Latin America must beef up financial regulation, cut
spending and make currencies more flexible, to combat the
threat of asset bubbles and economic overheating, the IMF has
There is obviously the risk that markets get ahead of
themselves, Nicolas Eyzaguirre, director of the western
hemisphere department at the IMF, said. The unprecedented
situation requires new frameworks and a new response, he
told Emerging Markets in an interview.
Demand for emerging market risk has meant that the so called
impossible trinity the hypothesis that its
impossible to manage exchange rates, control inflation and
allow the free movement of capital at the same time has
returned with a vengeance in Latin America.
Raising interest rates to curb domestic credit supply risks
attracting more capital inflows, as foreign investors rush for
yield amid ultra-low interest rates in mature markets,
Eyzaguirre said. Fiscal policy should be tightened but it
can not do all the work, he argued.
He said countries should adopt flexible exchange rates, as
undervalued currencies tend to trigger a surge in foreign
currency debt by domestic companies and attract more
Strong prudential measures in banking are needed, Eyzaguirre
said, but many countries do not have those frameworks in
place. As a result, we can see room for capital
controls even though they are more blunt in nature.
Brazil and Colombia have imposed restrictions on foreign
capital inflows in the past year, followed by emerging market
counterparts Taiwan, Indonesia and South Korea.
Eyzaguirre said valuations in Brazilian markets are not in
bubble territory, but that the risk of overheating of the
economy looms large, as a result of foreign investment and
strong commodity prices. You need to pay attention, so
that the economy does not grow faster than the current
structure of production can support.
Henrique Meirelles, president of the Brazilian central bank,
said in Cancun: The first line of defence [against
bubbles] is prudential rules. And we are on top of that.
He was referring to new regulations that force companies to
disclose derivative and foreign currency debt exposures.
Eyzaguirre said the policy challenge of ensuring stability
given the required co-ordination between fiscal, monetary and
banking authorities was a very new situation and in
many ways a greater challenge than the global