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AmericasMarch 6 2006

Latam recovery looks solid

All signals point to the Latin American economic recovery being sustainable, as governments have increasingly demonstrated fiscal responsibility, argues Luis A Moreno.
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Growth rates in Latin America (Latam) suggest that, in the midst of the current recovery, governments in the region have adopted macroeconomic policies aimed at ensuring long-term prosperity rather than giving in to the cyclical tendencies that have dominated their fiscal and monetary policies in previous booms.

After more than five years of near stagnation, the regional economy has grown at an annual average rate of 4.9% in the past two-and-a-half years. In 2005, it grew by 4.3%; a similar rate is expected for this year. For three years, the current account balance has been positive. Most countries had modest net external financing requirements and accumulated international reserves in 2005. Inflation has remained under control, despite the recovery of domestic demand and cost-push pressures due to high oil prices. On average, inflation in the region fell from more than 11% in 2002 to about 5.5% at present.

Domestic policies

The external environment has played a key role in the recovery. World economic growth was at its highest level in 30 years in 2004, and capital inflows to emerging markets increased significantly in the past two years, totalling $99bn in 2004.

While the region’s 2005 growth rate was modest considering the highly favourable international financial environment, it is evidence of the cautionary measures taken by most Latam countries to avoid overspending their transitory fiscal revenues.

Recent fiscal policy has been managed in most Latam countries with stabilisation criteria, whereas traditional fiscal management contributed to accentuating the cycles and intensifying instability. The average fiscal deficit in the region fell from 3.2% in 2002 to 0.5% in 2005, and average public indebtedness fell from 72% to 53% of GDP in the same period.

Monetary policies have also tended to be managed with stabilisation criteria. The system of inflation targets, which some of the region’s largest economies have adopted, has been successful in reducing inflation in the context of a more credible monetary policy, with less sacrifice in terms of growth. Low external interest rates have allowed domestic interest rates to fall as well.

Favourable conditions

Various governments in the region have taken advantage of favourable international financial conditions to pre-finance future debt payments, anticipating the uncertainty that elections or other events could bring. Some have extended the term of their obligations and reduced the proportion of their debts in foreign currency. This has allowed them to reduce the risk factor in relation to external shocks from financing or terms of trade, which would lead to higher exchange rates.

The fiscal responsibility that Latam governments have demonstrated in recent years can be attributed mainly to legislatures that have set limits to debt and deficits, giving more fiscal authority to the central governments and ministries of finance, and increasing the transparency of fiscal accounts. With 12 presidential elections due to take place in the region between November 2005 and December 2006, however, concerns have arisen about policy continuity.

Several factors seem to belie the view that new administrations, some of them left-of-centre, will stray away from prudent economic management. One is that a lack of fiscal or monetary discipline has been the exception rather than the rule among current centre-left governments in the region, partly because voters have punished administrations that have allowed inflation to rise. Moreover, new leaders will have to build coalitions across political boundaries to secure effective governance.

According to the latest Latinobarómetro survey, most Latin Americans think that the market economy is the only system that can help to develop their countries. In Venezuela, for example, 66% of the population believes there is no better system than a market economy, despite all its defects.

Markets seem to be discounting a move away from sound fiscal and monetary policies. Even in the face of rising interest rates in the US and an intensive electoral cycle, spreads on Latam bonds are at record lows. Besides, the region’s stock markets have been performing strongly for the past two years, attracting growing foreign investment. Investor interest is a weighty reason to continue to be optimistic about Latin America’s prospects.

Luis A Moreno is president of the Inter-American Development Bank.

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