Transcript Monetary Policy with Head Winds: Issues and Trade-offs

The New Face of LAC and Challenges Ahead:
Capital Inflows and Commodities
Augusto de la Torre
XXI Seminario Anual CIES 2010
Lima, Perú
17 de diciembre del 2010
Chief Economist Office
Latin America and the Caribbean
The World Bank
1
Agenda
 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:
financially globalized yet resilient
3
Defining and measuring resilience
 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 globalization
Financial Openess (Flows)
Simple Averages
20
18
Percentage of GDP
16
14
12
10
8
6
4
2
0
Other South Am.
Countries
Central Am. +
Dom. Rep.
Caribbean
LAC-6 + URY
Note: 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
5
Exposure to the shock: degree of trade openness
Trade Openness
Simple Average
120
Percentage of GDP
100
80
60
40
20
0
LAC-6 + URY
Other South Am.
Countries
Central Am. +
Dom. Rep.
Note: Trade openness is the sum of exports and imports as a percentage of GDP. Source: IMF’s WDI
Caribbean
6
Resilience: benchmarking LAC through the cycle
Resilience 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 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
Tigers, but particularly bad for the Caribbean
GDP Growth Collapses
Across LAC Countries
GDP Growth Collapses
Across Regions
0%
0%
-2%
Percentage Points
Percentage Points
-2%
-4%
-6%
-8%
-10%
-4%
-6%
-8%
-10%
-12%
-14%
-12%
-16%
-14%
South
Africa
HIC
East
Asian
Tigers
LAC
China
Ant & Barb
Grenada
Venezuela
Paraguay
Mexico
Panama
Costa Rica
Trin & Tob
Honduras
Peru
El Salvador
Argentina
LAC
Brazil
Chile
Guatemala
Colombia
Dom Rep
Uruguay
Nicaragua
Jamaica
Guyana
Dominica
Suriname
Ecuador
Belize
Bolivia
-18%
ECA
India
GDP Growth Collapses
Within LAC Regions
-5.0%
-5.5%
Percentage Points
-6.0%
-6.5%
-7.0%
-7.5%
-8.0%
-8.5%
-9.0%
Caribbean
Central Am. +
Dom. Rep.
LAC-6 + URY
Other South Am.
Countries
Notes: 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)
8
Resilience: benchmarking LAC through the cycle
Resilience 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 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
and ahead of the MIC average
Cyclical Growth Dynamics in a Comparative Setting
Historic cycle
Current cycle
Historic cycle
Current cycle
-3.5
Notes: 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.
10
T+8
T+6
T+4
T+2
-4.5
T-8
T-6
T-4
T-2
T
T+2
T+4
T+6
T+8
T+8
T+6
T+4
T+2
T
T-2
T-4
-4.5
T-6
-4.5
-3.5
-2.5
T
Historic cycle
Current cycle
-3.5
-2.5
-1.5
T-2
-2.5
-1.5
-0.5
T-4
-1.5
-0.5
T-6
-0.5
0.5
Growth Rate (%)
Growth Rate (%)
0.5
T-8
Growth Rate (%)
0.5
High Income Countries
Middle Income Countries
T-8
Latin America & the Caribbean
Heterogeneity across LAC countries in terms of the length
of the recession (based on IP indexes)
Speed of Recovery
Months between peak and trough in IP Indexes
18
Number of months
16
14
12
10
8
6
4
2
0
Brazil Argentina Peru
Sources: World Bank’s Global Economic Monitor (Oct 2010).
Uruguay MexicoVenezuela Chile Colombia
11
Strength of the recovery: LAC recovering potential output
faster than the Tigers
Expected GDP Levels Relative to Trend GDP
Expected GDP Levels in 2010 and 2011
Relative to GDP in 2008
5%
35%
2010
30%
2011
2010
2011
0%
20%
Percent
Percent
25%
15%
10%
-5%
-10%
5%
-15%
0%
-5%
ECA
HIC
South
Africa
LAC
East
Asian
Tigers
India
-20%
China
ECA
HIC
South
Africa
East
Asian
Tigers
LAC
China
India
Expected GDP Levels Relative to Trend GDP
LAC Countries
30%
2010
2011
20%
Percent
10%
0%
-10%
-20%
Ant. & Barb.
Trin. & Tob.
Venezuela
Grenada
Belize
Honduras
Mexico
Costa Rica
Jamaica
El Salvador
Colombia
Nicaragua
Chile
Guatemala
Ecuador
Dom. Rep.
Suriname
Paraguay
Brazil
Panama
Dominica
Bolivia
Peru
Guyana
Argentina
Uruguay
-30%
Notes: 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).
12
Strength of the recovery: LAC growth in 2010 trails East
Asia, but some LAC countries with Asian-like growth rates
GDP Growth Forecasts for 2010 and 2011
Across Regions
10%
12%
2010
8%
2011
10%
GDP Growth Forecasts for 2010 and 2011
Across LAC Countries
2010
2011
6%
8%
4%
6%
2%
0%
4%
-2%
2%
-4%
0%
South
Africa
ECA
LAC
East
Asian
Tigers
India
Ant. & Barb.
Venezuela
Jamaica
Grenada
El Salvador
Trin. & Tob.
Dominica
Belize
Guatemala
Ecuador
Honduras
Nicaragua
Guyana
Costa Rica
Bolivia
Suriname
Dom. Rep.
Colombia
Mexico
Panama
Chile
LAC
Paraguay
Uruguay
Brazil
Peru
Argentina
-6%
HIC
China
2009 Real GDP Growth and Forecasts for 2010-11
Annual GDP Real Growth Rate, Weighted Averages
8%
2009
6%
2010
2011
4%
2%
0%
-2%
-4%
-6%
LAC-6 + URY
Other South Am. Central Am. + Dom.
Countries
Rep.
Caribbean
Country groupings are weighted averages. Haiti is not included among the Caribbean countries. Source: Consensus Forecasts (November 2010).
13
LAC: 2010 growth recovery has vastly exceeded
expectations…
Difference in 2010 Growth Projections
Nov-10 vs. Mar-09, Weighted Averages
4.0%
3.5%
7.1%
Current growth rate projection for 2010
8.4%
5.7%
Percentage Points
3.0%
2.5%
10.5%
2.0%
3.9%
1.5%
2.4%
1.0%
0.5%
0.0%
3.1%
-0.5%
-1.0%
South
Africa
High
Income
Europe &
Central
Asia
Source: Consensus Forecasts (March 2009 and November 2010).
China
India
Latin East Asian
America & Tigers
Caribbean
14
… especially among the most financially globalized
commodity exporting LAC countries
Difference in 2010 Growth Projections
Nov-10 vs. Mar-09, Weighted Averages
5.0%
Percentage Points
4.0%
Current growth rate projection for 2010
6.4%
3.0%
2.0%
3.5%
1.0%
-1.2%
0.0%
-1.0%
-2.0%
Other South Am.
Countries
Source: Consensus Forecasts (March 2009 and November 2010).
Central Am. + Dom.
Rep.
LAC-6 + URY
15
Resilience: benchmarking LAC through the cycle (2)
Shielding the poor
 While a year ago 10 million people were expected to fall into poverty ($4 a
day) in 2009, we now know (actual data) that only 2.1 million people did

Poverty increased mainly in Mexico and some Central American Countries; it actually
continued to decline (at a lower rate) in Brazil, Peru, Uruguay
 If poverty reduction is as elastic to growth as it was during the 2000-2007
expansion, 7 million Latinos will climb out of moderate poverty in 2010
Unexpectedly strong labor market performance
 During 2009, the LAC unemployment rate increased much less than in ECA
and slightly more than in the East Asian Tigers ...
 ... the increase in unemployment given the decline in GDP was much milder
than in previous crises
 ... the trend towards labor market formalization was not reversed …
 … and all this despite constant or increasing real average wages
16
Shielding the poor: milder increase in poverty compared
to the past and heterogeneous effects within the region
Change in Moderate Poverty
Change in Moderate Poverty
(US$ 4 a day)
(US$ 4 a day)
4
4
3
2
Percentage Points
1
0
-1
-2
-3
0
-2
-4
-6
2009 - 2010*
2008 - 2009
2007 - 2008
2006 - 2007
2005 - 2006
2004 - 2005
2003 - 2004
2002 - 2003
2001 - 2002
2000 - 2001
1999 - 2000
1998 - 1999
1997 - 1998
1996 - 1997
1995 - 1996
1994 - 1995
-4
1993 - 1994
Percentage Points
2
-8
Andean Region
2004 - 2005
2007 - 2008
Central America &
Mexico
2005 - 2006
2008 - 2009
Cono Sur Extended
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)
2006 - 2007
2009 - 2010*
17
Resilience: benchmarking LAC through the cycle (2)
Shielding 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 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
to the downturn than previously in most of LAC
Semi-Elasticity of Unemployment
with Respect to GDP Growth
2.5
Previous recession
Current Recession
2.0
1.5
1.0
0.5
0.0
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Note: 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.
19
Driving forces of resilience and performance
20
Driving 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-driven
Silent 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
LAC breaking with history: countercyclical macro policy
Monetary Policy Rates
Inflation-Targeting LAC Countries, in %
Monetary Policy
Changes in Monetary Policy Rates
16%
0%
Brazil
-1%
Percentage Points
14%
12%
Colombia
10%
8%
Mexico
Chile
6%
-2%
-3%
-4%
-5%
-6%
-7%
4%
US
2%
-8%
Peru
Chile
Jamaica
Colombia
Dom. Rep.
Peru
Brazil
Barbados
Uruguay
Honduras
Mexico
Trin. & Tob.
Paraguay
Guatemala
Nov-10
Jul-10
Sep-10
May-10
Jan-10
Mar-10
Nov-09
Jul-09
Sep-09
May-09
Jan-09
Mar-09
Nov-08
Jul-08
Sep-08
May-08
Jan-08
Mar-08
Nov-07
Jul-07
Sep-07
Argentina
Costa Rica
-9%
0%
Variation in the cyclically-adjusted primary surplus
(in percentage points of GDP)
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
In previous crises
-2.5
During current global crisis
-3.0
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Dom. Rep.
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.
23
LAC and the East Asian Tigers:
Flexible exchange rates cushioned the shock this time…
Latin America & Caribbean
Previous Crisis
130
130
120
Index Jul-97 = 100
Index Jul-97 = 100
120
110
100
90
110
100
90
80
80
Apr-97 May-97 Jun-97
Argentina
Mexico
Brazil
Peru
Jul-97
Aug-97 Sep-97
Chile
Venezuela
Oct-97
Jun-08
Argentina
Mexico
Colombia
Dom. Rep.
Jul-08
Aug-08 Sep-08
Brazil
Peru
Oct-08 Nov-08 Dec-08
Chile
Venezuela
Colombia
Dom. Rep.
East Asia & Pacific
Current Crisis
East Asia & Pacific
Previous Crisis
130
130
120
120
Index Jul-97 = 100
Index Jul-97 = 100
Latin America & Caribbean
Current Crisis
110
100
110
100
90
90
80
80
Sep-94
China
Philippines
Oct-94 Nov-94 Dec-94 Jan-95
Indonesia
Singapore
Korea, Rep.
Thailand
Feb-95 Mar-95
Malaysia
Jun-08
China
Philippines
Jul-08
Aug-08 Sep-08
Indonesia
Singapore
Oct-08 Nov-08 Dec-08
Korea, Rep.
Thailand
Malaysia
Notes: 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).
24
… not least because reduced currency mismatches helped
dispel the “fear of floating” in most of LAC
Share of the Domestic and Foreign Public Debt in Total Debt
Selected LAC Countries
Corporate and Banks' Dedollarization in LAC
80%
70%
100%
1990-1993
90%
80%
60%
70%
50%
40%
60%
50%
2006-2009
40%
30%
30%
20%
20%
2001-2003
10%
2006-2008
10%
0%
1998
0%
Corporate
Issues in Foreign Currency / Total Issues
Note: GDP-weighted averages of the periods noted.
Banks
Foreign Liabilities / Broad Money
Source: Gozzi et al. (2009), IFS
Sources: Gozzi et al (2009), Reinhart, Rogoff and Savastano (2003), IFS.
2008
Mexico
1998
2008
Colombia
Domestic
2002
2008
Brazil
Foreign
25
LAC breaking with history: no systemic damage at home
Financial Crises Around the World
26
The driving forces: policy-driven (2)
Safer international integration…
 The region became a net creditor in debt and a net debtor in equity
… in 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
international financial markets
10%
Net Creditor
Net Debt Position vis-à-vis Rest of the World
Net Equity Position vis-à-vis Rest of the World
A Safer Integration in Peru
Finance
10%
0%
0%
-10%
-20%
Percent of GDP
-10%
Net Debtor
Percent of GDP
Net Debtor
Net Creditor
A Safer Integration in LAC
Finance
-20%
-30%
-40%
-50%
-30%
-60%
Net Equity Position vis-à-vis Rest of the World
-70%
Net Debt Position vis-à-vis Rest of the World
Note: 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).
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-80%
1990
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
-40%
28
The driving forces: policy-driven (2)
Safer international integration…
 The region became a net creditor in debt and a net debtor in equity
… in 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
by common factors
Emerging Market Asset Returns and Common Factors
Average R-Squared from Country Regressions
100%
Early Period (2000-2005)
Late Period (Jan-05 to Jul-08)
Crisis (Aug-08 to Apr-09)
90%
Percent
80%
70%
60%
50%
40%
30%
20%
10%
0%
Equity
Foreign Exchange
CDS Spreads
Notes: 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.
30
The driving forces: policy-driven (2)
Diversification 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 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
intensifying trade and FDI links to Asia
LAC Exports to Selected Regions
as % of total exports, 2008 data
80%
EAP
Euro Zone
US
70%
Percent
60%
50%
40%
30%
20%
10%
Suriname
Barbados
Jamaica
Nicaragua
Trin. & Tob.
Honduras
Guatemala
Mexico
Bahamas
Guyana
Ecuador
Colombia
Belize
Dom. Rep.
Bolivia
Paraguay
Ecuador
Haiti
Panama
Venezuela
Uruguay
Argentina
Brazil
Costa Rica
Dominica
Peru
Chile
0%
Source: IMF’s Direction of Trade Statistics (DOTS).
32
Real de-coupling: growth in EMs has become more
sensitive to China and less sensitive to the G-7
Independent Variables:
G-7
G-7, Late
China
China, Late
CRB
WTI
α
Observations
R-squared
G-7 + G-7, Late
China + China, Late
Panel Estimations
Emerging Markets
(1)
(2)
(3)
0.432***
1.636***
0.988***
(0.000)
(0.000)
(0.000)
0.146**
-1.299***
-0.763***
(0.043)
(0.000)
(0.000)
0.850***
0.557***
(0.000)
(0.000)
0.420***
0.174***
(0.000)
(0.006)
0.091***
(0.000)
0.013***
(0.005)
0.028***
-0.086***
-0.040***
(0.000)
(0.000)
(0.000)
1357
1357
1357
0.12
0.578***
(0.000)
0.26
0.347***
(0.000)
1.270***
(0.000)
0.30
0.226***
(0.000)
0.731***
(0.000)
LAC-7
(4)
1.936***
(0.000)
-1.54***
(0.000)
0.847***
(0.000)
0.535***
(0.000)
0.060*
(0.058)
-0.023**
(0.012)
-0.101***
(0.000)
264
0.26
0.397***
(0.000)
1.382***
(0.000)
CRB
(5)
0.960
(0.253)
China
(6)
0.052
(0.592)
2.826***
(0.000)
-0.269***
(0.000)
63
0.097***
(0.000)
64
0.27
0.00
Panel Estimations
Non-Euro Advanced Economies
(7)
(8)
0.327*
0.169
(0.081)
(0.435)
0.492**
0.487**
(0.033)
(0.039)
0.121*
0.050
(0.067)
(0.511)
-0.153***
-0.223***
(0.005)
(0.002)
0.000
0.028*
(0.000)
(0.069)
0.000
0.002
(0.000)
(0.611)
264
264
0.42
0.818***
(0.000)
-0.054
(0.579)
0.43
0.657***
(0.000)
-0.172
(0.123)
Notes: 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.
33
The co-movement of growth between LAC countries and
China has been clearly trending upward…
Output Co-Movement Between LAC and China
20 years rolling correlation of the Real GDP Growth
0.8
0.6
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
Source: National Authorities. Note: Solid colors reflect correlation values significant at a 10% confidence interval.
2008
34
The driving forces: exogenous factors
Rebound 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 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
effects across the region
Cumulative Change in Terms of Trade
150
350
Wheat
110
Copper
250
Soybean
90
200
70
150
50
100
Oil (rhs)
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
Jan-07
May-07
Sep-06
May-06
Jan-06
Sep-05
30
May-05
50
Oil WTI, Current US$
130
300
Jan-05
Wheat, Copper and Soybean, 01-Jan-05=100
Commodity Prices
Oil WTI in Current US$, Wheat, Copper and Soybean: Index 01-Jan-05=100
Bolivia
Ecuador
Chile
Paraguay
Trin. and Tob.
Colombia
Peru
Argentina
Mexico
Uruguay
Brazil
Panama
Guatemala
Costa Rica
Nicaragua
Dominica
Dom. Rep.
Honduras
-40%
2008q4 - 2009q4
2001q4 - 2008q2
-20%
0%
20%
40%
60%
80%
100%
120%
Around 93% of LAC’s population and 97%
of its economic activity is in countries
which are net exporters….
Source: Bloomberg.
36
140%
The driving forces: exogenous factors
Rebound 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 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
A swing from risk aversion to risk appetite is boosting
capital flows to EMs
Financial Conditions Indexes
Lehman
United States Financial Stress
5
VIX
CBOE Volatility Index
Citi's Memo Greece
6
100
Citi's Memo
Greece
Lehman
90
St Louis Federal Reserve Bank Financial Stress Index
80
4
70
3
60
2
50
40
1
30
0
20
-1
10
Oct-10
Dec-09
May-10
Jul-09
Feb-09
Sep-08
Apr-08
Jun-07
Nov-07
Jan-07
Mar-06
Aug-06
Oct-05
Dec-04
May-05
Jul-04
Feb-04
Sep-03
Apr-03
Nov-02
Jan-02
Oct-10
May-10
Jul-09
Dec-09
Feb-09
Sep-08
Apr-08
Jun-07
Nov-07
Jan-07
Mar-06
Aug-06
Oct-05
May-05
Jul-04
Dec-04
Feb-04
Sep-03
Apr-03
Jun-02
Nov-02
Jan-02
Sources: Bloomberg
Jun-02
0
-2
38
Capital flows to LAC have surged in 2010 to levels higher
than those observed in 2007
Source: National BOP data. LAC-7 countries comprise Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.
39
Policy challenges
(Assuming the HICs do not drag all down)
40
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 rebalancing
Interest rate
differentials / risk
appetite comeback
HIC-EM
asymmetry:
output gap &
inflation
pressures
“Frothy” capital
inflow surge to EMs
Global imbalances
EM resistance
to appreciation
(to dollar
depreciation)
Lower than otherwise
interest rates in HICs
 QE2
• Global coordination failure
• What is good for a particular nation is not necessarily good for the world
42
Currency appreciation pressures are already felt and
bound to intensify in several LAC countries…
Chile
Brazil
Colombia
8.0
-4.0
-6.0
-3.0
-6.0
Appreciation pressures
Reserve Accumulation
Appreciation pressures
Exchange Market Pressure
Reserve Accumulation
Appreciation pressures
Reserve Accumulation
6.0
5.0
2.0
4.0
1.0
3.0
0.0
2.0
1.0
-1.0
0.0
-2.0
Appreciation pressures
Reserve Accumulation
Exchange Market Pressure
Appreciation pressures
Sep-10
Jan-10
Sep-08
May-09
Jan-08
Sep-06
Reserve Accumulation
May-07
Jan-06
May-05
Jan-04
Sep-04
May-03
Sep-02
Jan-02
May-01
Sep-00
Jan-10
Sep-10
May-09
Sep-08
Jan-08
May-07
Jan-06
Sep-06
May-05
Jan-04
Sep-04
May-03
Jan-02
Sep-02
May-01
Jan-00
-3.0
Sep-00
-2.0
-4.0
Jan-00
-1.0
-3.0
Exchange Market Pressure
Note: 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
Jan-10
Exchange Market Pressure
Peru
Mexico
3.0
Sep-10
May-09
Jan-08
Sep-08
May-07
Jan-06
Sep-06
May-05
Jan-04
Sep-04
May-03
Jan-02
Sep-02
May-01
Jan-00
Exchange Market Pressure
Sep-00
Jan-10
Sep-10
May-09
Jan-08
Sep-08
May-07
Jan-06
Sep-06
May-05
Jan-04
Sep-04
Sep-02
May-03
Jan-02
May-01
Jan-00
6.0
Sep-00
Sep-10
Jan-10
-4.0
May-09
-2.0
-2.0
Jan-08
-2.0
Sep-08
0.0
May-07
0.0
-1.0
Jan-06
0.0
Sep-06
2.0
May-05
1.0
Jan-04
2.0
Sep-04
4.0
May-03
2.0
Jan-02
4.0
Sep-02
3.0
May-01
6.0
Jan-00
4.0
Sep-00
8.0
43
Policy 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
 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 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, macroprudential 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
to turn the cyclical recovery into higher long-run growth?
Relative GDP Per Capita of Selected Regions relative to the US
80%
Gold Standard
Period
Interwar Period
Lost
Decade
Import Substitution
Washington
Dissensus
70%
Washington
Consensus
60%
50%
40%
LAC/US
30%
Asian Tigers/US
20%
10%
Peru/US
Source: Maddison (2009) and IFS’s WEO (October 2010)
2008
2002
1996
1990
1984
1978
1972
1966
1960
1954
1948
1942
1936
1930
1924
1918
1912
1906
1900
0%
47
The latest commodity price boom has been unusually
broad-based and long-lasting
LAC-7 Economies: Share of Commodities Experiencing a Boom
100
terms of the number of
commodities it affected…
… and the number of
countries it benefited
 For LAC, it has been the
80
60
40
20
0
Jan-62
May-64
Sep-66
Jan-69
May-71
Sep-73
Jan-76
May-78
Sep-80
Jan-83
May-85
Sep-87
Jan-90
May-92
Sep-94
Jan-97
May-99
Sep-01
Jan-04
May-06
Sep-08
longest lasting boom since
records have been kept
share LAC commodities in boom %
 The most comprehensive in
LAC-7 commodity index in boom
LAC-7 commodity index in bust
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.
48
Natural resource curse hypothesis: should LAC worry
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 savings – needed to convert natural capital into
other forms of wealth … even if prices were not volatile
 Sad reality: savings negatively
20
Too much of the rent is consumed,
not invested
Adjusted net saving (% of GNI)

40
correlated with resource rents
 Harsh reality: difficult to save
 The pace of local investment of
LT savings matter – to avoid
Dutch Disease
VEN
PER
0
CHL BOL
ECU
-20

High social discount rate, given
pressing development needs
Difficulties in organizing collective
action in inter-temporal horizon
MEX
DOM ARG
GTM
NIC
BRACOL
TTO
-40

HND
0
20
40
60
80
Non-renewable resource rents (% of GNI)
100
50
And 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
Approval Ratings of Government
90
80
Lehman Brothers
70
60
50
40
30
Chile
Ecuador
Bolivia
Venezuela
100
Feb-06
May-06
Aug-06
Nov-06
Feb-07
May-07
Aug-07
Nov-07
Feb-08
May-08
Aug-08
Nov-08
Feb-09
May-09
Aug-09
Nov-09

51
Thank you
52