Latin America urged to cut spending

08/10/2010 | Thierry Ogier

The IMF and World Bank are calling on Latin American governments to slash spending to stem the risk of economic overheating

De la Torre: "the sooner the better"

Washington institutions are urging Latin economies to tighten fiscal policy “the sooner the better” to avoid overheating, instead of leaving the burden entirely on monetary policy.

Their advice comes as economists sound the alarm over spending cuts in advanced economies.

The World Bank’s chief economist for Latin America and the Caribbean, Augusto de la Torre, launched an “urgent” call to policymakers to redress their fiscal and monetary policy mix, now that the worst of the global financial crisis is behind them.

“Fiscal policy in many countries in Latin America has become procyclical, therefore shifting the burden even more on to central banks,” he told Emerging Markets.

Nicolas Eyzaguirre, Western hemisphere director at the IMF, said: “You do not have particularly contractionary fiscal policies in Brazil, Chile or Argentina. We trust that they [Latin American countries] will tighten fiscal policy in due course.

“Mexico is more proactive, they have started the fiscal tightening cycle at a proper time. It is too soon to say countries are surrendering to short term pressures. They are still on time. What I would advise is the sooner the better.”

Just a handful of countries are in recession, such as Venezuela and Haiti, while Central America also registers a “lacklustre” performance.

Meanwhile, several South American countries are cruising towards more than 7% growth, but Eyzaguirre worries that this “cannot go on forever. ... It is good, if not too good, but it does not look sustainable,” he said, adding that a slowdown towards 4% next year would be desirable.

Eyzaguirre said a firm policy response is needed. “This is contingent on government adjusting their policies to avoid overheating. When you are growing, the population is happy, sometimes it takes time for the government to begin to do some retrenchment.”

The threat of overheating is becoming clear. De la Torre believes policymakers are addressing the issues, but that more could be done. “Many central banks have been very proactive to pre-empt inflationary pressures”, he said.

“[But] central banks are overburdened with this task – monetary policy shouldering most of the burden – it would be desirable for fiscal policy to complement that effort.”

Such “bad equilibrium” does not necessary means trouble, but it implies that “the Latin American ability to grow on a non inflationary path is weaker than in the East Asian tigers,” said de la Torre. “It may promote fiscal profligacy and foster financial excesses in emerging markets.

“The region therefore needs to start addressing the issue of resiliency in good times in earnest, significantly rebalancing the policy mix. A shift of gears is needed to unburden monetary policy.

“The stimulus implemented during the crisis should be withdrawn and fiscal and financial buffers rebuilt. So far, very little is being done, especially on the fiscal front but also on the macro-prudential front. A much more substantial role should be played by fiscal adjustment and increased public savings.”

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