC, it has been the longest lasting boom since records have been kept

48

Source: World Bank staff calculations based on export commodity price data from Cunha, Prada and Sinnott (2009a, 2009b).

Note: The figure represents the share of the LAC-7 economies Top 16 commodities experiencing a price “boom” for each period of time. Booms and bust in commodity prices were defined following the Bry-Brochan cycle dating exercise. The figure also shows the boom-bust intervals for the overall commodities index.

LAC-7 Economies: Share of Commodities Experiencing a Boom

Natural resource curse hypothesis: should LAC worry Natural resource curse hypothesis: should LAC worry about becoming the granary and mine of China?about becoming the granary and mine of China?

Three valid concerns … Productivity/growth trap

Technical upgrading, spillovers, linkages, diversification? Institutional/political trap

Rent-seeking behavior, institutional capture, reduced resource mobilization efforts? Complications associated with decentralization (ear-marking)?

Environmental and social sustainability

And one red herring (Prebisch-Singer Hypothesis) Recent econometric evidence does not support theory that commodity prices are

on downward trend and, even if so, that it would adversely affect growth

49

Long term savingsLong term savings – needed to convert natural capital into – needed to convert natural capital into other forms of wealth … even if prices were not volatileother forms of wealth … even if prices were not volatile

Sad reality: savings negatively correlated with resource rents Too much of the rent is consumed,

not invested

Harsh reality: difficult to save High social discount rate, given

pressing development needs Difficulties in organizing collective

action in inter-temporal horizon

The pace of local investment of LT savings matter – to avoid Dutch Disease 50

BRA PERNIC

ARG

COL

ECU

MEX

TTO

DOM

BOL

HND

GTM VEN

CHL

-40

-20

020

40A

djus

ted

net s

avin

g (%

of G

NI)

0 20 40 60 80 100Non-renewable resource rents (% of GNI)

And short term volatility requires other strategiesAnd short term volatility requires other strategies

Self protection: reduce income volatility through diversification

Market insurance to hedge price volatility

Self insurance (saving) to smooth fiscal spending and act counter-cyclically

Not easy, but Chile’s experience shows that saving out of windfalls (to use in downturns) can have economic and political pay offs

51

52

Thank youThank you

Documents

The New Face of LAC and Challenges Ahead: Capital Inflows and Commodities