What a difference a year makes. A year ago, at the Inter-American Development Bank’s 45th annual meeting of the board of governors in Peru, the talk was of a modest recovery after five years of stagnation. Latin America and the Caribbean had grown by 1.5% in 2003, an incipient rebound that was in welcome contrast to the contraction of the previous year. Yet, the mood was still cautious, reflecting the fragility of the revival.
A year later, on the opposite side of the world in Okinawa, Japan, there was an altogether different tone to the bank’s 46th annual meeting. Its governors – finance ministers and central bank governors – were able to crow about growth of 5.7% across the region, easily outstripping the most optimistic forecasts a year earlier and the fastest expansion since 1980. With the exception of Haiti, every Latin American and Caribbean country recorded positive growth, pushing aggregate per capita income up more than 4%, in contrast to a cumulative 1.7% decline over the previous five years. And for the first time in several years the unemployment rate in the region fell.
Asian demand
Though the long trip to Japan had presented delegates with a travel headache (causing many to abandon the trip), it was fitting that the meeting was held in Asia, given that it is Asian demand for Latin America’s resources in particular that has fuelled vigorous growth. Allied to and because of this, sharp rises in the price of commodities, especially petroleum, soya, coffee and metals, pushed exports up 23% in nominal terms last year.
But underpinning the recovery was more than just robust demand for commodities from Asia and other parts of the world; the revitalisation of business investment and household consumption also took place in 2004. Just as important, foreign direct investment was back – the $45.8bn in investment capital that flowed into Latin America and the Caribbean was only slightly up on 2002 but marked a healthy turnaround from the 20% drop-off in 2003.
There is also good news from crisis-hit countries such as the Dominican Republic, where President Leonel Fernandez is winning plaudits for his tough measures to restore stability to the economy. In Uruguay, which fell victim to the Argentine financial crisis, an agreement with the IMF is being negotiated. Growth is expected to top 6% in 2005 while the fiscal deficit should narrow to just 2% of GDP.
To an extent, it appears that past lessons have been learnt. Despite vigorous growth, inflation across the region slowed to an average of 7.4% – a revolution compared with the triple-digit inflation that was raging in the region in the early 1990s. And this time nearly all countries were able to improve their fiscal accounts. Improvements in debt management policies lowered foreign currency-denominated and exchange-linked debt in countries such as Brazil and Mexico. Colombia successfully issued a $375m peso-denominated bond that won praise from all quarters. And many countries have taken advantage of favourable market conditions to pre-finance a large portion of their obligations coming due in 2005 and build foreign exchange reserves as a cushion against future turbulence.
Analysts wary
But for all the good feeling, an ominous note of caution was sounded. Despite the appearance of improved economic management, some analysts are as yet unconvinced of the extent to which the region has progressed towards controlling spending, implementing fiscal reforms and taking advantage of the current upswing to prepare for future downturns. Some countries, such as Argentina and Venezuela, have increased primary spending to boost growth and finance populist measures.
While economic conditions permitted an improvement in fiscal balances, countries such as Argentina, Brazil, Colombia, Costa Rica, Ecuador, Peru, Uruguay and Venezuela still have relatively high public sector debt-to-GDP ratios, making them vulnerable to a tightening of liquidity in capital markets – exactly the trend now under way.
With 10 Latin American countries going to the polls before the end of 2006 to elect presidents, reform momentum has slowed, including the fiscal reforms that are needed to make these countries’ public finances less vulnerable to external shocks. In Colombia, Ecuador and Mexico important reforms have ground to a near-halt pending the outcome of elections or the resolution of political impasse.
Moreover, leftist politics are gaining traction across the region, with Uruguay the fifth country to elect a left-wing leader in Tabare Vazquez. Though this trend has not diverted the likes of Brazil and Chile – and so far Uruguay – away from orthodox fiscal and monetary policies, the governments of Argentina and Venezuela have revealed populist sensibilities.
An International Institute of Finance research brief highlights the Argentine government’s refusal to negotiate utility tariff increases, its attempts to use non-market mechanisms to prevent price increases, its recent attack on foreign investors and its unilateral and confrontational approach to its sovereign debt restructuring, which have all raised serious questions about its approach to the private sector and private capital. In Venezuela, the government has set minimum sectoral credit requirements that banks must follow in allocating their loan portfolios and foreign exchange controls have become a permanent feature of policy.
New phenomenon
IDB president Enrique Iglesias believes that indications of political discontent and fatigue in the region – a consequence of ordinary people not seeing a substantial development dividend from democracy – are hardly surprising. In his view, democratic shifts have taken place mostly in the political sphere – political freedoms, the upholding of human rights and the seating of governments by free, competitive elections – but a push for democracy as the “institutional scaffolding” that sets the stage for growth and development is a relatively new phenomenon in Latin America.
“There are some worrisome signs of a return to populism,” says Mr Iglesias. Bolivia, Ecuador and Peru all face such discontent and disillusionment. Peru has enjoyed 43 consecutive months of economic expansion but its failure to spread economic prosperity has alienated voters from the political system.
Progress in other reforms has also been limited. Mr Iglesias stresses the obvious but hard to achieve: Latin America and the Caribbean must avoid over-specialising again in raw materials that are vulnerable to cyclical swings in demand. To avoid this, a number of microeconomic impediments must be eliminated. A reflection of such impediments is the fact that Latin America’s productivity growth has been and remains slow – during the 1990s it averaged 0.7% of GDP compared with 2.7% in east Asia.
The reasons are obvious, say analysts. Low trade integration with the rest of the world (total trade is only 45% of the region’s GDP, compared with nearly 80% in east Asia), rigid labour markets, weak property rights and judicial systems, and lack of access to credit, particularly for small businesses hold the region back.
The World Bank’s “Doing Business” survey ranks Latin America as the toughest region to do business in a number of categories. And the IDB’s 2004 annual report notes: “There appears to have been very little policy action to improve the investment climate and the quality of economic regulation.”
If there are question marks over the pace of domestic reform, the consensus view is that the external environment will be benign if not favourable throughout 2005 and 2006. Such optimism is, however, predicated on a number of assumptions. With interest rates in the US and other industrialised countries trending upwards, the pressure will be on central banks to tighten monetary policy while borrowing costs for Latin American countries will head upwards. Added to this is the moderation in global growth that is likely to result from rising interest rates, which will cool Latin America’s export growth.
There is no question that the external environment will be less conducive to growth in 2005 than it was a year ago – what remains to be seen is how severe the deterioration may be. A hard landing in China, for instance, would deflate commodity prices more rapidly than the hoped-for managed slowdown of the economy. A steeper rise in the US interest rates would also inflict damage, reducing capital flows to the region and hitting financing charges.
Possible reversal
The improvements in public sector debt-to-GDP ratios observed in many countries could be reversed in 2005, symptomatic of many countries’ failure to follow through with liability management initiatives designed to reduce foreign exchange denominated debt and variable interest rate debt.
Growth across Latin America and the Caribbean is forecast at 4.5% in 2005, translating into a per capita growth rate of almost 3%. If that rate can be sustained until 2015, then the region will succeed in meeting the Millennium Development Goal of halving extreme poverty. But as José Luis Machinea, executive secretary of the Economic Commission for Latin America and the Caribbean, points out, it would mark a dramatic departure from historical growth rates that have average just 1.2% per capita between 1990 and 2004. Latin America is enjoying a boom now but its sustainability is far from assured.
