Brazilian president Luiz Inacio Lula Da Silvas quip in
mid-2008 that the global financial crisis was the wests
problem "Bushs crisis", as he famously put it
might have gone down in history for its sheer conceit.
By the end of that year, Brazil had suffered its sharpest slump
in a decade, snuffing out any lingering belief that Latin
Americas largest economy was immune to the crisis then
sweeping the globe.
But eighteen months on,
rather than being derided for its arrogance, Lulas jibe
has taken on new meaning for much of Latin America not
just Brazil as the region stages an unprecedented
rebound, following its worst recession in a generation.
Latin America withstood
the onslaught of the crisis remarkably well in sharp
contrast to previous bouts of global financial turmoil. Across
the region, a combination of healthy foreign exchange reserves,
improved current accounts and healthier fiscal positions helped
Latin economies on the way into the crisis; and when disaster
finally struck, flexible exchange rates and strong banking
systems helped absorb the impact, while pump priming and a
large monetary impulse have since nudged the region towards a
The Institute of
International Finance (IIF) forecasts output in the region will
surge by 4.8% this year, led by Brazil, Chile and Peru,
following a 2.3% contraction in 2009. And confidence abounds.
Brazils finance minister Guido Mantega says Brazil is on
course for 5.2% growth this year, its best economic performance
since 2007, when GDP increased 6%. And Mexico despite
last year having suffered a 6.5% contraction, its worst slump
since 1932 has raised its estimate for 2010 economic
growth to 3.9%, citing signs of recovery in internal and
"I think in general
things are going well in Latin America," Guillermo Ortiz,
Mexicos former central bank governor tells Emerging
Markets. "The crisis caught the continent in a much better
position. It only really hit Latin Americas real
Yet broader economic
conditions remain weak: despite a rebound in trade, Latin
Americas export contraction hasnt let up,
especially for non-commodities; remittances a key source
of revenue across the continent are likely to remain
constrained because of persistent unemployment in the developed
world; and fiscal expansion is pushing up deficits that will be
increasingly hard to finance. Before the world economy fully
recovers many countries will either have to curb expenditures,
raise taxes, or both.
"Latin America weathered
this crisis fairly well its the first time in a
long time. But I feel fairly strongly that policy-makers are
now too complacent," says Claudio Loser, senior fellow at the
Inter-American Dialogue and former western hemisphere head at
the IMF. "The euphoria is not justified."
The sharp improvement in
external factors in early 2009 led to a substantial turnaround
in capital flows. As a result, the emphasis of immediate
macroeconomic policy shifted dramatically from recession
fighting to coping with a strong rebound in capital inflows,
booming asset prices and credit and rapidly appreciating
currencies in short, preventing overheating.
Eyzaguirre, the IMFs Western Hemisphere director, says:
"The stage is set for a bubble to develop. There is obviously
the risk that markets get ahead of themselves and take a
transitory situation as more permanent in nature."
"Economies could grow
more than they are able to sustainably," adds Eyzaguirre.
"Fiscal outlays could take an overly positive reading of the
Gray Newman, managing
director and senior Latin America economist at Morgan Stanley,
also believes that widespread over-exuberance could cloud the
policy perspective. "The market has focused so much on the
cycle. But whats not acceptable is for policy-makers to
fall into the trap of following market participants. The
problem is when policy-makers begin to get caught up in the
euphoria of the investment community thats the
risk for 2010/2011."
The contrast in attitudes
today between the regions central banks and finance
ministries coming out of the crisis is striking, says Liliana
Rojas-Suarez, senior fellow at the Center for Global
Development and a former chief economist at Deutsche Bank. The
former are "extremely aware of dangers and are not complacent
at all. But when we move to the fiscal side the situation is
very different: politics start playing a much larger role."
Unwinding fiscal policy
would reduce demand from the private sector and so "reduce the
risk of overheating," according to Alejandro Izquierdo,
principal economist at the IDBs research department.
Countries that pursued
fiscal expansion during the crisis must rein in spending while
the going is good, he warns. "This is the time to start cutting
back. You need to unwind in the good times or else you
cant have counter-cyclical policy in the next crisis. And
you can only have counter-cyclical policies in a crisis if you
At the outset of the
crisis, Latin America found it difficult to implement
counter-cyclical fiscal policies, Rojas-Suarez points out. Only
Chile and Peru undertook fiscal stimulus without risking the
sustainability of their public debt.
In contrast, Brazil,
which undertook a significant expansion, there is a source of
growing concern over policy-makers ability to reverse
fiscal stimulus including curtailing lending from state
development bank BNDES especially in an election
"Latin American found it
very difficult to adopt expansionary policies, but theyre
going to find it even harder to contract the fiscal stance,"
says Rojas-Suarez. "Its time to start talking about exit
minister Guido Mantega insists that the situation is
manageable. "We are going to be on target, because the country
is fiscally responsible and has little external vulnerability,"
he tells Emerging Markets in an interview.
But that view is not
universal. "I fear for Brazil," says Rojas Suarez. "If they
dont reverse the fiscal expansion they are going to find
themselves in a situation where the fiscal position could be
"Investors are now
clearly differentiating countries, but they have not yet priced
in the potential for a fiscal problem in Brazil. But its
there," she adds.
have shown little intention of changing expansionary policy
apart from phasing out a series of tax breaks that fuelled the
consumer market in times of crisis.
Fitch notes that the
countrys gross general government debt burden of over 70%
of GDP will remain roughly 30% above Mexicos, hammering
home the need for Brazil to unwind its expansion as the
economic recovery takes hold.
Still, fiscal policy is
only one albeit critical part of the story. As
Eyzaguirre notes: "You can have fiscal policy in check, but if
financial intermediation gets too bullish, you get a private
credit boom and you could end up with a bubble very
He says authorities
should also focus on monetary, exchange rate and prudential
regulations. "You cant put all the weight on one policy.
You cant just do fiscal or monetary or exchange rate or
prudential or capital controls. You have to do a little bit of
But perhaps a bigger
concern is Latin Americas vulnerability to external
factors a reality which remains largely undiminished and
Newman notes that although the downturn turned out to be
shorter than expected, it was interrupted and reversed
principally by a significant turnaround in China.
"It was a significant
policy reaction from the Chinese authorities that began to turn
this around in the first months of 2009," he says. Had the
downturn lasted significantly longer, "the region would have
suffered disproportionately more than some of the developed
countries. We shouldnt forget that."
Newman says that "some of
the glow that is surrounding emerging markets today could rub
off" if the global economic recovery stalls. He says:
"Lets not confuse what has been some of the very strong
cyclical positives for the region with some of the [structural
reform] agenda that has yet to be resolved."
Says Rojas-Suarez: "The
real story is that Latin America is following the global cycle.
We should not have illusions that Latin America on its own has
been able to avert a major collapse. This is an illusion. The
truth is that the lions share has been determined by
The IDBs Izquierdo,
together with Ernesto Talvi, executive director of CERES, a
Uruguay based think tank, argue in a recent paper ("The
Aftermath of the Crisis") that strong fundamentals at the
country level might alone not be enough to stave off
fundamentals played a role, the "key innovation" during the
past crisis was "the readiness" of international financial
institutions principally the IMF to act as lender
of last resort at the height of the turmoil.
Izquidero and Talvi lay
out two scenarios for the global economy which could have
vastly different consequences for Latin America (see chart).
Under the benign scenario, China maintains double-digit growth
while developed economies expand their output around 2% a year.
Global liquidity stays abundant, international capital keeps
flowing, and commodity prices recover further. The result would
be roughly 3% average growth for Latin Americas biggest
economies in 2010, increasing to a yearly average of 5% from
But they present a
sobering and equally plausible alternate
scenario. In it, increasing private sector demand in industrial
countries and inflationary pressures signals the end of
quantitative easing and triggers tighter monetary policy
and substantially higher real interest rates in rich countries.
This leads to a crowding out of capital flows in 2011 and
Under this scenario,
growth in China decelerates sharply, bringing commodity prices
down and resulting in widening spreads on emerging market debt.
As in the benign scenario, average GDP growth for Latin America
would be 3% in 2010, but it would peak in 2011, and then drop
to below 2% by 2014 as external conditions for emerging markets
"In this less benign
global scenario, fiscal consolidation is less likely to take
place," says Izquierdo.
The risks of another
global downturn can hardly be discounted. A growing number of
prominent voices including Harvard economist Ken Rogoff
are warning of a potential crash for Chinas
economy. Fearing overheating, authorities have raised
banks reserve requirements twice this year after economic
growth surge and property prices rallied.
All the more reason for
policy-makers to take heed. Says Ortiz: "We need to take
advantages of these better times in Latin America to continue
the process of fiscal consolidation, to keep bringing down debt
to GDP levels, continuing being more efficient in our
economies, pushing through badly needed structural