Maintitle

Copyrights

Alicia Bárcena

Executive Secretary

Antonio Prado

Deputy Executive Secretary

Osvaldo Kacef

Chief

Economic Development Division

Ricardo Pérez

Chief

Documents and Publications Division

www.eclac.org/de

The Economic Survey of Latin America and the Caribbean is issued annually by the Economic Development Division of the Economic Commission for Latin America and the Caribbean (ECLAC).This edition was prepared under the supervision of Osvaldo Kacef, Chief of the Division; Jürgen Weller was responsible for its overall coordination.

In the preparation of this edition, the Economic Development Division was assisted by the Statistics and Economic Projections Division, the Division of International Trade and Integration, the ECLAC subregional headquarters in Mexico City and Port of Spain, and the country offices of the Commission in Bogota, Brasilia, Buenos Aires, Montevideo and Washington, D.C.

Chapter I, “Regional overview”, was prepared by Osvaldo Kacef with input from Vianka Aliaga, Claudio Aravena, José Manuel Arroyo, Rodrigo Cárcamo, Fernando Cantú, Juan Pablo Jiménez, Luis Felipe Jiménez, Cornelia Kaldewei, Sandra Manuelito, Ramón Pineda and Jürgen Weller. The chapters of the second part drew on material written by consultants Mario Abuhabda, Ricardo Carneiro and Roberto Zahler, and on inputs prepared by officials of the Economic Development Division and other participants in a workshop held in Santiago in April 2011 and partly financed by the Federal Ministry for Economic Cooperation and Development of Germany and the German Agency for International Cooperation.

The country reports are based on studies conducted by the following experts: Martín Abeles (Argentina), Olga Lucía Acosta and Alejandra Corchuelo (Colombia), Dillon Alleyne (Guyana and Jamaica), Claudio Aravena (Ecuador), José Manuel Arroyo (Paraguay), Rodrigo Cárcamo (Bolivarian Republic of Venezuela), Álvaro Fuentes (Uruguay), Juan Alberto Fuentes (Cuba), Randolph Gilbert (Haiti), Michael Hendrickson (Bahamas and Belize), Luis Felipe Jiménez (Chile), Beverly Lugay (Eastern Caribbean Monetary Union), Sandra Manuelito (Peru), Rodolfo Minzer (Panama), Carlos Mussi (Brazil), Ramón Padilla (Costa Rica and Mexico), Benjamin Rae (Plurinational State of Bolivia), Juan Carlos Rivas (Guatemala), Kelvin Sargeant (Barbados, Suriname and Trinidad and Tobago), Francisco Villarreal (Dominican Republic and El Salvador) and Willy Zapata (Honduras and Nicaragua). Benjamin Rae reviewed the notes for the Caribbean countries.

The economic projections were prepared by Claudio Aravena, Fernando Cantú and Sandra Manuelito. Alejandra Acevedo, Vianka Aliaga, Leandro Cabello, Jazmín Chiu, Diana Fajardo, Rodrigo Heresi, Isabel López and Damián Vergara were responsible for the processing and presentation of the statistical data.

Notes

In this publication, the term “country” is used to refer to territorial entities, whether these are States as understood by international law and practice or simply territories for which statistical data are maintained on a separate and independent basis.

The word “dollars” refers to United States dollars, unless otherwise specified.

The following symbols have been used in the tables shown in the Survey: Three dots (…) indicate that data are not available or are not separately reported. A dash (-) indicates that the amount is nil or negligible. A point is used to indicate decimals.

United Nations Publication

ISBN: 978-92-1-121765-0 • ISSN printed version: 0257-2184 • ISSN CD-ROM: 1811-6191

E-ISBN: 978-92-1-055012-3

LC/G.2506-P • Sales No.: E.11.II.G.3

Copyright © United Nations, November 2011. All rights reserved

Printed in Santiago, Chile • 2011-552

Applications for the right to reproduce this work, either in whole or in part, should be sent to the Secretary of the Publications Board, United Nations Headquarters, New York, N.Y. 10017, U.S.A. Member States and their governmental institutions may reproduce this work without prior authorization, but are requested to mention the source and inform the United Nations of such reproduction.

Contents

Foreword

Executive summary

Part 1

The economic situation in Latin America and the Caribbean in 2010-2011

Chapter I

Regional overview

Part 2

International integration and macroeconomic policy challenges

amid global economic turmoil

Chapter I

Changing external financing sources and macroeconomic regimes in the region:

the uneven impacts of external

shocks and response policies

Methodological annex

A. Criteria for table I.3

B. Criteria for table I.5

Chapter II

Integration into international financial markets in the current context of high external liquidity

Chapter III

Fiscal policy challenges in a context of high, fluctuating commodity prices

Chapter IV

Summary and concluding remarks on the challenges of the medium-term

external outlook

Bibliography

Foreword

The sixty-third edition of the Economic Survey of Latin America and the Caribbean covers 2010 and the first half of 2011. During this period the economies of Latin America and the Caribbean continued to recover from the global financial and economic crisis whose fallout spread across the region in the second half of 2008 and in 2009. The upturn that began late in 2009 and gained unexpected momentum in 2010 was sustained by a recovery whose characteristics were without precedent in the world economy and by the macroeconomic policies implemented by the countries themselves. The recovery carried over into 2011, albeit with economic growth easing back in response to both external and domestic factors.

The first part of this edition of the Economic Survey looks at the nature of the recovery and the factors underlying its initial momentum and later slackening. The differences between countries and subregions are examined along with the challenges now being faced in a setting defined by a highly liquid international economy and surging commodity prices. The outcome of the recovery is analysed in terms of economic activity, labour markets and the external sector, taking account of how macroeconomic policies have been adapted to the challenges arising in the post-crisis world. Detailed consideration is afforded to the uncertainty currently prevailing in the global economy, the resulting risks for growth and the internal factors pointing to a further, albeit gentle, slowdown in growth in 2012. This part of the Economic Survey is complemented by an extensive statistical annex.

The second part of this Economic Survey delves into the challenges posed by highly liquid conditions in international financial markets combined with high prices for the region’s key commodities. The contrasting situations these external conditions represent for the countries of the region are reviewed in detail, taking account of the very different patterns of trade and engagement with international financial markets and the varying depth of domestic financial systems. Consideration is given, as well, to the macroeconomic tools available to policymakers in the current circumstances and the advantages and drawbacks of each, both for rising to short-term challenges and in the interests of longer-term, sustained development.

The Economic Survey closes with an analysis of the situation in the countries of Latin America and the Caribbean during 2010 and the first half of 2011. The individual country notes are accompanied by tables showing the evolution of the main economic indicators. These notes, like the specific statistical annexes for each country, are published on the CD-ROM included with the print version and on the ECLAC website (www.eclac.org). The tables in the statistical annex can be used to obtain a rapid overview of the information for the last few years and to create spreadsheets. The disk also contains the first and second parts in electronic format. The cut-off date for the statistical information in this publication was 30 June 2011.

Executive summary

After contracting in 2009, GDP expanded by 5.9% in Latin America and the Caribbean in 2010, albeit with the region’s hallmark differences in performance from one country to another. The expansion in output was driven by strong domestic demand in the forms of both consumption and investment, and by buoyant external demand. On the domestic demand side, private consumption (up 5.9%) was sustained by an upturn in employment and wages, brightening economic expectations, an expansion in lending to the private sector and, in some countries, an upswing in remittances from emigrant workers. Public consumption rose at a more modest rate of 3.9% and investment jumped by 14.5%, with strong growth in the machinery and equipment segments in particular. On the external demand side, exports of goods and services were especially buoyant —rising by over 10%— in the Southern Common Market (MERCOSUR) countries, the Dominican Republic, El Salvador, Mexico and Nicaragua. Meanwhile, imports of goods and services increased by more than 10% at constant prices on the back of robust domestic demand within the region, which rose 7.5%.

For 2011, the Economic Commission for Latin America and the Caribbean (ECLAC) projects regional GDP growth of 4.7%, or 3.6% in per capita GDP, as the recovery that began in the Latin American and Caribbean economies in the second half of 2009 firms up. The slippage in this rate compared with 2010 may be attributed to loss of momentum in the international economy and, in some cases, the gradual withdrawal of public policy stimulus implemented to deal with the fallout from the crisis. For 2012, regional growth is projected at 4.1%, equivalent to a rise of 3.0% in per capita GDP, notwithstanding the downturn in external conditions and, on the domestic front, complex policy challenges arising from dilemmas over the direction of certain macroeconomic variables.

In the near term, activity levels in the economies of Latin America and the Caribbean are being sustained largely by private consumption, thanks to an improvement in labour indicators and an expansion in lending. At the same time, expectations of buoyant domestic demand and the depletion of idle production capacity, combined with more readily available credit, are fuelling investment.

The unemployment rate is projected to fall again in 2011, to between 6.7% and 7.0% —below pre-crisis levels— as continued growth boosts the employment generation capacity of the region’s economies. Indicators show formal wage employment rising as a proportion of total employment in several countries, suggesting that the new jobs being created are of better quality. This setting of economic growth and jobs rising in both numbers and quality could herald fresh gains in poverty reduction.

Amid burgeoning domestic demand, rising prices for commodities, especially food and fuels, are exerting upward pressure on the inflation rate. The region’s central banks are once again facing a dilemma in this respect. On the one hand, they need to maintain price stability. On the other, they must try to keep their export sectors (or those producing import-substitution goods) competitive amid heavy upward pressure on the region’s exchange rates. Currency appreciation is being driven by a combination of highly liquid external conditions, the solidity of some Latin American economies and, in several cases, massive inflows of foreign exchange resulting from high export commodity prices and foreign investors’ renewed appetite for emerging country assets.

These circumstances present a number of risks and difficulties, both in the short term and in the medium and longer terms. First, the increase in financial inflows makes the region more vulnerable to speculative capital movements, a further risk being that the sheer magnitude of the resources involved could exceed the capacity of the financial systems to manage them and lead to financial asset or real-estate bubbles. Over a longer period, real exchange-rate appreciation could erode the external component of demand for goods, especially if world trade loses momentum, as it may if growth in the developed countries slackens as mid-2011 projections suggest it will. The combination of real exchange-rate appreciation and rising commodity prices could push the region further towards intensive specialization in the production and export of primary goods, thus leaving its economies more open to external shocks and possibly fuelling macroeconomic volatility. This would certainly hurt the economies’ capacity to grow, generate productive employment and reduce inequality.

These risks may not be imminent, yet there are grounds for caution. Advantage should be taken of the current favourable conditions to strengthen the region’s external position and generate public sector savings in order to recover the policy space used up during the crisis. Measures such as short-term capital controls could also help to limit vulnerability. These recommendations are, moreover, compatible with efforts to contain currency appreciation. Recouping fiscal space is therefore vital for the countries of the region. It would help them to face not only the classic public policy challenges (the need for greater investment in physical and social capital) but also those arising from developments on the international front. More substantial public sector savings would allow governments to steer clearer of contractionary monetary policy and would help to reduce the tension between strategies to counter inflation and those to contain

currency appreciation.

The second part of this report looks at the challenges thrown up in the context of high commodity prices and abundant liquidity flowing towards Latin American assets. The Latin American and Caribbean countries in this situation have the opportunity to use these resources to foster long-term growth, but must at the same time deal with greater inflationary pressures, loss of competitiveness through currency appreciation and the threat of “reprimarization” —a shift back towards primary production— of their productive apparatus.

Although the governments of the region may draw upon a range of tools to contain the negative implications of this international setting, these all have a cost, are not guaranteed to work and may cause unwanted side effects. The challenge for policymakers, then, is to craft the right mix of tools for each country’s specific pattern of trade and financial engagement and to create an enabling environment for investment, employment and the greater well-being of the population at large.

Part 1

The economic situation in Latin America and the Caribbean in 2010-2011

Chapter I

Regional overview

A. Introduction

ECLAC projects growth of 4.7% for the region in 2011, which represents a rise of 3.6% in per capita GDP. Growth will be driven by the ongoing recovery that began in the economies late in 2009, although slackening in the global economy, coupled with the gradual withdrawal of the crisis-response policies implemented by the region’s governments, are acting as a drag on the rate. As will be explored below, economic expansion should continue in the region, even with global conditions turning less favourable and the performance of certain macroeconomic variables raising complex policy dilemmas for economic authorities in the region. As a result, regional growth is expected to ease back to around 4.1%, equivalent to a rise of 3% in per capita output, in 2012.

Figure I.1 shows that, consistently with the pattern of the last few years, the highest rates of growth have been in South America, whose combined estimated growth rate for 2011 is 5.1%. Central America as a whole, driven in particular by sustained growth of the Panamanian economy, is expected to register growth of 4.3% and the Caribbean economies, 1.9%.

The growth of the region’s economies in 2011 is being sustained to a large extent by private consumption, thanks to improving labour indicators and an expansion in credit. Meanwhile, as idle production capacity has been depleted by sustained domestic demand fuelled by looser credit conditions, investment is on the rise and is regaining pre-crisis levels.

Sustained economic growth is also enhancing the economies’ employment-generating capacities and the unemployment rate is expected to come down again in 2011, to between 6.7% and 7% —below pre-crisis levels. What is more, indicators for the first part of 2011 show formal wage employment rising as a proportion of total employment in several countries, suggesting that the new jobs being created are of better quality. Continued economic growth and jobs rising in both numbers and quality should usher in fresh gains in poverty reduction.

Amid burgeoning domestic demand, rising prices for commodities, especially food and fuels, are exerting upward pressure on the inflation rate. Accordingly, several of the region’s countries have tightened their monetary policy stances, which is broadening spreads between domestic and international interest rates and this, amid highly liquid external conditions, is pushing up exchange rates in the region. Although the countries are continuing to accumulate international reserves, they are doing so not so much through the current account (which is in fact running a widening deficit in most of the countries) but increasingly through the financial account, particularly by way of relatively short-term operations.

These developments are all extremely important for short-term macroeconomic policy management, resource allocation and strategic decisions on production specialization. The analytical chapters of this issue of Economic Survey look at macroeconomic policy and, in particular, its implications for the exchange rate in view of the very different ways in which the countries of the region participate in the global economy. The rest of this chapter is structured as follows. Section B looks at the current conditions in the international economy. Section C examines the behaviour of the main domestic and external macroeconomic aggregates; and section D

discusses macroeconomic policies and the policy challenges facing the region and considers the outlook for economic growth.

FIGURE I.1

LATIN AMERICA AND THE CARIBBEAN: GDP GROWTH, 2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary data.

B. The international economy

Estimates for global economic activity have been revised downwards following slower-than-expected recovery in global output from the impact of the global financial crisis: the current projections for 2011 and 2012 are 3.3% and 3.6%, respectively (see figure I.2).[1] Sluggish growth in the world economy and particularly in the developed countries is undoubtedly a function of continuing difficulties in those countries’ financial markets associated, among other factors, with household deleveraging, weaknesses in real estate markets and the sovereign debt problems of some European countries. At the same time, mounting concern over the sustainability of public debt in those economies is also lending an increasingly austere slant to their public finances, which represents a further drag on growth prospects.

1 See United Nations, World Economic Situation and Prospects. Monthly Briefing, No. 32, New York, Department of Economic and Social Affairs (DESA), June 2011.

FIGURE I.2

WORLD ECONOMIC GROWTH, 2009-2012

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary data.

b Projections.

The developed economies are projected to yield a combined growth rate of 2% for 2011, perhaps rising to 2.4% in 2012. For the reasons noted earlier, economic recovery is likely to be fragile in the United States, with growth projected at 2.6% in 2011 (2.8% in 2012). Japan’s economy, reeling from the combined effects of the earthquake, tsunami and problems associated with nuclear power generation, will recover very slowly, by an estimated 0.7% in 2011 (2.8% in 2012). In Europe, the outlook is very mixed. Although overall the European region is projected to return to economic growth of 1.85% in 2011 and 1.9% in 2012, Germany and the Nordic countries are expected to expand at above-average rates, while the countries grappling with the worst sovereign debt and fiscal problems will continue to register low growth or remain in recession.

Developing economies will lead global growth, with a rate of 6.2% projected in both 2011 and 2012. Within this context of across-the-board growth rates above the global average, the strongest performers will be China (9.1% in 2011 and 8.9% in 2012) and India (8.1% in 2011 and 8.2% in 2012).

1. International financial conditions and their impact on economies in the region

The problems of a set of countries (Greece, Ireland, Italy, Portugal and Spain) grew steadily worse throughout 2010. These countries’ economies have been characterized by structural fiscal deficits and very low levels of private savings, translating into steadily rising public debt and a sustained current account deficit.[2] This combination led to a series of critical episodes in Greece, Iceland and Ireland, whose bailouts required the creation of a special institution —the European Financial Stability Fund (EFSF)— and involved the International Monetary Fund (IMF), the European Central Bank (ECB) and the governments of countries on a sounder financial footing. Other, smaller countries in the euro area (those sometimes referred to as the peripheral countries) and European countries outside the euro area were also caught up in the turmoil.

2 The worst case was Greece, which is facing high levels of public debt, a structural fiscal deficit of 12.5% of GDP and a an external deficit of almost 14% of GDP. For measures of the structural fiscal and current account position of these countries, see International Monetary Fund (IMF), World Economic Outlook Database, April 2010.

Meanwhile, in the United States monetary measures were taken to allow an ordered winding down of low-quality credit exposure and, in general, heal the financial system after the recession that followed the financial crisis. As a result, some signs of an economic upturn began to emerge in the United States in 2010. The slow pace of the recovery persuaded the Federal Reserve to keep the monetary policy rate at historically low levels, however. Japan, whose economy has been at a standstill for a number of years, continued in 2010 to direct monetary policy towards promoting economic recovery, with very low rates of interest.

In contrast with this picture, the emerging economies recovered quickly from the crisis, many of them keeping public debt low and their financial system solvent as they did so (see table I.1). As a result, they have gained a stronger position relative to the developed economies, as is apparent from the region’s sovereign risk ratings, which are lower than those of some developed economies previously considered more solid.

As a result of all these factors, global liquidity has expanded sharply and the main reserve currencies, especially the dollar, have lost value.[3] As a corollary, financial flows into the region, including foreign direct investment, have surged and, in some cases, local currencies have appreciated in both nominal and real terms.

3 Authorities in the euro area have afforded greater priority to improving the liquidity position of bank assets than to stimulating demand and have sterilized the monetary impacts of their interventions. As a result, the euro has not been so weak as the dollar.

This was not the only external shock to affect the region, however. Rapid growth in emerging economies has created vigorous demand for commodities, pushing up prices of metals, hydrocarbons and foods, and these price rises have been exacerbated by the value slippage of the main reserve currencies. The currencies of net commodity exporters have thus been pushed towards appreciation, which has worsened inflationary pressures in these countries.

This complex external scenario has carried over into 2011 and shows some signs of becoming worse. In the United States, the priority continues to be to foster the recovery of output and employment levels, which are also viewed as necessary conditions for restoring the financial system to health. With inflationary expectations low, the Federal Reserve has indicated that monetary stimulus will not be withdrawn in the immediate term —at least up to mid-2012.[4] The fiscal authorities are engaged in lengthy negotiations over the reduction of the deficit, but sharp adjustments such as those made in Europe are not anticipated. The highly liquid global conditions originating in the United States may therefore be expected to persist in the second half of 2011. In Europe, and in the euro area in particular, the focus of macroeconomic policy thus far has been very different.

4 The need to maintain monetary stimulus until the economy shows more solid signs of recovery was set forth starkly by Paul Krugman in his article “Inflation and economic Hooliganism”, New York Times, 11 May 2011.

Unlike the situation in the United States, the monetary effects of measures implemented in response to the crisis have been largely sterilized. In addition, ECB began raising interest rates in April 2011 as inflationary expectations mounted. Projections show inflation running at around 3%, above the ECB yearly target of 2%, so the Bank is unlikely to change its policy stance in the short term.

TABLE I.1

LATIN AMERICA: RISK PREMIUMS ON FIVE-YEAR CREDIT DEFAULT SWAP CONTRACTS, 2007-2011 a

(Basis points)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official data.

a Data for 2011 refer to first five months only.

Fiscal policy in the euro area has focused on restoring solvency as a basic condition for economic recovery, even if these budget adjustments have a short-term recessionary impact. Growing doubts over debt sustainability in some countries prompted drastic spending cuts on the basis that, in the medium term, confidence in public sector stability and solvency would stimulate investment and employment. The debt sustainability issues of the worst compromised countries have yet to be resolved, however.

In particular, Greece has again become a source of uncertainty, on the expectation that the measures taken to meet the fiscal targets agreed upon with IMF, ECB and EFSF will fail to reduce the country’s deficit as much as it had been hoped and this has jeopardized the disbursement of the next tranche of funding. According to both the Government of Greece and experts on international finance, Greece’s debt must be restructured (that is, its present value reduced), in order to ease the burden of debt servicing, increase the probability of payment and avoid the vicious cycle of near-term recessionary fiscal contraction, which would worsen the domestic deficit. The difficulties such a proposal implies for the assets of ECB (one of the bailout creditors), as well as fears of contagion spreading to other over-indebted countries have delayed the implementation of a solution of this sort.

For the time being, although the monetary policy put in place by the ECB could strengthen the euro, the lack of a resolution for Europe’s sovereign debt problems is casting a heavy pall of uncertainty over the future of the euro area and this will continue to drive flows of financial resources towards other, safer and more profitable areas of the world financial market. The downgrading of some of these countries’ sovereign debt in the second quarter of 2011 may add to the flight of financial resources from Europe.

In the case of Japan, sovereign debt quality has suffered as a result of the impacts of natural disasters on economic activity and public spending. Nonetheless, as the authorities maintain their objective of avoiding currency appreciation and stimulating recovery, monetary policy will continue to be directed towards expanding liquidity.

The overall picture at the global level is therefore one of strongly contrasting macroeconomic policies adopted in key financial and economic centres. Financial flows may therefore be expected to continue flowing into emerging countries, bringing about pressures towards real currency appreciation, high commodity prices and mounting inflation. Uncertainties abound, however, in particular with respect to the sustainability of public debt in some highly indebted European countries and the point at which economic recovery in the United States will achieve sufficient momentum to prompt a monetary policy shift.

BOX I.1

POTENTIAL IMPACT OF THE 2011 JAPANESE EARTHQUAKE AND TSUNAMI ON LATIN AMERICA AND THE CARIBBEAN

Like previous natural disasters, the earthquake and tsunami that struck Japan on 11 March 2011 will have deep, long-lasting repercussions on the local economy but a much shorter-lived impact on the global economy. Even so, although the areas hit by the catastrophe account for less than 4% of Japan’s economic activity, the destruction of part of the country’s electricity-generating capacity has had a ripple effect across the entire national economy.

Following the Kobe earthquake of 1995, Japan demonstrated its capacity for rapid economic recovery. Although productivity levels plummeted in the short term, the reconstruction effort brought about a speedy recovery and it was not long before devastated infrastructure and housing had been rebuilt. However, the 2011 earthquake was much more severe than the 1995 one; so, although economic activity is expected to pick up again after a period of contraction, the destruction caused by the tsunami and the damage to the country’s nuclear power plants threaten to stall further recovery and could have a broader impact on production. In fact, the impaired power-generating capacity —not only at plants directly affected but also at others shut down as a preventive measure given the risk of aftershocks— has taken a toll on the rest of the country’s industry, in particular the automotive, vehicle parts, electronics and semiconductor sectors. In many instances the supply of raw materials has been temporarily cut off, affecting production both in Japan and in other countries that are part of the global production chains in which Japan is a key link. According to projections, output could contract by between 1% and 3% before returning to slightly positive levels in 2012. Global economic growth in 2011 is thus expected to slip by half a percentage point.

As was the case following previous external crises, the impact will make itself felt in Latin America and the Caribbean through trade and financial channels.

In the near term, the interruption of normal transport and distribution operations and the contraction of domestic economic activity in Japan will very likely lead to a drop in imports. However, as the reconstruction effort gets under way in the medium term, imports of raw materials and fuel should rise again. In 2008 and 2009, only 3.6% and 3.8% of total exports from Latin America and the Caribbean went to Japan. Inasmuch as exports to Japan from Chile, Peru and the Plurinational State of Bolivia exceed the regional average, the buoyant global demand for those exports —minerals and hydrocarbons— means that they can be diverted to other markets in order to offset the decline in demand from Japan. In absolute terms, Brazil and Chile are the region’s main exporters to Japan, followed by Peru, Mexico and Argentina. In the services sector, the region exports very little to Japan, and Japanese tourism accounts for a very small share of the tourism service exports of Caribbean countries.

Japan accounted for 3% of total foreign direct investment in the region in 2010, and has recently been taking on greater significance in Brazil (5% of the total) and, in previous years, in Chile and Peru.a That investment has historically targeted mining resources in Brazil, Chile and Peru and, more recently, financial services in Brazil. The earthquake in Japan is not expected to trigger any radical changes in the long-term direction of this category of investment.

As for the earthquake’s impact on portfolio investment and other financial flows into the region, analysts think existing trends may intensify because of uncertainty about the future of the public debt of Japan and the United States. Investors are expected to demand higher returns (implicit interest rates) on financial investments, which would bump up the cost of financing for the region.

Japan’s public debt has been following a steady upward path driven by persistent deficits and weak or zero economic growth, which has meant only marginal increases in tax revenue. Gross public debt is approaching 225% of GDP, although discounting debt held by government agencies brings that level down to 100% of GDP, comparable with other developed countries. In contrast with other countries, however, most of Japan’s public debt is in the hands of its own residents. Even so, signs are that there will be further deterioration in the short term as the projected drop in activity will yield even less tax revenue and public spending will be stepped up to fund reconstruction. In the medium to long term, the country’s ageing population will make for a heavier burden in pensions and health spending. All these factors have prompted credit-rating agencies to downgrade the quality of Japan’s sovereign debt.

Japan is —after China— the main holder of United States debt. As it was initially thought that private creditors would sell off some of those debt holdings to finance reconstruction and cover insurance payouts by insurance companies holding those bonds, the weeks following the earthquake saw an appreciation of the yen that was halted only after intervention by the central banks of the Group of Seven. As it happens, the insurance companies appear to have sufficient current revenue from premiums to cover earthquake-related payouts, thus allaying initial fears of a mass rush to liquidate financial assets. In the medium term, the ageing of Japan’s population points to a trend towards dissaving and a subsequent reduction in demand for financial assets, including United States treasury bonds, thus pushing up the financial cost of debt at the global level. Ultimately, the outcome will hinge on a series of factors relating to global public finances, which will continue to suffer in the short and medium terms, especially in developed countries, as a result of the measures adopted to weather the recent global financial crisis.

Source: Economic Commission for Latin America and the Caribbean (ECLAC).

a See ECLAC, Foreign Direct Investment in Latin America and the Caribbean, 2010, Santiago, Chile, 2011.

C. Recent major developments in the Latin American and Caribbean economies

1. Macroeconomic aggregates

The region’s GDP expanded by 5.9% on average in 2010, although the performance was very uneven from one country to another. The countries posting the highest growth rates were the members of MERCOSUR —Argentina (9.2%), Brazil (7.5%), Paraguay (15.0%) and Uruguay (8.5%)— and Panama (7.5%), the Dominican Republic (7.8%) and Peru (8.8%). By contrast, output contracted in the Bolivarian Republic of Venezuela and Haiti, by 1.4% and 5.1%, respectively. In the latter case, the downturn was attributable to the earthquake of January 2010, which struck a severe blow to economic activity. The GDP contraction in the Bolivarian Republic of Venezuela reflected a slump in domestic demand as a result of declining government revenues from oil exports and drought-induced electric power rationing in the first semester.

South America registered growth of 6.4% and Central America,[5] 4%. The Caribbean countries together expanded by 0.4%. The three economies that account for roughly 70% of this subregion’s GDP —Jamaica, Barbados and Trinidad and Tobago— experienced a contraction in output (-1.3%), stagnation (0.3%) and lacklustre growth (2.5%), respectively.

5 Calculation includes Costa Rica, Cuba, the Dominican Republic, El Salvador, Guatemala, Haiti, Honduras, Nicaragua and Panama.

GDP growth was driven by strong domestic demand in the form of both consumption and investment and by buoyant external demand. On the domestic demand side, private consumption growth (up 6.0%) was due to an upturn in employment and wages, brightening economic expectations, an expansion in lending to the private sector and, in some countries, an upswing in remittances from emigrant workers. Public consumption rose at a more modest rate of 3.9%. Investment jumped by 14.3%, with strong growth in the machinery and equipment segment in particular. Gross fixed capital formation rose from 20.3% in 2009 to 21.4% in 2010, though this falls short of the 22.1% posted in 2008.

Exports of goods and services yielded high growth rates —over 10%— in the member countries of MERCOSUR, the Dominican Republic, El Salvador, Mexico and Nicaragua. Meanwhile, imports of goods and services increased by more than 10% at constant prices on the back of robust domestic demand within the region (7.5%), with capital goods and consumer durables, especially automobiles, standing out in particular (see figures I.3 and I.4).

FIGURE I.3

LATIN AMERICA: YEAR-ON-YEAR QUARTERLY VARIATION IN COMPONENTS OF SPENDING, 2008-2011 a

(Percentages and constant dollars at 2005 prices)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Figures for 2011 refer to first quarter only.

FIGURE I.4

LATIN AMERICA: YEARLY VARIATION IN GROSS FIXED CAPITAL FORMATION, 2004-2010

(Constant dollars at 2005 prices)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

By sector of economic activity, commerce, financial and business services and the transport and communications sector expanded across the board. The performance of the goods-producing sectors, however, including mining, manufacturing and agriculture, varied across the region. The agricultural sector enjoyed strong expansion in the MERCOSUR countries, thanks to good harvests as weather conditions returned to normal. Mining output rose in Brazil and Colombia (in both cases owing to increased petroleum production) and in the Plurinational State of Bolivia (with higher natural gas production). Manufacturing activity expanded at above-average rates in Argentina, Brazil, Colombia, Mexico and Peru.

Disposable gross national income in the region was up by 7.6%, reflecting an average gain in terms of trade[6] and an upturn in inflows of emigrant remittances.

6 The terms-of-trade gain was around 3.4% of GDP on average in 2010. Exporters of oil, minerals and metals gained the most, while practically all the Central American countries (Costa Rica, Dominican Republic, El Salvador, Honduras and Panama) suffered terms-of-trade losses.

Investment, measured in current dollars as a percentage of GDP, rose from 19.8% in 2009 to 21.6% in 2010. Notwithstanding the expansion in private consumption, national saving was also up in GDP terms (from 19.5% in 2009 to 20.5% in 2010), and external saving climbed to 1.2% of GDP. Data available for the first half of 2011 indicate that economic growth has held steady, with first-quarter growth rates in several countries similar to those recorded throughout 2010. ECLAC projects the regional GDP growth rate at 4.7% for the year overall.

2. Wages and the labour market

The economic upswing in 2010 helped to nudge the employment rate up to a new high of 54.9%, a rise of 0.6 percentage points.[7] As figure I.5 shows, the employment rate began to recover strongly in the first quarter of 2010, although this was not the case in all the countries. In

18 countries with comparable data, only 8 showed a rise in employment: Argentina, Brazil, Colombia, Dominican Republic, Nicaragua, Peru, Plurinational State of Bolivia and Uruguay.

7 Unlike the series published previously, this regional rate is calculated using nationwide employment data wherever available.

FIGURE I.5

LATIN AMERICA (9 COUNTRIES): GLOBAL PARTICIPATION RATE AND EMPLOYMENT RATE, FIRST QUARTER OF 2008

TO FIRST QUARTER OF 2011 a

(Four-quarter moving average, in percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a The data for each quarter represent the average value for the rolling year (four quarters) ending that quarter.

b Data for 2011 are preliminary.

The participation rate also changed in 2010, with a rise of 0.3 percentage points. Given that the labour supply behaves procyclically in many countries, this may be interpreted as indicating that the economic upturn improved people’s perceptions of their employment options. As figure I.5 shows, the uptrend in the participation rate became apparent in the fourth quarter of 2009 and continued until the fourth quarter of 2010, before falling back slightly early in 2011, which could reflect a labour supply contraction among young people.[8]

8 In 2010, youth labour force participation fell more or rose less than that of more mature adults in several countries (including Argentina, the Bolivarian Republic of Venezuela, Brazil and Colombia). This may be attributable to a long-term trend whereby young people are spending longer in the education system.

In 2010, the faster rate of labour supply growth lessened the impact of higher employment levels on the urban unemployment rate, which nevertheless eased back from 8.1% to 7.3% and thus returned to the level of 2008, which had been a 20-year low. In absolute terms, the number of employed in the region’s urban areas rose by 6.4 million in 2010, while the urban unemployed decreased by 1 million to stand at 17.1 million. The stronger labour demand reflected in the higher employment rate also helped to lower underemployment rates.

With the economic upturn in 2010, real wages continued to rise, albeit at lower rates than in 2009, given the uptick in inflation (see figure I.6).[9] Taking the number of employed to have risen by 2.8% and average real labour income by an estimated 2.6% (weighted average), the wage mass increased by around 5.5%[10] and this has acted as a strong driver of domestic demand.

9 Minimum wages rose by just under 2% in real terms, measuring by the median variation of 19 countries, after a significant jump in 2009 (see table A-26). In 2010 the variation showed greater dispersion, however, which reflects differences in wage policy in the countries.

10 For some countries this estimate uses broader measurements than those shown in figure I.6 and table A-25, which refer to wages in the formal sector.

FIGURE I.6

LATIN AMERICA (SELECTED COUNTRIES): VARIATION IN FORMAL-SECTOR REAL AVERAGE WAGES AND IN THE

REAL MINIMUM WAGE, 2009-2010

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

At the subregional level, the varying rates of economic growth in 2010 led to very different rates of job creation. For the South American countries as a group, the employment rate rose 0.4 percentage points (simple average for seven countries with comparable data). In Mexico and Central America the rate dropped by 0.2 percentage points (average for six countries) and in the Caribbean it fell by 1.3 percentage points (average for three countries).

Generation of wage employment rose much more quickly in 2010 than in 2009, whereas self-employed work showed a smaller rate of increase (see figure I.7). Wage employment increased relative to total employment in Argentina, Brazil, Costa Rica, Ecuador and Panama, and formal wage employment rose rapidly in Brazil, Chile, Nicaragua and Uruguay. By sector of employment, the number of employed in tertiary activities and agriculture continued to rise in 2010, but the distinctive feature of the year was the recovery of employment in manufacturing and construction.

FIGURE I.7

LATIN AMERICA AND THE CARIBBEAN: YEAR-ON-YEAR VARIATION IN EMPLOYMENT RATE, BY BRANCH OF ACTIVITY AND OCCUPATIONAL CATEGORY, 2009 AND 2010

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary data.

The output elasticity of wage employment was 0.56 for an average of eight countries with data available, implying that job creation was accompanied by a significant jump in average labour productivity (see table I.2). The output elasticity of formal employment was even higher, at 0.83 for an average of 10 countries.

TABLE I.2

LATIN AMERICA (SELECTED COUNTRIES): OUTPUT ELASTICITY OF WAGE EMPLOYMENT AND FORMAL

WAGE EMPLOYMENT, 2010

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

In early 2011 the region overall continued to create employment and reduce unemployment rapidly. For a weighted average of nine countries, the employment rate has continued to rise significantly, by 0.4 percentage points year-on-year. Although this rate is lower than during the post-crisis upswing, given that the participation rate fell slightly, it has risen enough to have a strong impact on the unemployment rate: for the countries with information available, unemployment came down by 0.7%. Importantly, the expansion in employment continues to be associated with formal job creation. For the year overall, the regional urban unemployment rate is projected to drop again, from 7.3% to somewhere between 6.7% and 7.0%.

Although higher food and fuel prices have pushed up inflation, real wages continued to rise in the early part of 2011 at rates similar to those of 2010 thanks to strong labour demand, falling unemployment rates, a shortage of workers with specific skills and gains in labour productivity.

BOX I.2

LABOUR PRODUCTIVITY

One characteristic of economic development in Latin America in the 1980s and 1990s was the lack of progress in closing the wide labour productivity gap between the region and more developed countries. The gap even began to widen again at the start of the twenty-first century, on comparing the region with the member countries of the Organization for Economic Cooperation and Development (OECD) and with the international average (see figure 1). The year 2004 marked a trend change, as average labour productivity in the region began to grow at similar rates to the rest of the world and faster than

OECD countries.

Leaving aside the differing labour productivity levels among the countries of the region, it is apparent that the upturn in labour productivity was widespread but uneven. Early in the decade, labour productivity stagnated in most countries while falling sharply in others. From 2004 (earlier, in some instances) there was a general upswing in productivity, despite disparities in the rate of growth. The impact of the 2009 crisis on average productivity varied again; for example, it declined more steeply in the Bolivarian Republic of Venezuela, Colombia and Mexico than elsewhere. The 2010 economic recovery had a positive —although mixed— impact on productivity. While Brazil and Peru were able to surpass pre-crisis levels, recovery in other countries was slower or has yet to materialize.

FIGURE 1

LATIN AMERICA AND THE CARIBBEAN, WORLD AND OECD COUNTRIES: LABOUR PRODUCTIVITY, 1995-2008

(Index: 1995=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of International Labour Organization (ILO), Key Indicators of the Labour Market (KILM) and World Bank GDP series.

FIGURE 2

LATIN AMERICA (7 COUNTRIES): LABOUR PRODUCTIVITY, 2000-2010

(Index: 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official data.

Examining labour productivity by industry, it is clear that the two primary sector industries (agriculture, forestry and fishing, and mining and quarrying), which have traditionally recorded the lowest and highest labour productivity, respectively, also reflect the two extremes in terms of recent variations. Agriculture, forestry and fishing experienced a surge, and mining and quarrying a marked decline in average productivity. As far as agriculture in concerned, this is part of a long-term trend attributable to the expansion of commercial agriculture (which is not labour-intensive) and the decreasing share in employment of low-productivity small farming. Declining labour productivity in mining may have to do with low-yield deposits being brought into production in response to high prices for many minerals.

The highest productivity gains were made in manufacturing, but were interrupted (as in other industries) by the 2009 crisis. Within the tertiary sector, commerce shows particularly volatile productivity, reflecting its role as an “employer of last resort” during a crisis, owing to the low entry requirements. Accordingly, at the beginning of the last decade when economic growth was sluggish, average labour productivity in commerce plummeted. During the subsequent period of higher growth, the buoyancy of domestic demand generated a boom in the industry, cut short once again by a sharp contraction in 2009.

FIGURE 3

LATIN AMERICA (7 COUNTRIES): LABOUR PRODUCTIVITY BY INDUSTRY, 2000-2010

(Index: 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official data.

Notably, the upturn in labour productivity from 2004 on did not translate into a comparable rise in real wages in the formal sector, which grew at a slower pace in most countries. This appears to have been a factor in deteriorating functional income distribution and a fall in unit labour costs.

In many countries, lower local labour costs were offset by currency appreciation, which increased labour costs as measured in other currencies. Brazil, Colombia and Costa Rica all experienced a drop in unit labour costs in local currency, but a rise in those costs in dollars.

FIGURE 4

LATIN AMERICA (7 COUNTRIES): RATIO OF THE AVERAGE REAL FORMAL SECTOR WAGE INDEX TO

THE LABOUR PRODUCTIVITY INDEX, 2000-2010

(Index 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official data.

FIGURE 5

LATIN AMERICA (7 COUNTRIES): RATIO OF THE AVERAGE REAL FORMAL SECTOR WAGE INDEX TO THE LABOUR

PRODUCTIVITY INDEX, ADJUSTED BY DOLLAR EXCHANGE RATE, 2000-2010

(Index: 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official data.

3. Inflation

Measured by the consumer price index (CPI), regional inflation stood at 6.5% in 2010 as a weighted average. Inflation ran at over 10% in Argentina, Jamaica and Trinidad and Tobago, as well as in the Bolivarian Republic of Venezuela, which recorded the region’s highest rate of 27.4%. All the countries except Ecuador registered a higher rate than in 2009, owing largely to higher prices for foods and beverages practically across the board (see figure I.8).

The inflation rate continued to rise in 2011, driven basically by food and beverage prices, although fuels and transport services and, in some cases, housing, have risen in price as well. Core inflation has also begun to climb amid rapid growth in domestic demand. In May 2011, 12-month core inflation stood at 5.6% after sitting just above 5% throughout 2010 (see figure I.9). Producer prices, too, have seen a fairly widespread increase. In fact, they have risen much faster than consumer prices in all countries except the Bolivarian Republic of Venezuela.

The Caribbean countries with data available show relatively high rates of inflation, whereas the Central American economies are running rates below the regional average, as is Mexico where inflation has been slowing since late 2010 (see figure I.10). An inflation rate of 7.5% is projected for the region overall in 2011.

FIGURE I.8

LATIN AMERICA AND THE CARIBBEAN: 12-MONTH VARIATION

IN CONSUMER PRICE INDEX, FULL INDEX, FOOD AND BEVERAGES ONLY AND ALL OTHER COMPONENTS,

DECEMBER 2009-DECEMBER 2010

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

FIGURE I.9

LATIN AMERICA: 12-MONTH VARIATION IN CONSUMER PRICE INDEX AND CORE INFLATION, 2007-2011a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Data for 2011 refer to first five months only.

FIGURE I.10

LATIN AMERICA AND THE CARIBBEAN: 12-MONTH VARIATION IN CONSUMER PRICE INDEX, SIMPLE AVERAGES, 2007-2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Data for 2011 refer to the first five months.

b Data for the Caribbean refer to Jamaica, Suriname and Trinidad and Tobago.

TABLE I.3

LATIN AMERICA AND THE CARIBBEAN: 12-MONTH VARIATION IN CONSUMER PRICE INDEX, FULL INDEX, FOOD AND

BEVERAGES ONLY AND ALL OTHER COMPONENTS, MAY 2010 AND MAY 2011

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

4. The external accounts

(a) The balance-of-payments current account

In 2010, Latin America recorded a current account deficit equivalent to 1.2% of regional GDP, somewhat larger than the deficit of 0.4% in 2009 (see figure I.11). While the income and services accounts remained stable, the relative decline in the transfers balance and, above all, the narrowing of the trade surplus (from 1.5% of GDP in 2009 to 1.0% in 2010) caused a deterioration in the region’s external accounts. More robust growth in imports than in exports was attributable to the upturn in domestic demand and the currency appreciations that took place in most of the countries of the region.

FIGURE I.11

LATIN AMERICA: CURRENT ACCOUNT STRUCTURE, 2006-2011 a

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Does not include data for Cuba. Data for 2011 are projections.

The heftier overall current account deficit reflected a considerably larger deficit in the MERCOSUR and Central American countries and a reduction in the surplus of the mineral exporting countries (Chile and Peru). By contrast, the Caribbean recorded a better external balance, since higher oil prices contributed to a more substantial surplus in Trinidad and Tobago and stronger metal prices had a similar result in Suriname, while Jamaica’s deficit diminished.

The current account deficit of Latin America is projected to widen slightly in 2011 to 1.5% of GDP. The trade surplus should continue to hold at around 1% of regional GDP owing to higher prices for the main exports combined with a slower rise in imports. What will widen the current account deficit, however, will be a larger negative balance on the services account and a smaller transfers surplus. This downturn will be fairly widespread except in the hydrocarbon-exporting countries. The Caribbean, on the other hand, is projecting a larger current account surplus overall, associated with the increase in international commodity prices and the sustained rebound in remittances and tourism inflows, although the average balance masks the fact that almost all the countries in this subregion are running a deficit on their external accounts.

(i) The balance of goods and services

As shown in figure I.12, external demand for goods produced in the region started to pick up steadily in the second quarter of 2009, although without regaining pre-crisis levels in the case of the United States and the European Union. On the other hand, exports to China and the rest of Asia at the end of 2010 were 12% and 28% higher, respectively, than in mid-2008. Exports to the United States are estimated to have pulled even with their pre-crisis level in the second quarter of 2011, whereas those to the European Union are not expected to do so until early 2012.

FIGURE I.12

LATIN AMERICA: TOTAL EXPORTS BY DESTINATION, 2006-2011 a

(Billions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Does not include data for Cuba. Data for 2011 are projections.

In view of the growth rate in external demand, Latin American exports are expected to expand by 26.9% in 2011, thanks to a 16.6% rise in prices and an 8.8% increase in volume. Once again, mining and petroleum products will grow the fastest, by as much as 39.3%, a slightly higher rate than in 2010. Meanwhile, exports of agricultural products and manufactures will expand by 18.9% and 21.8%, respectively (see table I.4).

TABLE I.4

LATIN AMERICA: YEAR-ON-YEAR VARIATION IN INTERNATIONAL TRADE BY MAIN PRODUCT CATEGORIES, 2008-2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Does not include data for Cuba. Data for 2011 are projections.

Imports are projected to grow at a similar pace as exports in 2011, by an estimated 27.6%, almost three percentage points below the 2010 rate. Imports of fuels and consumer goods will continue to trend strongly upward, by 44.2% and 29.5%, respectively. In 2010, when imports surged faster than exports, Latin America’s trade surplus narrowed by 13% to stand at approximately

US$ 50 billion. In 2011, however, as imports and exports grow at similar rates, the trade surplus will move back up to some US$ 57.5 billion.

In 2010, export growth over 2009 was strongest in the mineral-exporting countries (31.7%), Mexico (29.9%) and the members of MERCOSUR (29.8%). In the hydrocarbon-exporting countries, the gain was 18%; meanwhile, Central America and the countries of the Caribbean recorded rises of 12.3% and 11.1%, respectively. In the case of Mexico and Central America, the expansion was due mainly to higher export volumes, and in the other countries to higher prices.

Figures I.13 and I.14 show projections of international trade by subregion. Both exports and imports are seen to have staged a full recovery in all countries. Price variation will be the main driver of the trade upsurge in the mineral- and hydrocarbon-exporting countries and to a lesser extent in MERCOSUR. In Mexico and the Central American countries, which trade mainly in manufactures and essentially with the developed markets, export values will move up more slowly and the effects of price and volume will be more evenly divided. Since manufactures account for a substantial percentage of imports, their growth is strongly associated with increased volumes and more homogenous across the subregions than exports.

The upturn in regional trade in 2010 brought an expansion in transport-based services; accordingly, the larger increase in goods imports in relation to exports had a parallel effect in the services balance. Travel services too, grew much more rapidly on the import side than the export side on the strength of economic growth and currency appreciation, particularly in the case of Brazil. As a result, in 2010, the deficit on the services balance jumped by 45% with respect to 2009 for the region as a whole and stood at approximately US$ 50 billion.

FIGURE I.13

LATIN AMERICA: PROJECTED VARIATION IN EXPORT VALUES

BY VOLUME AND PRICE, 2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Does not include data for Cuba.

FIGURE I.14

LATIN AMERICA: PROJECTED VARIATION IN IMPORT VALUES

BY VOLUME AND PRICE, 2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Does not include data for Cuba.

Figure I.15 shows trends in international tourist arrivals, with a significant rebound in 2010 in all subregions following the slump in 2009. All countries benefited from the upturn in tourist arrivals, in particular the South American economies, where the numbers rose by 10.4% even though the international crisis in 2009 damaged this subregion’s tourism industry less than others. Mexico, the region’s leading tourist destination, received approximately 22 million visitors (4.4% more than in 2009), only 1 million fewer than were recorded for all the South America countries and 2 million more than in the Caribbean. A number of factors augur well for continued growth in this sector: the region’s efforts to improve tourism-related accessibility and infrastructure; improvements in tourist security in some countries; the vigorous promotion of some destinations in international markets; and the brightening prospects for the global economy. The data to April 2011 attest to this positive outlook (see figure I.15).

FIGURE I.15

LATIN AMERICA AND THE CARIBBEAN: YEAR-ON-YEAR VARIATION IN INTERNATIONAL TOURIST

ARRIVALS, 2009-2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures from the World Tourism Organization (UNWTO).

a Figures for 2011 refer to first two months only.

(ii) International prices and terms of trade

Export commodity prices surged in 2010 with very few exceptions (such as rice and soybean flour). Among agricultural products, prices rose by 9.9% for foods, 25.4% for tropical beverages (coffee, tea and cacao) and 41.6% for agricultural and forestry-related raw materials. Prices for the subcategory of oils and oilseeds increased by a more moderate 3.5%. Minerals and metals were up by 29.3% in price, and energy products by 27.9%. The uptrend spread to prices of manufactures, which rose especially from late 2010 onwards.

As figure I.16 shows, commodity prices have regained the ground lost during the international crisis. In fact, with the exception of energy products and oils and oilseeds, they have exceeded the highs of 2008: the food price index published by the Food and Agriculture Organization of the United Nations (FAO) reached a new peak in February 2011. Factors relating to both supply and demand underlie these price surges. On the supply side are: (i) poor weather conditions, which hurt coffee production in Central America and South America; (ii) the drought in the Russian Federation, which pushed up prices for wheat and wheat substitutes; (iii) the post-election crisis in Côte d’Ivoire, which drove up cacao prices; and (iv) political instability in the Middle East, which influenced prices for oil and petroleum products. On the demand side was the global economic recovery and strong demand for commodities on the part of China, India and other emerging economies. Commodity prices are expected to continue moving upward during 2011, although less steeply than in 2010 as world economic growth slows, demand eases following completion of stock replenishment and the supply-side response to higher prices and more favourable climate conditions kicks in. This change is already apparent in the slowing of food and agricultural price inflation. These trends have had an uneven impact on the region’s terms of trade, as shown in figure I.17. In 2010 exporters of minerals and metals (Chile and Peru) and hydrocarbons (Bolivarian Republic of Venezuela, Colombia and Plurinational State of Bolivia) benefited the most from higher export prices, followed by the member countries of MERCOSUR. Mexico, which exports mainly manufactured goods, saw smaller gains, while the Central American countries, as net food and energy importers, suffered terms-of-trade losses. Overall, Latin America enjoyed an 8.1% gain in its terms of trade in 2010.

FIGURE I.16

LATIN AMERICA AND THE CARIBBEAN: PRICE INDICES FOR COMMODITIES AND MANUFACTURES, 2007-2011 a

(Index: 2000=100, three-month moving average)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the United Nations Conference on Trade and Development (UNCTAD) and the Netherlands Bureau for Economic Analysis (CPB).

a The categories of commodities are weighted by their share in Latin America’s exports.

FIGURE I.17

LATIN AMERICA: VARIATION IN THE TERMS OF TRADE, 2009-2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures of the United Nations Conference on Trade and Development (UNCTAD), International Monetary Fund (IMF), World Bank and Bloomberg.

a Does not include data for Cuba. Preliminary data for 2009 and 2010 and projections for 2011.

The region’s terms of trade will maintain the current trend in the short term, although the improvements will be smaller than in 2010. The countries standing to gain the most are again the exporters of minerals and hydrocarbons; and again, the opposite will occur in Central America, which will see its terms of trade deteriorate. For Latin America and the Caribbean as a whole, a positive variation of 6.2% is projected for 2011.

(iii) The income and transfers balance

The deficit on the factor income account for Latin America rose from US$ 98.1 billion in 2009 to US$ 114.6 billion in 2010 but narrowed in relation to GDP, from -2.5% to -2.4% between the two years, on the strength of regional economic growth. The wider absolute deficit[11] chiefly reflected heftier outflows of profits and dividends, given the rise in international commodity prices and more substantial interest payments. In 2011 this deficit is likely to continue widening in absolute terms in view of projections for economic growth and still-rising prices for the region’s export commodities, although in relative terms it should hold steady at around 2.4% of regional output.

11 Four countries accounted for 90% of the increase in the deficit: Brazil, Chile, Colombia and Peru; the rest of the countries showed smaller negative variations or even improvements in their income balance.

After plunging in 2009, remittances from migrant workers began to rise again in early 2010, as shown in figure I.18. With the exception of Colombia, the Dominican Republic and Ecuador, all the countries shown in the figure ended the year with a positive variation. However, growth in family remittances has been modest and levels of income from this source still fall far short of the highs observed before the crisis. The prime cause here is a sluggish labour-market recovery in developed countries, particularly Spain and the United States, the main destinations for migrants from Latin America and the Caribbean. Labour market projections for these countries suggest that growth in remittances will be modest in 2011.

FIGURE I.18

LATIN AMERICA AND THE CARIBBEAN (9 COUNTRIES): QUARTERLY YEAR-ON-YEAR VARIATION IN REMITTANCES

FROM EMIGRANT WORKERS, 2009-2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Data for 2001 refer to first quarter only.

Like remittances, the transfers account for the region also reflected a rise, of 80% and 118% in incoming transfers for Haiti and Chile, respectively, associated with grants and official assistance extended in the wake of the earthquakes that hit the two countries.[12] The surplus on the transfers balance narrowed from 1.5% of GDP in 2009 to 1.2% in 2010, although it increased in absolute terms. In 2011 the account is projected to yield a surplus equivalent to 1.0% of regional GDP.

12 Also reflected in the transfers account is a decrease of 58% on the credit side in Argentina, associated with an allocation of special drawing rights by the International Monetary Fund (IMF) that was registered as a current transfer in the third quarter of 2009 and not repeated in 2010.

(b) The capital and financial account

In 2010, external financial conditions —in the form of abundant global liquidity and stronger net investment inflows— once again led to a positive overall balance in the region’s balance of payments, with international reserves climbing to the equivalent of 16% of regional GDP.

This picture disguises somewhat divergent trends, however. As figure I.19 shows, net inflows of foreign direct investment (FDI) and portfolio investment into South America and Mexico have been rising vigorously since 2007, except for a hiatus in 2008 when the global financial crisis broke out. In fact, net portfolio investment flowing into these countries reached US$ 109.157 billion in 2010, exceeding for the first time —and by quite some way— net FDI, which came in at US$ 59.995. The figure also reflects the role played by reserves accumulation in absorbing external liquidity, which is associated with the exchange-rate-related objectives of several countries in this group.

FIGURE I.19

SOUTH AMERICA AND MEXICO: CURRENT ACCOUNT BALANCE AND COMPOSITION OF EXTERNAL FINANCING, 2000-2010

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

A very different situation prevails in the Central American countries, Dominican Republic and Haiti, however (see figure I.20). In this group, net FDI was the main component of positive inflows on the financial account, whereas portfolio investment was virtually insignificant. The next largest positive component was net other investment liabilities, which captures the effects of cross-border flows of bank deposits, loans and debt instruments. The surge in this category of inflows in 2010 was enough, together with the relatively stable net FDI flows, to finance the increase in the current account deficit over the year.

The pattern is even more pronounced in the Caribbean countries, where net FDI was virtually the only positive component of the financial account, while net other investment liabilities —mainly banking flows— were often negative (see figure I.21).

FIGURE I.20

CENTRAL AMERICA, DOMINICAN REPUBLIC AND HAITI: CURRENT ACCOUNT BALANCE AND COMPOSITION OF EXTERNAL FINANCING, 2000-2010

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

FIGURE I.21

THE CARIBBEAN: CURRENT ACCOUNT BALANCE AND COMPOSITION OF EXTERNAL FINANCING, 2000-2010 a

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Includes data for the following countries: Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Suriname and Trinidad and Tobago.

Net FDI is thus continuing to follow its long-term, steady upward path and was largely unaffected by the financial crisis of 2008. Recently, and especially in 2010, portfolio investment has accounted for an increasingly larger share of the region’s financial account; this has to do with the tremendous surge in global liquidity that resulted from developed countries’ responses to the global financial crisis and with the lower relative risk offered by economies in the region, especially Brazil, Colombia, Mexico and Peru (see table I.5). These are the countries that receive the bulk of flows from net FDI, portfolio investment and other investment liabilities, which partly explains their stockpiling of reserves and the efforts many of them have deployed to stave off currency appreciation. Chile stands out among the countries receiving FDI because it had a negative net portfolio investment flow over the period; this was attributable to the outward diversification of its pension funds and the build-up of resources in its sovereign funds on the back of high copper prices.

TABLE I.5

LATIN AMERICA (19 COUNTRIES): EXTERNAL FINANCIAL FLOWS, 2007-2010

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

The region has continued enjoying access to international capital markets, and its risk ratings

—while higher than before the global financial crisis— are still significantly lower than those of other regions. As can be seen in figure I.22, private entities, especially banks, made voluminous and frequent external bond issues in 2010 and have continued to do so thus far in 2011. Sovereign issues, on the other hand, have declined, reflecting the efforts by the public sector in the region to pare back its foreign debt over the past several years.

The region’s continued financial inflows, access to financial markets and historically high levels of international reserves show that its external financial position remains solid. Some specific developments merit closer examination, though. As shown in figure I.23, external debt has come down considerably as a percentage of GDP in South America and Mexico, thanks to economic growth and the fiscal and external surpluses posted in the years leading up to the global financial crisis (see figure I.23). Central America too has reduced its debt-to-GDP ratio quite significantly, largely owing to debt relief schemes such as the Heavily Indebted Poor Countries (HIPC) Debt Initiative, but by a smaller percentage than South America and Mexico given very difficult financial conditions and the slower pace of growth experienced by this group of countries. On the other hand, in the Caribbean countries —except for Trinidad and Tobago— external borrowing in relative terms has crept upward since the global financial crisis. This reflects the bleak financial conditions in the subregion since the crisis, which resulted in smaller net FDI inflows and lower current account balances (see figure I.21).

FIGURE I.22

LATIN AMERICA: EXTERNAL BOND ISSUES AND

COUNTRY RISK, 2004-2011 a

(Millions of dollars and basis points)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures from LatinFinance, Bonds database; JP Morgan and Merrill Lynch.

a Does not include data for Cuba. Data for 2011 refer to first four months only.

FIGURE I.23

LATIN AMERICA AND THE CARIBBEAN: GROSS EXTERNAL BORROWING, 2000-2010 a

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Does not include data for Cuba.

D. Macroeconomic policies

1. Monetary and exchange-rate policy

International financial conditions combined with rising commodity prices, in particular for foodstuffs and fuel, to complicate monetary and exchange-rate policy management in the region starting in the second half of 2010. Mounting inflationary pressures and expanding aggregate domestic demand prompted several countries to tighten monetary and credit policies initially created to weather the crisis, the majority of which continue to be in effect. Moreover, abundant liquidity in international financial markets and the resulting capital inflows to the region strengthened local currencies but undermined the competitiveness of the tradable goods sectors.

The region’s monetary and exchange-rate policymakers now face the challenge of maintaining price stability while keeping exchange-rate appreciation from diverting resources towards the production of non-tradable goods, as that would hinder diversification in the region’s manufacturing sector. The solution will lie in measures such as interest rate management, intervention in the foreign-exchange market —generally coupled with open-market operations designed to sterilize the monetary effect of foreign currency purchases— and the deployment of fiscal, exchange-rate, monetary and financial instruments regarded as unconventional until very recently, in an effort to restrict or discourage capital inflows. Despite the changes in policy rates, monetary policy in 2010 and the first part of 2011 maintained a distinctly expansionary slant. Benchmark interest rates and growth in the main monetary aggregates are fuelling credit expansion in the region, thus boosting aggregate domestic demand. As noted earlier, however, since mid-2010 some central banks in the region have raised monetary policy rates in response to inflationary pressures, especially external pressures relating to rising food and fuel prices in international markets. Figure I.24.A shows the rate hikes implemented by eight central banks in the region since mid-2010; despite these increases, the policy rates in those countries remain below the levels registered in 2008. Six other central banks in the region have maintained low rates similar to those set during the crisis (see figure I.24.B), and four others continued to cut their benchmark rates in 2010 and 2011 (see figure I.24.C).

FIGURE I.24

LATIN AMERICA AND THE CARIBBEAN (SELECTED COUNTRIES): MONETARY POLICY RATES, 2008-2011

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

Overall, the management of benchmark interest rates by central banks in Latin America and the Caribbean has resulted in minor adjustments to nominal lending rates and, given the inflation levels expected, this has meant a reduction in lending rates in real terms. Moreover, the behaviour of the main aggregates reflects the expansionary nature of monetary policy and the recent efforts to mitigate its effects on aggregate demand. Thus, in many of the region’s countries the monetary base grew in real terms in 2010, albeit at a slower pace than in 2009 in many cases, with M1 and M2 following similar paths. In 2011 thus far, monetary aggregates have continued to grow, but at lower rates than those posted in 2010 (see figure I.25).[13]

13 The monetary base shrank in real terms in only 6 countries and expanded in the other 16 countries, albeit at a slower pace in 6 of them. Of the 21 countries for which information is available in real terms for 2010, the M1 aggregate contracted compared with 2009 in only 2 countries while growth slowed in 7 countries. With regard to real M2, of the 20 countries for which data are available, the aggregate fell in only 2 countries while growth slowed in 6.

FIGURE I.25

LATIN AMERICA AND THE CARIBBEAN (SELECTED COUNTRIES): VARIATION IN MONETARY AGGREGATES, 2008-2010

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

Credit expanded significantly in 2010 in real terms. Of the 13 countries with information available, variations in lending were positive in 9 countries and negative in only 4 (see figure I.26). This trend is a reflection, in part, of the steps taken by central banks to boost credit, mitigate the effects of the crisis on the region’s economies and create liquidity conditions conducive to stimulating aggregate demand. Public sector lending started to grow in mid-2008 when the crisis began to reverberate in the region and caused lending by private financial institutions, to contract in 2009. With regard to the destination of lending, the growth posted in 2010 was fairly widespread and encompassed the industrial and commercial sectors as well as mortgage lending and consumption in general. In the first quarter of 2011, credit continued to expand vigorously, especially consumer lending, which accounted for a greater share of total lending.

FIGURE I.26

LATIN AMERICA (SELECTED COUNTRIES): REAL-TERM VARIATION IN TOTAL LENDING, 2008-2010

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

As noted earlier, abundant global liquidity and its repercussions on the region’s money markets triggered currency appreciation pressures. In an effort to reverse this trend, some countries took steps to restrict capital movements, coupled with other measures such as stockpiling international reserves at central banks, pre-payment of external debt by national treasuries and streamlined arrangements for domestic financial and non-financial agents (such as pension fund operators and public enterprises) to hold some of their international assets abroad.

In 2010, all non-dollarized economies in Latin America and the Caribbean with the exception of the Bolivarian Republic of Venezuela and Uruguay accumulated international reserves, which by the end of 2010 exceeded, as a percentage of GDP, the pre-crisis levels recorded in 2007 in most cases. In the first few months of 2011, the region’s central banks continued to build up reserves and in some cases (Brazil, for instance) intervened heavily in the foreign-exchange market. Following the strong appreciation of the Brazilian real in nominal terms and as part of the effort to stem capital inflows, the Central Bank of Brazil acquired US$ 31.7 billion in reserves in the first four months of 2011, 273% more than the year-earlier period. Argentina, Chile, Colombia and Costa Rica also actively intervened in the foreign-exchange market in early 2011. In March and April 2011, Peru —breaking from its practice for much of 2010— drew down US$ 1 billion in reserves with an eye to mitigating the nominal exchange rate volatility triggered by its presidential elections.

Despite the efforts deployed, 11 of the region’s countries recorded nominal appreciations in 2010 and early 2011, in particular Brazil, Colombia and Uruguay but also, to a lesser extent, Chile, Costa Rica, Mexico and Peru (see figure I.27). Against appreciating nominal exchange rates and increasing inflationary pressures, the extraregional real effective exchange rate of Latin America and the Caribbean fell by 3.5% between 2009 and 2010. The drop in the real exchange rate was widespread: in South America, it fell by an average of 2.6% in the period, or by 7% if the Bolivarian Republic of Venezuela is excluded from the calculation, while in Central America, Mexico and the Caribbean it was down by 4.5%. In the first four months of 2011, the average extraregional effective exchange rate for the region remained virtually unchanged from December 2010, with the average for South America falling by 1.4% and the average for Central America, Mexico and the Caribbean rising by 1%.

FIGURE I.27

LATIN AMERICA AND THE CARIBBEAN (SELECTED COUNTRIES): VARIATION IN REAL EFFECTIVE EXCHANGE RATE, MAY 2011 COMPARED WITH 1990-2009

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

In April 2011, the overall effective real exchange rate stood at more than 20% below (i.e. currency appreciation) the 20-year average in the Bolivarian Republic of Venezuela, Brazil, Colombia, Guatemala, Paraguay and Trinidad and Tobago and at more than 10% below the long-term average in Costa Rica, Honduras, Jamaica and Uruguay. In the Bolivarian Republic of Venezuela, persistent high inflation partly offset the implicit devaluations of January 2010 and January 2011.

2. Fiscal policy

Following the fiscal activism pursued by the countries of the region in 2009, two developments in particular shaped the year-end results for 2010. One was growth in fiscal revenues on the strength of higher economic activity levels and, in countries specializing in the production and export of natural-resource-intensive goods, the rebound in commodity prices. The other was on the spending side, as governments sought to temper the impact of public policy as a driver of demand, although those efforts were not even across all countries. The outcome has been better fiscal performance on the whole, with estimates for 2011 indicating that the region will return to a primary balance near equilibrium (-0.1% of GDP).

However, even with the improved health of public accounts, the fiscal policy space for managing revenue, spending and public debt has been critically diminished by the crisis, as can be seen in figure I.28. While the period 2003-2007 saw a solid expansion of the fiscal space thanks mainly to higher revenue flows and lower debt levels, spending increases and revenue dips during the crisis caused the fiscal space to shrink, and that space was not regained in 2010.

At the central government level, the region ran a primary deficit of 0.4% of GDP in 2010 (measured as a simple average), compared with a deficit of 1.1% in 2009; in terms of the overall balance (that is, including debt service payments), the deficit narrowed from 2.9% to 2.0% of GDP. In 2010, half the Latin American countries reviewed ran a primary surplus, while in the period 2003-2008 an average of 15 (nearly 80% of the total) had done so.

FIGURE I.28

LATIN AMERICA (19 COUNTRIES): VARIATION IN FISCAL SPACE

(REVENUE, EXPENDITURE AND CENTRAL GOVERNMENT DEBT),

2003-2007 AND 2007-2010 a

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a The triangles represent the fiscal space in direct proportion to disposable income and inverse proportion to expenditure and debt.

TABLE I.6

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT FISCAL INDICATORS, 2007-2010

(Percentages of GDP at current prices)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a At 31 December each year, using the average exchange rate applicable to external debt at the end of the period.

b Non-financial public sector.

c Simple average.

d General government.

e Fiscal years.

FIGURE I.29

LATIN AMERICA AND THE CARIBBEAN: THE PUBLIC ACCOUNTS, 2000-2011

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Estimate.

b Projection.

Underlying the general performance of the region’s public accounts are differing patterns in the countries (see figure I. 30). As indicated earlier, the countries of South America —for the most part commodity exporters that grew above the regional average— posted a significant increase in tax revenue (except for Colombia, the Plurinational State of Bolivia, Uruguay and, especially, the Bolivarian Republic of Venezuela), and that was the main factor behind the improvement in the public accounts. In most cases, higher revenue flows were accompanied by a drop in current spending as a percentage of GDP (Argentina and the Bolivarian Republic of Venezuela being the exceptions). Mexico and the Central American countries saw much weaker fiscal revenue flows; in half of those economies (Costa Rica, Guatemala, Mexico and Panama) the public accounts worsened, while the others witnessed some improvement (Cuba, Dominican Republic, El Salvador, Honduras and Nicaragua) but not on a level comparable to South America and mainly as a result of lower spending.

Renewed economic growth in 2010 enabled the region to bring in an average tax take equivalent to 14.9% of GDP, which was still below the historic high of 15.1% recorded in 2007. Tax collection levels in a full 50% of the countries have already returned to the levels preceding the 2008-2009 crisis, although clear variations in tax revenue trends can be observed in the period 2007-2010.

A look at quarterly performance of tax revenues in some countries of the region over 2009-2011 shows an across-the-board recovery beginning in the fourth quarter of 2009. That recovery gained strength throughout the first three quarters of 2010 but lost steam in the fourth quarter, except in Argentina and Colombia.

In 2010, fiscal spending was reduced by just under 0.5 percentage points of GDP, with 13 of the 20 countries examined reporting spending cuts. Nearly all countries of the region curtailed their current expenditure, while increasing capital spending. The regional average shows a drop in current spending of 0.5 percentage points of GDP and an uptick in capital expenditure of nearly 0.2 percentage points of GDP. Primary current expenditure was down by approximately 0.3 percentage points of GDP.

FIGURE I.30

LATIN AMERICA (19 COUNTRIES): CONTRIBUTION OF REVENUE AND EXPENDITURE VARIATIONS TO VARIATION IN OVERALL BALANCE, 2009-2010 a

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Total expenditure does not include net lending.

b The overall balance includes statistical discrepancies.

c General government.

d Includes both tax and non-tax revenue from commodities.

FIGURE I.31

LATIN AMERICA AND THE CARIBBEAN (19 COUNTRIES): CENTRAL GOVERNMENT REVENUES, 1990-2011 a

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Data for 2011 are projections.

FIGURE I.32

LATIN AMERICA (SELECTED COUNTRIES): REAL-TERM YEAR-ON-YEAR QUARTERLY VARIATION IN TAX REVENUE, EXCLUDING SOCIAL SECURITY, 2009-2011 a

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Data for 2011 refer to first quarter only.

b Includes non-petroleum tax revenues.

FIGURE I.33

LATIN AMERICA: CENTRAL GOVERNMENT EXPENDITURE,

1990-2011 a

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Does not include Cuba. Data for 2011 are projections.

The region’s level of public spending at year-end 2010 was 1.8 GDP percentage points above the 2007 level. The increase stemmed from a large rise in primary expenditure (2.1 percentage points of GDP), which offset the drop in interest payment outlays during the period (0.3 percentage points of GDP). Of the 20 countries examined, five reported expenditure 3 percentage points of GDP higher than in 2007. The countries with the largest increases were Ecuador (9.5 percentage points of GDP), Argentina (5.3 points), Costa Rica (4.9 points), Panama (4.8 points) and Chile (4.7 points). The countries in which interest payments dropped the most were Brazil, Costa Rica, Ecuador, Panama and Uruguay, all with reductions of around 1 percentage point of GDP. Conversely, the Plurinational State of Bolivia, Honduras and the Dominican Republic saw interest payment increases of 0.2, 0.3 and 0.6 percentage points of GDP, respectively, during the period. The region’s current expenditure rose on average by more than 1 percentage point of GDP but interest payments contracted slightly, so primary current spending was up by around 1.5 percentage points. Capital expenditure rose by 0.5 percentage points of

GDP approximately.

In summary, following the deterioration observed in 2009, the countries of the region are slowly recreating their fiscal space through higher fiscal revenue inflows, steady spending levels in GDP terms and lower debt-to-GDP ratios. The strategies for expanding that space will vary from one country to the next: in some countries, the authorities should focus on strengthening a weak tax burden; in others (those having more robust revenue structures), efforts should focus on containing the expansion of current public spending. In some Caribbean countries, the recurring issue of public debt sustainability will need to be addressed.

3. Summary and outlook

Beginning in the second half of 2009, the Latin American and Caribbean region has been recovering steadily from the fallout of the global crisis and —thanks to rising domestic and external demand— it is today growing at rates considered relatively high for its economic history. The region is expected to grow by 4.7% in 2011 and by 4.1% in 2012, but that growth will take place in a setting of mounting uncertainty brought about by the external context, as will be discussed below. World economic growth, especially in developing countries, has resulted in significantly improved terms of trade, especially in the majority of South American economies, in some Caribbean economies similarly specialized in commodity production and export and, to a lesser extent, in Mexico. In Central America and most of the Caribbean economies, however, the opposite effect is observed because of their position as net importers

of commodities.

Abundant liquidity in the global economy coupled with low relative risk levels in the region have opened access to international financial markets for both the public and private sectors. This has fuelled credit expansion in the region and spurred domestic demand for consumption and for investment. The clear improvement in labour market indicators driven by the economic recovery is an additional key element that explains in part why private consumption has remained so buoyant.

These developments all evolved within a framework that is still marked in some cases by a strong presence of public policies implemented to mitigate the effects of the crisis, although some governments have announced plans to dismantle these measures. For instance, while it is true that public spending has been gradually declining since 2009 (as a percentage of GDP), the projected levels for 2011 are still above pre-crisis levels.

Higher commodity prices (in particular for foodstuffs and fuel) are combining with robust domestic demand to exert upward pressure on the inflation rate. The region’s central banks thus once again face the dilemma of whether to focus on price stability or on attempting to defend the competitiveness of sectors that produce exportable goods and import substitutes, at a time when the mix of available international liquidity, the solidity of some Latin American economies and renewed appetite of foreign investors for assets in emerging countries is translating into strong pressure towards exchange-rate appreciation in the region.

Although, this topic will be examined in greater detail in the second part of this study, it is worth noting here the challenges posed in terms of macroeconomic policy design. First, bearing in mind that the recent price increases were triggered by a supply shock and that the demand for goods such as foodstuffs and fuels is relatively inelastic, monetary policy loses effectiveness as an inflation-fighting instrument, although it achieves the objective of allaying fears of further price hikes. Interest rate hikes, however, tend to widen the spread between domestic rates in the region and the rates prevailing on the financial markets of the developed economies. Capital inflows are thus attracted to the region, with the ensuing pressure towards currency appreciation in the foreign-exchange markets. Currency appreciation has a deflationary effect whose magnitude depends on the share of tradable goods in the household consumption basket, by which it alleviates inflation. In the short term, capital inflows also expand the credit available for sustaining domestic demand and even help to alleviate poverty: as consumption by the poorer strata is food-intensive, the relative price of foodstuffs should normally fall hand in hand with a falling real exchange rate. It is an anti-inflation strategy that appears to have no costs, and that is why economic authorities often cannot resist allowing some measure of appreciation.[14]

14 See ECLAC, Preliminary Overview of the Economies of Latin America and the Caribbean, 2010 (LC/G.2480-P), Santiago, Chile, December 2010.

The foregoing notwithstanding, the situation poses a series of risks and issues for the short term as well as with regard to growth prospects. For instance, the region could become vulnerable to speculative capital movements looking for very short-term gains, compounded by the fact that the resources flowing in often exceed financial system capacity and can create bubbles in financial asset prices and real estate markets.[15] At the same time, that capital can leave from one moment to the next, severely disrupting growth; this topic will be addressed in greater depth below.

15 See Nicolas Magud, Carmen Reinhart and Kenneth Rogoff, “Capital controls: myth and reality. A portfolio balance approach”, NBER Working Papers, No. WP11-7, Peterson Institute for International Economics, 2011.

A falling real exchange rate can impact the external component of the demand for goods, especially if world trade were to slow down, as could happen if growth in the developed nations stalls as is forecast for mid-2011. While there is no cause for immediate concern, the region’s balance-of-payments current account has been deteriorating systematically since 2006, including during times of very favourable terms of trade for the region. As can be seen in box I.3, the region’s current account estimated on the basis of international trend prices yields a higher deficit than the actual one, but financing of that deficit would pose no problem.

At the same time, excess global liquidity is pushing real exchange rates down and commodity prices up, acting as an incentive for intensive specialization in the production and export of primary goods. As indicated earlier,[16] this makes the region’s economies more vulnerable to external shocks and generates greater volatility in internal macroeconomic aggregates, such as investment; the overall impact is to stunt economies’ ability to grow, create productive employment and reduce inequality.

16 See R. Frenkel and M. Rapetti, “Fragilidad externa o primarización: ¿cuál es la principal amenaza para América Latina?”, Santiago, Chile, Economic Commission for Latin America and the Caribbean (ECLAC), 2011, unpublished.

Economic authorities across the region have tackled these complex macroeconomic policy dilemmas by launching measures that combine, to varying degrees, partially sterilized interventions in foreign-exchange markets and specific controls on capital inflows and financial regulations aimed at boosting demand or curbing the supply of foreign exchange on stock markets, thus alleviating pressure on currency prices. The effectiveness of the measures ultimately adopted, however, will hinge on the immediate macroeconomic policy context. For instance, as will be seen in detail below, these measures will produce greater impact if they are coordinated with fiscal policy measures to spur public sector savings, as that would reduce exchange-rate and inflationary pressure.

The situation described is not without its risks but those risks will not prevent the region from growing throughout 2011 and, it is expected, into 2012. The rate of growth, however, will likely approach a level closer to potential GDP. Much will depend on the progress made in resolving some uncertain situations, in particular in the developed economies. For instance, the United States economy has been recovering more slowly than expected, as reflected not only in data on level of activity but also in labour market indicators and real-estate market performance. Ongoing problems at some banks, households’ inability to shake off debt and the overall slow pace of the recovery are all elements that impinge on financial activity and conspire against the strategy of fostering growth through monetary policy; at the same time, budget deficits and high levels of indebtedness undermine the effectiveness of fiscal policy measures.[17]

17 See James Mason and others, Central Bank Watch: The Shifting Tides of Global Monetary Policy, Roubini Global Economics (RGE), June 2011.

BOX I.3

LATIN AMERICA’S CURRENT ACCOUNTS AT TREND PRICES

From 2003 to 2007, Latin America experienced an unprecedented current account surplus that averaged 1% of GDP. With the onset of the international financial crisis at the end of 2008, the region’s external balance turned negative, averaging a deficit of 0.8% of GDP during 2008-2010, in particular owing to the decline in the trade balance. Since the period under consideration coincided with a steady rise in the price of commodities, which make up a significant portion of the region’s exports, it is worth asking how the current account balance would look, if measured at trend prices for commodities.

To this end, a matrix was prepared containing the main commodities exported by Latin American countriesa and their respective international prices. The trend prices were obtained using 10-year moving averages.b Then, the ratio between the trend price and the actual price is used as the adjustment factor applied to export items.c For the sake of consistency, the adjustment is applied to both commodity exports and imports, the latter consisting mainly of oil and petroleum products. Given the positive and significant correlation between commodity exports and profit remittances from foreign direct investment (which shows as a debit on the income account), this component of the income account was also adjusted using the same factor.

In addition, given that the adjustment of exports and imports does not produce a symmetrical outcome, the net balance of the trade adjustment will generate an identical movement in GDP. Therefore, the current account balance in relation to GDP should be calculated as a proportion of this “corrected” GDP. Indeed, given that the demand for imports is a component of GDP, GDP must be adjusted to be consistent with adjusted imports, in line with their income elasticity.d Intuitively, if the region had not benefited from the very high export prices of the last few years, its disposable income would have been decidedly lower, as would its demand for imports.e

Table 1 shows the long-term income elasticity of imports for 10 countries, and for the region overall (average for 19 countries).f The estimates were calculated using annual data from the period 1980-2010. There is a significant dispersion in the long-term elasticities for each country, which vary from 1.3 to 1.4 in countries such as Chile, Peru and the Plurinational State of Bolivia, to above 3 in Brazil and Mexico. The aggregate for 19 countries in the region was 2.5.

TABLE 1

LATIN AMERICA AND THE CARIBBEAN (19 COUNTRIES): ESTIMATED INCOME ELASTICITY OF IMPORTS

Source: Economic Commission for Latin America and the Caribbean (ECLAC).

Note: LM, imports log; LPIB, gross domestic product log; LTCR, real exchange rate log.

Dependent variable: log (imports). Method: least squares (Newey-West heteroskedasticity and autocorrelation consistent (HAC) standard errors). Sample: 1980-2010.

Significant at 1% (***). 5% (**) and 10% (*).

Figure 1 shows the results of the adjustment for the regional aggregate (19 countries). At the regional level, the external balance is seen to be sustainable, since, measured at trend prices, the region would still have posted a slight current account surplus for 2003-2007 (an average of 0.1% of GDP). The reversal of the external balance during the international financial crisis —i.e. an external deficit at trend prices— peaked at 1.9% of GDP in 2008 and eased back to 1% in 2009; these figures are compatible with the region’s capacity to sustain net inflows of capital. In fact, during 2003-2010, the regional capital account averaged a surplus (net inflows) of 1.4% of GDP and, in particular, the net inflow of FDI averaged 1.9% of GDP (net portfolio investment: 0.5%; other net investment: -1%). In 2010, once the crisis was over, Latin America’s current account, measured at trend prices, posted a deficit of 1.8% of GDP (an effective deficit of 1.2%), while the capital account ran a surplus of 3.1% of GDP, with FDI making up 1.4% (net portfolio investment: 2.2%; other net investment: -0.5%).g

FIGURE 1

LATIN AMERICA AND THE CARIBBEAN (19 COUNTRIES): CURRENT ACCOUNT AT TREND PRICES, 2000-2010

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC).

Of course, the outcome of this exercise differs at the country level. Figure 2 shows the specific results for selected countries. Of the four countries that posted an actual surplus on their current account in 2010 —Argentina (1% of GDP), Bolivarian Republic of Venezuela (3.7%), Chile (1.9%) and Plurinational State of Bolivia (4.6%)— all except for the Plurinational State of Bolivia recorded a deficit measured at trend prices (-0.1%, -0.2%, -1.6% and 1.2%, respectively). The countries with the largest gap between their actual and corrected balances are, as may be expected, the exporters of hydrocarbons, particularly those for which this item represents a significant portion of the export basket, such as the Bolivarian Republic of Venezuela, Colombia, Ecuador and the Plurinational State of Bolivia. In Colombia and Ecuador, the actual current account deficit was 3% of GDP in 2010, but measured at trend prices, their deficits were larger: 4.2% and 4.7% of GDP, respectively.

The copper exporters, Chile and Peru, also had a wide gap, especially for 2006-2007, when the real price of the metal hit all-time highs. Brazil and Mexico showed the smallest gap between the actual and corrected current account balance, mainly because their export baskets are much more diversified than those of the other countries analysed. The downward adjustment of exports is offset in large part by the higher estimated income elasticity for both countries.

FIGURE 2

LATIN AMERICA AND THE CARIBBEAN (19 COUNTRIES): CURRENT ACCOUNT AT TREND PRICES, 2000-2010

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC).

a These products are wheat, corn, rice, soybean, copper, iron, steel, aluminium, silver, zinc, tin, nickel, lead, oil, coal and natural gas.

b Similar results are obtained using the Hodrick-Prescott filter for the trend prices.

c This adjustment reflects corrections in prices, not in volumes.

d The income elasticity of imports is calculated as follows:

e Of course, in seeking an overall balance, we could also consider a drop in private consumption and other effects. However, here we are focusing exclusively on correcting the elements that affect the current account.

f The specification estimated using the ordinary least squares method in each case corresponds to constrained versions of:

g As part of the revenue relating to FDI includes profits that are reinvested, the FDI figure used for calculating the current account balance at trend prices could be lower than the observed figure.

Japan, for its part, continues to rebuild in the wake of the March 2011 earthquake (see box I.1) and it will grow very little in 2011 but —given the low basis for comparison— slightly more in 2012. The prolonged stagnation of the Japanese economy began with the crisis that rocked the country’s banking system in the 1990s and for which a lasting solution has yet to be found.

This inauspicious outlook for growth in the developed economies is compounded by the situation in Europe, where the focus for the time being is on finding a solution to the Greek debt problem. Latin America’s experience, the level of Greece’s indebtedness and the severity of the fiscal adjustments needed to return the public debt to sustainable levels all point to the virtual inevitability of an across-the-board restructuring coupled with a hefty write-off. The European authorities have, however, thus far resisted this form of debt reduction, fearful of the possible contagion effect on other economies in difficult circumstances, including not just Ireland and Portugal but also Spain and Italy, despite the relative improvement seen in these countries recently.[18]

18 See Eduardo Levy Yeyati, “Grecia, entre la negación y la reprogramación inútil”, 20 May 2011 [online] http://yeyati.blogspot.com/.

While that fear is not entirely unfounded, the economic history of Latin America and the Caribbean holds —as noted above— important lessons for what is happening in Europe these days. A write-off is inevitable, but it should be conducted in an orderly fashion rather than left to market pressures and a possible haphazard approach. The contagion effect in the latter case could be devastating and even become systemic.

In the emerging economies, the outlook is somewhat brighter but the possibility cannot be ruled out that growing inflationary pressure in countries such as China, India and the Russian Federation, for instance, will lead to tighter monetary policy and, as a result, a slowdown in growth. That, in turn, would hamper the ability of those economies to sustain the growth in demand that is instrumental in correcting global imbalances.

Undoubtedly, there are a myriad of factors at play —slowdown of world economic growth, gradual absorption of available global liquidity and a higher risk component in financial assets, especially (but not only) of some European sovereign debt— that could culminate in a “flight to quality”. That would mean, as borne out in the recent crisis, greater demand for dollar-denominated assets and a sudden reversal in capital flows.

However, such a scenario does not appear imminent, although it could come to pass sooner rather than later depending on how the European debt problem is handled. The bad news is that the economic history of Latin America and the Caribbean clearly shows that reversals in capital flows rarely occur in isolation; rather, they are often accompanied by drops in international commodity prices and, consequently, a deterioration in the region’s average terms of trade, as can be seen in figure I.34. Notably, economies that are net commodity exporters and receive significant capital flows are much more vulnerable to such a turn of events than the majority of the economies of Central America and the Caribbean, which are net commodity importers and do not enjoy open access to international financial markets.

FIGURE I.34

LATIN AMERICA: CAPITAL FLOWS AND TERMS OF TRADE,

1980-2011

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

Inasmuch as net outflows of capital usually occur in parallel with a deterioration in the terms of trade, any further worsening on the international financial markets could create pressure on the region’s external accounts, in both its current and the capital components. If, and it is possible this will be the case, the scenario is compounded by a slowdown in growth and, by extension, a dropoff in trade, the most prudent recommendation would be that the region’s economies should prepare themselves as best they can to pursue a countercyclical strategy in a context of less abundant foreign exchange.

Again, the risks are not imminent but the situation does need to be taken seriously. That means tapping the current favourable conditions to accumulate international reserves and generate public sector savings in order to reclaim the policy space lost during the crisis. Controls or limits on short-term capital inflows would also help to make economies less vulnerable. These recommendations are compatible with the need to contain the currency appreciation referred to earlier. The instruments available to the region’s economic authorities to defend, to the extent possible, levels of competitiveness with longer-term objectives could also promote macroeconomic equilibria and counteract the volatility that has been a chronic feature in Latin America and the Caribbean.

In sum, rebuilding fiscal space is of vital importance to the countries of the region, as it would underpin efforts to meet not only traditional public policy challenges (the need for greater investment in physical and social capital) but also other challenges emerging on the international stage. In addition, with higher levels of public sector savings, monetary policy could be relaxed, thus alleviating the tension between anti-inflationary and exchange-rate strategies.

FIGURE I.35

LATIN AMERICA AND THE CARIBBEAN: GDP GROWTH, 2012

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

Part 2

International integration and macroeconomic policy challenges

amid global economic turmoil

Chapter I

Changing external financing sources and macroeconomic regimes in the region:

the uneven impacts of external

shocks and response policies

The composition of external financing has changed markedly over the past 30 years for the countries of Latin America and the Caribbean. Some macroeconomic regimes have been overhauled and external shocks are transmitted to the domestic economy in new ways. This chapter offers an overview of the shifts in the region’s main sources of foreign exchange, reflecting patterns in current account components in some cases and increased financial flows in others. It also looks at the main changes in macroeconomic policy regimes. Lastly, after reviewing structural elements that influence the way in which external shocks impact and spread through the domestic economy, it sets out an analytical framework for tackling the policy dilemmas faced by the countries of the region.

A. Recent changes in external financing in Latin America and the Caribbean

First, the main current account factors affecting external financing are changes in commodity prices, the composition of the income balance and migrant remittances.

Several countries in the region, especially the commodity producers and, to an even greater extent, the hydrocarbon, metal and mineral exporters, have benefited from higher international prices and external demand for their products. This has greatly boosted their terms of trade, slashed the trade deficits seen during the 1990s and, in particularly favourable years, produced a current account surplus. In some of these countries —Bolivarian Republic of Venezuela, Chile, Ecuador, Peru and Plurinational State of Bolivia— available gross national income expanded consistently above GDP growth between 2004 and 2010 (Kacef and Manuelito, 2008). However, for net importers of food and fuel, particularly the Central American economies, the recent hike in commodity prices has had the opposite effect: a deterioration in the trade balance. As in the past, therefore, the region remains vulnerable to external shocks related to commodities and raw materials, although their effect on the different countries is increasingly heterogeneous.

At the same time, the proportion of the regional income balance accounted for by net debt servicing and the repatriation of profits by resident foreign companies changed significantly.[1] During the 1980s and 1990s the deficit on the income account was largely the outcome of payments of interest on external debt. However, the composition of this deficit has been changing since the mid-1990s and to an even greater extent since 2000. Now its largest components are remittances of profits and dividends and payment of returns on portfolio investment assets held by resident foreign companies. This shift has been particularly notable in countries where a significant proportion of foreign direct investment (FDI) goes to natural resources (Chile and Peru).

1 In accordance with the methodology of the International Monetary Fund’s Balance of Payments and International Investment Position Manual, entries should be recorded on an accrual basis. Accordingly, a deficit entered on the income account gives rise to an equivalent entry in the balance of payments, but these entries do not necessarily coincide with those recorded on a cash basis (when payment has been effected).

At the regional level, the only component of the current account balance that remained in positive territory throughout the period 1990-2010 was current transfers,[2] owing to rising remittances from migrant workers. Starting in the 1990s, remittances became increasingly important to the region as growing numbers migrated to the United States and Europe, as well as to neighbouring countries. Meanwhile, advances in statistics and regulatory changes have enabled more accurate recording of incoming remittances and technological progress has made it easier for migrants to send money home. Although migrant remittances represent only 1.5% of GDP for the region overall, in some Central American and Caribbean countries they are a weighty source of financing, accounting for between 10% and 20% of GDP.

2 The travel account of the services balance also began to post a surplus throughout the region in the second half of the 1990s.

The second major shift in foreign exchange sourcing has been driven by changes in the components of the capital and financial accounts. The region is engaged, to differing degrees depending on the country, with the current phase of globalization and all its productive, trade, financial, demographic and cultural facets. In terms of production, this is reflected in the way in which the countries in the region participate in goods, services and factor markets, depending on their productive specialization strategy. A number of countries adopted strategies of capital and financial account liberalization and, given the shortage of resources following the debt crisis of the 1980s, opened various sectors of the domestic economy to FDI and deployed policies targeting this type of investment. This coincided with the emergence of attractive investment opportunities in various sectors of the region’s economies, such as retail commerce, banking, natural resources, tourism and other services.

As a result, since the mid-1990s, FDI has become one of the region’s main sources of external financial resources and in fact been more stable than other financial flows.[3] In several countries FDI makes up a hefty proportion of GDP: between 1997 and 2010 FDI exceeded 5% of GDP in Chile, Costa Rica, the Dominican Republic, El Salvador, Honduras, Nicaragua, Panama, Peru, the Plurinational State of Bolivia and Uruguay. In turn, Latin American countries have recently been investing increasingly abroad, especially within the region itself, reflecting the growing internationalization of national companies and their expansion into the rest of Latin America and the rise of a new breed of enterprise referred to as the trans-Latins (ECLAC, 2007). Despite the fact that net FDI flows into Latin America —i.e. the balance of inflows and outflows— are continuing to trend upward (with the exception of 2009), FDI has diminished in comparison with the peak levels reached in 2008.

3 Despite the relative stability of these flows in the region, FDI is not impervious to volatility.

A third change in the region’s sources of foreign exchange has been driven by the rapid economic growth and successful productive transformation of several Asian economies and the resulting surge in demand for raw materials. At the same time, the transition of Eastern European countries from centrally planned economies to market economies, together with economic consolidation in several countries with intermediate levels of development, has created a new type of asset: those of the emerging economies. These markets are increasingly attractive in a risk-tolerant and diversification-seeking investment climate. Several Latin American countries have been involved in this development with a rise in both inflows and outflows of financial resources. In 2010, portfolio investment inflows actually exceeded FDI inflows, reflecting increased global liquidity and low yields in developed countries in the wake of their efforts to offset the impacts of the crisis. These burgeoning portfolio flows are attributable to two factors: (i) the local financial markets of several countries in the region are showing vigorous growth, coupled with an improvement in their indicators of fiscal and financial soundness; and (ii) as investors seek profitability in an international context of low financial returns, these improved macroeconomic indicators have made the region’s countries more attractive as investment destinations and this has fuelled the growth of certain markets (Brazil, Chile and Peru).[4]

4 In 2010 portfolio investment in Latin America expanded significantly. For the first time since 1993 capital inflows from portfolio investment exceeded FDI inflows. An analysis of the net amounts shows an even greater difference. However, some countries, such as Chile, are experiencing sustained net outflows, linked to the portfolio diversification of the pension system and, in more recent years, the accumulation of sovereign fund resources held overseas.

External bond issues (initially sovereign bonds and then corporate bonds) have also been on the rise, albeit at varying paces. In fact, the surge in portfolio investment flows into the region also reflects the rise in bond issues since, although these consisted essentially of sovereign bonds in the early 1990s, they have shifted heavily in the 2000s towards corporate and bank bonds (the latter particularly in 2010).

Meanwhile, at the regional level, net other investment liabilities have on the whole led to outflows of resources, which in some countries can be attributed largely to the diversification of pension systems, the build-up of sovereign funds and the accumulation of assets overseas where national financial systems lack the capacity to absorb them. Sometimes these outflows are associated with banking crises. Only Brazil, Chile and Peru are receiving significant inflows drawn by favourable interest rate arbitrage (carry trade).[5]

5 Net other investment liabilities include accrued net changes in bank loans, foreign trade credits, currency and deposits held abroad and external debt other than bonds and exceptional financing. It therefore includes external borrowing from banking institutions, multilateral institutions (World Bank) and governments (Paris Club) (IMF, 2009).

Lastly, the improvement in the terms of trade, the renegotiation of debt under the Heavily Indebted Poor Countries (HIPC) Initiative, the sounder fiscal position and the substitution of external debt with domestic debt have helped to improve the region’s external public debt indicators in recent years.

B. Changes in patterns of external financing and their impact on macroeconomic policies

The changing patterns of external financing in the region identified in section A were due to exogenous factors such as global financial market trends, the deeper integration some countries have pursued in these markets and changes in macroeconomic policy regimes over the past 10 to 15 years. These policy changes have been prompted in part by the external fluctuations and insufficient and unstable growth that have been characteristic of the region. These trends are important from a policy viewpoint inasmuch as they combine with certain features of the economic structure to shape the impact of external shocks on the domestic economy, the resulting macroeconomic policy dilemmas and possible responses. These matters are examined here, considering macroeconomic policy within the framework of the structural diversity typical of the region’s economies.

To varying degrees, the governments of many Latin American countries undertook progressive reforms of their macroeconomic regime in the wake of the traumatic recessionary adjustments that followed the external overindebtedness and debt crisis of the 1980s, the large fluctuations in capital inflows of the 1990s and a series of crises in the region (in Mexico in 1994, in Brazil and Ecuador in 1998-1999 and in Argentina in 2001). Criticism of the conditionalities that multilateral financing agencies attached to their assistance for overcoming these crises also helped to drive the reforms.[6]

6 The conditionalities imposed on some Asian countries in 1997 as part of their crisis exit strategy provoked sharp criticism and were instrumental in prompting an internal review at the International Monetary Fund (IMF) (Frenkel, 2002; Greenville, 2004).

Several countries have shifted their fiscal policy more heavily towards keeping the public accounts in balance. Some have even built up countercyclical capacities, which has enabled them, among other achievements, to gradually reduce public debt, both as a percentage of GDP and in absolute terms. In several cases, this has shrunk the impact of external debt servicing on the balance of payments.

The monetary policy stance has, in general, leaned towards controlling inflation and some countries, notably

Brazil, Chile, Colombia, Mexico and Peru, have adopted specific inflation targeting schemes. Paraguay and

Uruguay have recently taken steps in this direction, as well. A number of countries have gone so far as to make the central bank independent from the executive branch, although this is not a requirement for monetary policy-based inflation targeting. Consistently with this inflation-oriented approach, more countries have opted for relatively flexible exchange-rate regimes, albeit with frequent interventions by the monetary authority in some cases. Conversely, a small group have either adopted the dollar as their legal currency in response to difficulties in controlling inflation or to restore confidence in their financial system (Ecuador, El Salvador) or else, for other reasons, maintain a heavily administered foreign-exchange regime (Bolivarian Republic of Venezuela).

BOX I.1

ASPECTS OF FISCAL POLICY IN LATIN AMERICA, 2000-2010

Most of the Latin American economies experienced robust growth and were able to pursue sound macroeconomic policies in the first decade of the twenty-first century. During this period, the region made progress towards greater fiscal solvency, thanks mainly to the higher fiscal revenues and low public debt payments that were a corollary of the economic upturn.

Its sounder fiscal position made Latin America better prepared to respond to the crisis of 2008-2009. When the crisis hit, most of the countries in the region were running primary surpluses (or only small deficits) and were carrying low levels of debt. The fiscal space created in the Latin American economies before the global financial crisis and the quick recovery of demand for the region’s exports in its wake underpinned an economic upturn in the region in mid-2009. The challenge now for Latin America is to consolidate those gains.

FIGURE 1

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT INCOME,

EXPENDITURES AND PRIMARY BALANCE, 1990-2011

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

FIGURE 2

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT PUBLIC DEBT, 1990-2010

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

These improvements notwithstanding, virtually no progress has been made in diversifying sources of fiscal revenues nor in expanding the tax base. Latin American tax systems continue to rely on indirect taxes and thus remain neutral or even regressive in terms of income distribution, on which they have little or no effect. Governments of countries whose public revenue depends heavily on non-tax income from the extraction and export of natural resources —especially commodities— have tended to find that the historically cyclical and volatile behaviour of prices for these goods has worsened macroeconomic vulnerability and limited their capacity to pursue countercyclical fiscal policies.

Latin America’s tax collection levels remain low compared with other regions and this represents an obstacle to investing sustainably in physical and human capital and to providing public goods and services.

With respect to the public debt, although the region has recently been able to denominate most of its external liabilities in local currency and thus reduce its exposure to exchange-rate risk, short- and medium-term debt still outweighs long-term debt, which heightens

financial volatility.

Since 2000, a number of the countries have adopted fiscal policy rules with a view to making public finance more sustainable (see table below). Most of these are budgetary rules (such as primary surplus or current account targeting) or rules on spending or debt (such as limits on the overall debt stock or its expansion).

TABLE

LATIN AMERICA AND THE CARIBBEAN: FISCAL RULES ADOPTED IN LATIN AMERICA, 2000-2010 a

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of fiscal responsibility acts of the respective countries and information from the Budget Office of the Ministry of Finance of Chile.

a The list is not exhaustive and some of the fiscal rules may no longer be in force.

No definitive conclusions may yet be drawn on the outcomes of these measures since the expansion of the fiscal space seen in the region has also coincided with the economic upturn, rising commodity prices and, therefore, burgeoning revenues. Public spending, too, increased steadily during this period. Yet the fact that such rules were established in the first place represents a sea change in fiscal policy management with respect to

previous decades.

When the financial crisis broke out, the Latin American countries that had fiscal rules all had schemes targeting either the current account or debt indicators. In principle, this tends to reduce the flexibility of fiscal policy for dealing with crises, especially where, as in several countries in the region, there are also rules on spending (which usually bar resort to discretionary incentives). In practice, then, severe shocks may force countries to break or change their own rules, as occurred in Argentina, Chile and Peru in the 2008-2009 crisis.

In short, while it is too soon to gauge the effects of the new fiscal institutional framework on the macroeconomic stability and performance of the Latin American economies, it is widely believed that it will help to expand the policy space and confer stability on the public accounts. Nevertheless, recent experience indicates that flexibility mechanisms are also needed in order to garner a response in the event of exogenous economic shocks.

Both recent experience and the challenges posed in the new macroeconomic context underpin the need to strengthen and consolidate fiscal institutions through medium-term budgetary frameworks, greater transparency and accountability, multi-year budgeting and national public investment systems.

Source: Economic Commission for Latin America and the Caribbean (ECLAC)

.

Several countries have allowed freer movements of portfolio and other financial investment flows (as distinct from FDI) as part of their efforts to secure deeper financial integration in international markets. This is the case for Brazil, Chile, Mexico, Peru and, to some extent, Colombia. As a result, capital mobility is greater than in previous decades but even the countries mentioned enforce some capital controls. Many countries have dispensed with FDI controls and adopted policies to promote FDI, which has come to account for a greater proportion of external financing than previously.

As financial integration has deepened, several countries have begun to view the vagaries of financial and goods and services markets, as well as real exchange-rate targets, with mounting concern. Accordingly, some of them, including Brazil and Peru, have allowed their international reserve holdings to swell significantly. This has occurred in less developed countries in other regions as well, especially following the Asian crisis. A further motivation for augmenting reserve holdings has been the countries’ need to build their own insurance against external shocks given the punitive conditionalities of multilateral balance-of-payment support mechanisms, the protracted negotiations for securing emergency financing and the historically procyclical nature of external financing in the region.

TABLE I.1

LATIN AMERICA AND THE CARIBBEAN: FOREIGN-EXCHANGE REGIMES, 1996-2010 a

Source: Economic Commission for Latin America and the Caribbean (ECLAC) on the basis of official information and exchange-rate classification by the International Monetary Fund (IMF).

a Refers to the exchange-rate regime that lasted longest during the reference year.

b The information in brackets relates to the year in which the regime reported in 1996 was introduced.

c Member of the Organization of Eastern Caribbean States (OECS).

d From September 1999 onwards.

The changes made to macroeconomic policy stances in the region have been fairly diverse and this has led to some discussion over their relative merits. The point here, however, is not the advantages to be gained from one policy response or another, but the fact that exogenous changes in global financial and goods markets elicited manoeuvres in several countries that changed the way external shocks spread through their economies, achieving, in some cases, greater freedom for the policy response. Thus, the lighter burden of external debt servicing flows, the build-up of external resources —whether in the form of central bank reserves or sovereign funds— and ready access to voluntary external capital markets have shaped a context in which several countries have managed to lift or at least relax the so-called external constraint that dominated macroeconomic policy management during the 1980s and much of the 1990s. The countries which have been able to issue foreign bonds in local currency and deepen their domestic market have shown that the fate of “original sin” (Eichengreen and Hausmann, 1999) —which limited non-inflationary financing of the deficit and left public finances vulnerable to currency mismatches— is surmountable, not inexorable.

Nevertheless, in these matters the situation varies significantly from one country to the next in the region. Several Central American and Caribbean countries have yet to succeed in consolidating their fiscal positions or raising their low tax burdens. As well, the few linkages these countries have with external financial markets are limited almost exclusively to FDI partly because they lack the domestic financial development to support greater financial integration with other markets. Because of these two factors, the channels by which external shocks are transmitted to those economies, the intensity of their effects and the response capacity are different from the situation in countries that have adapted their macroeconomic regime and improved both their financial development and their external integration. Consequently, the Central American and Caribbean countries concerned have less scope for dealing with an external shock. Although debt relief schemes (for example, the HIPC Initiative) and the improvement in the terms of trade since 2003 (Ecuador and Plurinational State of Bolivia) have eased the external constraints somewhat, the potentially tighter external liquidity situation and the shallow domestic financial development tend to bar routes towards countercyclical action.

The following section looks at the macroeconomic policy implications of the countries’ development levels and characteristics at this juncture of voluminous external liquidity and surging international prices for commodities and raw materials. Although the focus here is on domestic policy alternatives, any policies the governments adopt to prepare for external shocks need to be complemented by an international financial architecture that supports greater macroeconomic coordination between countries, particularly between large economies, and is capable of steering prudential global financial regulations towards financial stability.

1. Structural underpinnings of the uneven impact of external

shocks and countercyclical capacity amid abundant

global liquidity and high commodity prices

In the current climate, three structural characteristics are particularly important in determining how strongly the region’s domestic economies feel the shocks triggered by fluctuations in external liquidity and commodity prices and the policy options they have for tackling their consequences. First is the proportion of public revenue generated by the production and export of primary products (taxes, royalties and profits). Second is the degree of exposure to international financial markets (that is, the openness of the balance-of-payments financial account). And, third is the depth and scope of the domestic financial system as a channel for spreading external shocks through the local economy. While these are not the only traits of the region’s economies, nor are they the only sources of external vulnerability, these factors —and particularly the interaction between them— are especially relevant here since they do much to determine the countries’ capacities to implement countercyclical fiscal and monetary policies amid the external conditions of abundant liquidity and volatility.

Financial globalization has blurred the boundary between real and financial shocks. Global financial crises impact on commodity markets not only because they influence the future course of economies requiring those goods but also because those goods have become a category of financial asset in themselves, whose value fluctuates as financial conditions change. Consequently, even economies not exposed to external financial markets will be affected by their fluctuations, especially where commodity prices have a significant impact on public revenue and therefore on public finances and scope for deploying countercyclical fiscal policy.

The following sections present an analytical framework for examining how the interaction between these factors shapes the macroeconomic policies implemented to lessen the impact of external shocks.

(a) How external shocks and their impacts on public revenue interact with financial system development

The importance of primary products in a country’s trade and its net position as an exporter or importer of those goods have often been used as indicators of external vulnerability. The indicator used here is the proportion of public revenue generated by exports of primary goods, which it will be shown has notable fiscal policy implications (see table I.2). A country’s position as a net importer or exporter of raw materials means that the capacity of its fiscal policy to offset the impacts of price fluctuations is largely determined by the magnitude of public revenue from commodity exports and by the fiscal space generated by previous savings, existing borrowing capacity, spending reallocations or a higher tax burden. In principle, then, the larger the public revenue generated by the production and export of raw materials, the greater the fiscal policy space for softening the effects of international price surges on living standards, including through subsidies, price support measures and targeted income transfers. If the fiscal institutions have mechanisms for saving public revenue during boom periods of higher export prices, then they will be better able to avoid having to make contractionary fiscal adjustments when prices drop. In the absence of savings mechanisms, however, the sheer weight of this source of income in overall revenue can force spending to behave procyclically. By contrast, countries in which raw materials account for a smaller proportion of revenue may not experience direct effects on tax receipts, but still feel significant indirect impacts through the channels of consumption and production costs depending on how much they use raw materials. This would generate strong demand for policies to offset the impacts on the economy and the recessionary consequences of external price rises could hurt tax receipts. In this situation, countries have resorted to domestic and external public borrowing, reallocations of expenditure and higher taxes to minimize the repercussions on

public well-being.

TABLE I.2

LATIN AMERICA (8 COUNTRIES): REVENUE FROM COMMODITIES AS A SHARE

OF TOTAL CENTRAL GOVERNMENT REVENUE

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Average for the period.

A conflict of objectives may arise as commodity prices go up, since the goal of mitigating the effects of higher prices —for food and fuel for example— on living standards could clash with the objective of preventing unsustainable spending hikes or of keeping public spending to a level compatible with balanced public finances and general economic stability. This suggests that, as far as the institutional characteristics of each country allow, impact-softening programmes should target the poorest groups and should be treated as temporary measures while the disruption lasts. These policy issues are covered in the following chapters.

Procyclical public spending practices constitute a second channel for external fluctuations to impact on the economy. Transmission through this channel depends on the fiscal rules adopted, however, and significant progress has been made in the region in this regard. However, in several countries where income from commodities accounts for a large proportion of fiscal revenue, public spending levels and therefore economic activity continue to track variations in external commodity prices.

The depth and development of the financial system is also important, mainly for three reasons. First, because of the role that system plays —by means of adjustments in domestic credit volume— in spreading the effects of commodity-price-driven variations in private-sector revenue expectations. Second, because of the scope it allows for countercyclical measures through financial and regulatory policy. And third, because a more developed financial system offers an enabling setting for sustainable fiscal measures, inasmuch as local capital markets have recently become more important as non-inflationary sources of financing for public debt.

Table I.3 shows the countries arranged[7] in columns from left to right according to the share of central government revenue generated by commodities between 2007 and 2009, and in rows from top to bottom by the development of their financial system, taking into account the depth of their banking markets and capital market development indicators (shares and bonds and external bond issues).

7 The methodology and indicators used to arrange the countries are explained in the methodological annex.

Table I.3 shows that the countries exporting hydrocarbons and mining products, together with Argentina, have the largest proportion of commodity-based public revenue, as a result of which their fiscal situation will be partly determined by global economic trends owing to the procyclical effect of export prices. Three of these countries —Chile, Colombia and Mexico— also exhibit the region’s most developed financial markets, which could encourage the procyclical propagation of external fluctuations, mainly through lending.

TABLE I.3

MACROECONOMIC PROFILES BY SHARE OF PUBLIC REVENUE GENERATED BY COMMODITIES AND FINANCIAL SYSTEM DEPTH

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official country data.

a Three criteria were used to determine the relative position of each country: total lending to the private sector as a percentage of GDP; the existence of an active stock market and —where one exists— share turnover; and bond issues in international financial markets.

The countries with a smaller proportion of commodity-based public revenue include the Central American economies, Brazil, Paraguay and Uruguay. In these countries fiscal revenues will have to contend with demand for programmes to compensate for rising commodity prices and perhaps also with the impact on tax income of recessionary forces triggered by rising external prices. With the exception of Brazil and Panama, most of these countries have relatively shallow financial systems, as a result of which this propagation mechanism will be less significant than in other countries.

The group of countries with a large proportion of commodity-based public revenue, particularly those which also have well-developed financial systems, have a wide range of compensatory and countercyclical policies to draw upon, including multi-year public budget systems with their associated fiscal rules, monetary policies that can help to stabilize domestic spending (depending partly on the degree of openness to capital flows) and financial regulation policies designed to prevent credit-market overheating and misalignment of key prices, including the exchange rate. However, these countries are more exposed to external fluctuations in commodity prices and the domestic financial system could magnify the impacts of those variations.

In contrast, countries whose commodity-based income accounts for a small share of total public revenue and which have less developed financial systems have a more limited range of policy options, and fiscal policy and debt sustainability are crucial in determining ability to deal with the impacts of external fluctuations.

(b) How exposure to international capital flows interacts with depth of financial system development

To form an idea of the level of exposure to external financial fluctuations, detailed figures are needed on the net position (foreign assets and liabilities), which are generally not available. The indicator used here is the region’s sources of external financing in flow terms, in other words, changes in the net position for particular instruments. The assumption is that greater exposure to the most volatile financial flows is associated with increased vulnerability to both negative and positive external financial shocks. The most volatile flows are net movements of portfolio investment and other investment liabilities by non-residents during the period 2007-2009. The former consists of net acquisition of financial assets by non-residents for short-term portfolio investment, while the latter are mainly net debt flows (bank and non-bank). Table I.4 presents data illustrating the magnitude of these flows and of FDI as sources of external financing, ranked by the weight of the most volatile component.

TABLE I.4

NET FLOWS OF EXTERNAL FINANCING BY NON-RESIDENTS, 2007-2009

(Percentages of goods exports)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official data provided by the countries.

The aim here is not to offer an opinion on the advisability of a higher or lower level of exposure to foreign markets. This has been extensively discussed in the technical literature and both the benefits and the costs have been identified. Rather, it is to emphasize that high liquidity and external volatility create a different set of conditions for monetary and exchange-rate policy, as is currently being seen in the region.

The depth (scale of financial intermediation) and reach of the financial system (size of the banking, shareholding, debt and other lending segments, and the existence of secondary liquid and asset markets) raise the stakes even higher in terms of how volatility in external financing spreads to the domestic economy. This is because the financial system represents a direct interface between the external and domestic financial environments.

The size of the financial system in turn has a bearing on the effectiveness of monetary policy as a countercyclical policy tool and the central bank’s ability to take such action. It is easier for the monetary authority to stabilize or steer small financial markets (such as the currency market or the mortgage asset market), but its influence on aggregate demand is stronger in bigger markets.

In order to look more closely at the situation in a given country it must be recalled that external fluctuations are not transmitted to the domestic economy in a linear fashion, but are mediated by certain traits of the financial system; so, too, are their implications for the efficacy of monetary and regulatory policies. For example, where banks source much of their funding abroad, the larger the proportion of bank credit as a percentage of GDP, the more likely that external fluctuations will spread directly and certainly procyclically to domestic credit and spending, especially negative shocks that precipitate sudden stops in external financing. Deep capital markets (shares and bonds) and, in particular, diversified markets could disperse this effect somewhat, however, because the larger and more diversified the financial system as a whole, the more options exist (in terms of both the source and the destination of funds) for offsetting a foreign liquidity shift.[8] In non-diversified systems, by contrast, a financial shock is concentrated in a few market segments, where the impact may be magnified. The same is true of banking systems in which credit is concentrated in only a few banks, customers and sectors. The key factor is therefore the combination of depth, reach and diversification of the financial system as a whole.

8 During the recent global financial crisis, central banks in some countries in the region (such as Brazil and Chile) played a countercyclical role by bolstering lending (ECLAC, 2010). Of course, central banks are not large enough (in comparison with the entire financial system) to be able to completely offset the impact of external financial shocks.

Financial systems of a greater size, reach and depth are generally considered favourable for the financing of investment, durable consumer goods and the needs of growth, provided that they are sustainable over time and not temporarily engendered by over-optimism or credit bubbles.

Table I.5 orders countries from left to right based on the change in net position of the most volatile components of external financing during 2007-2009. Vertically, they are listed by the degree of development of their financial system.[9] The monetary policy stance and exchange-rate regime are also indicated in several cases where they play a key role in transmitting external financial shocks.

9 The methodology and indicators used to rank the countries are explained in the methodological annex.

From a policy point of view, there is a substantial shift in macroeconomic policy and sources of exposure to external fluctuations from the top left to the bottom right of the table (in other words, from less exposure to capital flows and limited financial depth to a higher level of both variables). Indeed, in the first case, fiscal policy is the preferred tool for tackling external shocks, which are triggered primarily by external demand (volume and value) for goods and services. As financial systems develop and countries engage more actively with external financial markets, monetary, exchange-rate and regulatory policies become more influential in the domestic spread of shocks. At the same time, to volatility in external goods and services markets is now added volatility in financial markets.

From the perspective of economic growth, numerous proposals argue that deeper domestic financial system development is needed to underpin the financing of investment, alongside other development measures. Meanwhile, the advantages and disadvantages of external financial engagement in terms of growth —that is, looking to the right-hand side of the table— are the subject of much debate. Nevertheless, it is indisputable that many economies in other regions (such as the Republic of Korea, Taiwan Province of China and, more recently, the emerging Asian economies) which have achieved high growth rates from low starting points have done so using strategies that have led to greater financial development and external engagement, far beyond the levels seen in Latin America and the Caribbean. Following the external debt crisis of the 1980s, some Latin American and Caribbean countries made a similar transition, albeit at an evidently slower pace and in a non-linear fashion; and some of them have adopted strategies to deepen their participation in external financial markets. However, depending on the circumstances, temporary limits have been placed on external market integration, both to avert the consequences of unsustainable rises in expenditure and to avoid distorting the incentives to produce tradable goods.

TABLE I.5

MACROECONOMIC PROFILES BY EXPOSURE TO THE MOST VOLATILE COMPONENTS OF EXTERNAL

FINANCING AND FINANCIAL SYSTEM DEPTH

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official data provided by the countries.

a Four criteria were used to determine the relative position of each country: external bank credit to the domestic banking sector as a percentage of total external bank loans to the country extended by banks reporting to the Bank for International Settlements (BIS) (2008-2010 average); capital inflows from portfolio investment as a percentage of goods and services exports (2007-2009 average); capital inflows from other investment as a percentage of goods and services exports (2007-2009 average), and capital inflows from foreign direct investment as a percentage of goods and services exports (2007-2009 average).

b Three criteria were used to determine the relative position of each country: total lending to the private sector as a percentage of GDP; the existence of an active stock market and —where one exists— share turnover; and bond issues in international financial markets.

Briefly, then, a regional assessment of how high international liquidity and commodity price volatility affect macroeconomic policy must take into account structural differences between the economies that mediate both the impacts of these variables and the leeway for macroeconomic regimes to adapt. Such an assessment must look not only at the global trends that have altered the nature of external financing, but also at the main channels through which external shocks (both real and financial) are transmitted to the economies, and how these shape the available policy responses.

This section has identified three structural characteristics that influence how shocks are transmitted and the respective policy responses. First, the extent to which commodity price variations impact on public revenues was examined in order to point up the fiscal policy consequences of those variations. Second, the importance of the most volatile components of external financing as a source of funding was examined to ascertain the likelihood of external financial fluctuations having a domestic market impact. Third, the depth and size of financial systems were examined because financial system development has a hand in determining not just the means and intensity with which external shocks spread in economies but also the policy responses adopted. The considerable variation in these structural characteristics across the countries of the region must be taken into account when analysing the relevant policies. At the same time, a fuller understanding of macroeconomic functioning and potential countercyclical measures can only be achieved by examining the interaction between these characteristics and the fiscal, monetary and exchange-rate policy stance.

Methodological annex

In the preparation of tables I.3 and I.5, three criteria were used to determine the relative position of each country and to arrange the countries by degree of exposure to external shocks, by share of public revenue generated by commodities and by volume of external financial flows as a percentage of exports.

Details on the criteria are provided below, including the indicators and classifications used to establish the relative position of the countries in the tables and thus illustrate the differences across the countries in terms of exposure and complexity of policy decision-making.

A. Criteria for table I.3

1. Development of domestic financial system

The following three indicators were considered for this criterion, each broken down into three levels:

(a) Total credit to the private sector as a percentage of GDP:

(i) ≤ 30%

(ii) ≥ 30% and ≤ 60%

(iii) ≥ 60%

(b) Existence of an active stock market and —where one exists— share turnover:

(i) Stock market does not exist or is of no relevance

(ii) Stock market with share turnover ≤ 15%

(iii) Stock market with share turnover > 15%

(c) Bond issues in international financial markets:

(i) No bond issues in international markets

(ii) Single bond issue in the international market

or exclusively sovereign issues in 2007-2010

(iii) More than one bond issue in the international market, including corporate issues, in 2007-2010

2. Public revenue generated by commodities as a share of total central government revenue

The countries’ relative positions were established by using the average of this indicator for the period

2007-2009, broken down as follows:

(i) No revenue from this source

(ii) ≤ 20%

(iii) > 20%

B. Criteria for table I.5

1. Development of domestic financial system

The same indicators were used as for table I.3.

2. Exposure to external financial markets

Four indicators were used to establish the relative position of the countries under this criterion, each broken down into three levels as follows:

(a) External bank credit to the domestic banking sector as a percentage of total external bank loans to the

country, [10] average for the period 2008-2010:

10 According to data from the Bank for International Settlements (BIS).

(i) > 20%

(ii) ≤ 20% and ≥ 10%

(iii) < 10%

(b) Capital inflows from portfolio investment as a percentage of goods and services exports, average for the period 2007-2009:

(i) ≤ 0.5%

(ii) ≥ 0.5% and ≤ 3%

(iii) > 3%

(c) Capital inflows from other investment as a percentage of goods and services exports, average for the period 2007-2009:

(i) ≤ 0%

(ii) > 0% and < 10%

(iii) ≥ 10%

(d) Capital inflows from foreign direct investment as a percentage of goods and services exports, average for the period 2007-2009:

(i) ≤ 10%

(ii) > 10% and < 20%

(iii) ≥ 20%

Chapter II

Integration into international financial markets in the current context of high external liquidity

A. Recent trends in the international economy

and their impact on the region[1]

1 This section is based on Zahler (2011).

Starting in 2003, a number of shifts in the international economic cycle, greater appetite for risk among international investors seeking more profitable options than those offered by developed countries and significant macroeconomic changes in Latin American countries all combined to bring down the risk perception of the region’s economies and make local financial assets more attractive. The climate for external financing thus became extremely favourable.

This transformation was driven by both global factors and local factors relating to the region’s economies. On the global front were mounting trade imbalances between the United States and emerging countries (particularly China), abundant international reserves in many developing economies and the considerable development of international financial markets, which dramatically pushed up the sums traded. All of these factors contributed to a significant increase in liquidity on international financial markets.

Factors associated with the region’s own performance that helped to improve risk perception included lower external public debt (which brought down debt interest payments, thus improving access to international financial markets for the region’s countries thanks to lower rates associated with high liquidity), higher growth rates and (for most South American countries) improved terms of trade and a considerable expansion of international reserves.[2] This combined with changes in the management

2 In the first part of this edition of Economic Survey, figures I.19 to I.23 illustrate the main external financing trends of Latin America and the Caribbean by subregions.

of macroeconomic policy variables. Foreign-exchange regimes became more flexible and some countries adopted managed currency float regimes with interventions by monetary authorities.

The international financial crisis in 2008-2009 threw these patterns into reverse. As global economic activity slumped and uncertainty grew over the state of the banking systems in developed countries, the reactions of international financial market agents led to sharp reductions in liquidity, commodity prices and the external financing options available to Latin American and Caribbean countries. Yet from mid-2009, these trends began to ease and international financial markets showed renewed interest in emerging economies.

Following the recent international financial crisis, a number of developments in the global economy have influenced the design and implementation of macroeconomic policy in the region’s countries, depending on their degree of integration in the international financial markets. The five developments outlined below have been particularly significant in this regard.

1. Expansionary monetary and fiscal policies in the United States

As a percentage of GDP, the fiscal deficit in the United States went from an average of 2.5% of GDP in 2003-2007 to 10% in 2009, 8.9% in 2010 and around 10.9% forecast in 2011. Public debt expanded from an average of 63% of GDP in 2003-2007 to 84% in 2009 and 93% in 2010, with the figure expected to reach 103% in 2011. This last public debt figure is not far short of the 120% of GDP recorded in 1947, as a result of funding the Second World War (see figures II.1 and II.2).[3]

3 Unlike in the United States, in 2010 the European Union began to reverse expansionary fiscal policy, first as a result of the fiscal and banking crises in Greece, Ireland and Portugal, and second because of the decision to prioritize the sustainability of the fiscal accounts, especially in Germany and the United Kingdom.

Since December 2008, monetary policy in the United States has kept the reference rate at between 0% and 0.25% while boosting liquidity through Federal Reserve intervention in the form of quantitative easing programmes (QE1 and QE2) (see figure II.3).[4] All of this has helped the United States economy to come out of the 2008-2009 crisis more quickly and strongly than euro area countries, the United Kingdom and Japan

4 Initially, these policies had limited effects and personal credit continued to contract up to the third quarter of 2010. From then on, credit began to recover, however. At the same time, debt servicing as a percentage of individual disposable income has been falling since mid-2009 (see [online] http://www.federalreserve.gov/econresdata/releases/statisticsdata.htm).

(see figure II.4).[5] Policies of this nature should result in the dollar depreciating in relation to other currencies and it has indeed lost value in real multilateral terms over the past few years, and more sharply of late (see figure II.5).

5 The European Central Bank (ECB), the Bank of England and the Bank of Japan also adopted an expansionary monetary policy, although involving smaller volumes and a shorter period of time than in the United States. From April 2011, the ECB began to raise the benchmark interest rate from 0.25% (its level since May 2009) to 0.5%. The Bank of England has kept the same benchmark interest rate (0.5%) since March 2009, while the Bank of Japan’s discount rate has been at 0.3% since December 2008.

FIGURE II.1

UNITED STATES: FISCAL BALANCE, 2000-2012

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures provided by the United States Office of Management and Budget [online] http://www.whitehouse.gov/omb/budget/Historicals.

a Projections.

FIGURE II.2

UNITED STATES: PUBLIC DEBT, 1994-2010

(Trillions of dollars and percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures provided by the United States Office of Management and Budget [online] http://www.whitehouse.gov/omb/budget/Historicals.

a Projections.

FIGURE II.3

UNITED STATES: MONTHLY RATE OF VARIATION FOR M1, JANUARY 2010 TO JANUARY 2011

(12-month rate of variation, in percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures from Bloomberg.

FIGURE II.4

DEVELOPED COUNTRIES: QUARTERLY GDP, DECEMBER 2006

TO MARCH 2011

(Seasonally adjusted series, December 2006 index=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures from Bloomberg.

FIGURE II.5

UNITED STATES: MONTHLY INDEX OF THE REAL MULTILATERAL EXCHANGE RATE, JANUARY 2000 TO APRIL 2011

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures provided by the Federal Reserve of the United States [online] http://www.federalreserve.gov/releases/h10/summary/indexbc_m.htm.

From the point of view of restoring global equilibrium, the reserve accumulation and balance-of-payments current accounts of China, Japan, Germany and the main oil-exporting countries, as well as the United States’ trade imbalance with the rest of the world, suggest that the dollar should be devaluated —mainly in relation to the renminbi, yen, euro and the currencies of the main oil-exporting countries. However, there are several obstacles to such a devaluation, although it would certainly be positive in the medium and long terms for the world in general and Latin America in particular.

China and most of the major oil exporters operate a fixed or semi-fixed exchange-rate in relation to the United States dollar. This being the case, any adjustment (real currency appreciation in relation to the dollar) can only be achieved over the long term through inflation differentials. Conditions in the euro area (except for Germany) preclude appreciation of the euro in the short term. Japan, meanwhile, has shown that it is prepared to intervene in the foreign-exchange market to avoid further appreciation of its currency.

As a result, since mid-2010, the local currency has appreciated sharply in Japan and several emerging countries that have more flexible exchange-rate policy regimes or are more integrated into international financial markets. Within the Latin American and Caribbean region, this has been the experience of Brazil (which coined the term “currency wars”), Chile, Colombia and, to a lesser extent, Mexico. In Peru, the nominal exchange rate has been less volatile than in other countries examined (see figure II.6). Nevertheless, the real effective exchange rate of most Latin American countries has displayed a downward trend (i.e. local currency appreciation).

FIGURE II.6

SELECTED COUNTRIES AND REGIONS: NOMINAL EXCHANGE RATE AGAINST THE DOLLAR, JANUARY 2009 TO MAY 2011

(Local currency units per dollar, December 2009 index=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures from Bloomberg.

These conditions affect the macroeconomic management and growth of several Latin American countries in two ways. First, a number of countries have applied measures aimed at slowing the rate of currency appreciation (or last least eliminating some of its volatility), which has more to do with dynamics of the international economic and foreign-exchange markets than with productivity increases in the tradable sectors of region’s economies. Second, overly rapid appreciation of local currencies leads to risk of a surge in domestic spending as a result of the wealth effect generated by relative price changes.

In order to ride out the two situations (excessive currency appreciation and unsustainable domestic spending), several countries have built up international reserves and introduced capital controls, mainly either reducing their profitability in limiting (“discouraging”) the entry of short-term capital flows. A number of countries have also introduced macroprudential measures, especially to avoid domestic credit-market overheating.

Since the impacts of excess international liquidity began to take effect, and especially after the United States introduced the second round of quantitative easing (QE2), several emerging countries have adopted measures to soften the impact of capital inflows on their exchange rates. In Asia, the Republic of Korea and Thailand introduced measures to limit net entry of foreign short-term capital in mid-2010. Several Latin American and Caribbean countries have put in place policies to build up international reserves, as well as implementing short-term capital controls.

2. Fiscal and banking crises in some euro area countries

The financial markets had not identified great differences in country risk within the euro area until late 2009. From then on, and especially during the first half of 2010, the critical fiscal and bank solvency situations in some of the region’s countries dramatically changed this perception. Greece, Ireland, Italy, Portugal and Spain were the worst affected. Portugal, Ireland and Greece received assistance from the European Central Bank (ECB), the European Union and the International Monetary Fund (IMF). The need to put public debt back on a sustainable track has led to a very different fiscal and monetary policy mix in the euro area and in the United States. With the euro area policy stance directed towards reducing fiscal expenditure and tightening liquidity, the ECB has raised benchmark interest rates. The United Kingdom has adopted a similar approach.

Despite the assistance given to some economies and the efforts of the European Union, ECB and IMF, international financial markets are still doubtful of the most fragile countries’ ability to pay. And in spite of major progress made in Spain, for the first time since records began some Latin American countries have lower country-risk ratings than several euro area countries (see figures II.7 and II.8).

This situation, combined with the higher interest rates in non-European emerging countries such as those in Latin America, has attracted capital flows into emerging countries, which in turn magnify the effect described in the previous section. This complicated macroeconomic management in countries which are more deeply integrated with international financial markets.[6]

6 As a percentage of GDP, inflows of active portfolio investment assets to Brazil rose from 0.8% in 2006 to 3.1% in 2009-2010; in Peru the figure went from net outflows of 1.8% of GDP in 2009 to net inflows of 3.1% of GDP in 2010; Mexico went from 2.2% in 2009 to 3.8% in 2010.

FIGURE II.7

EURO AREA (SELECTED COUNTRIES): RISK PREMIUMS ON

FIVE-YEAR CREDIT DEFAULT SWAP (CDS) CONTRACTS, JANUARY 2009 TO APRIL 2011

(Basis points)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures from Bloomberg.

FIGURE II.8

LATIN AMERICA: RISK PREMIUMS ON FIVE-YEAR CREDIT DEFAULT SWAP (CDS) CONTRACTS, JANUARY 2009 TO APRIL 2011

(Basis points)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of figures from Bloomberg.

3. Emerging economies are growing faster but still

participate little in international financial markets

A wide gap has opened up between the GDP growth rate of emerging and developed countries since the beginning of the 2000s (see figure II.9), and the first have thus gained importance in terms of world economic performance. Between 1980 and 1999, the gap between the growth rates of developed and emerging countries was 0.54. Between 2000 and 2009, this gap widened to 4.2 percentage points, and between 2003 and 2009, to 5 percentage points. The growth of China and India, coupled with the buoyancy of Brazil, Indonesia and other densely populated countries that are well integrated into the world economy, suggests that these countries, as well as attracting increased FDI flows, are offering better prospects for return on equity.

FIGURE II.9

GDP GROWTH AND GROWTH GAP BETWEEN DEVELOPED AND EMERGING COUNTRIES, 1980-2011

(Percentages and percentage points)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of International Monetary Fund (IMF), World Economic Outlook Database, April 2011.

However, the domestic capital markets of emerging countries that are well integrated into the international economy are much smaller than those in developed countries (see figure II.10), and bear no relation to the relative size of their economies. In 2010, the stock exchange capitalization of emerging countries represented 13% of worldwide stock exchange capitalization, while their GDP (measured in purchasing power parity) was around 50%. In Latin America, stock exchange capitalization was below 3%, while regional GDP accounted for about 7% of world GDP.

FIGURE II.10

WORLDWIDE STOCK EXCHANGE CAPITALIZATION

BY REGION, 2008

(Percentages)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of the World Federation of Exchanges (WFE) database.

Nevertheless, even conservative risk diversification strategies in developed countries are tending to direct financial flows towards emerging economies, and this has increased with financial globalization. Although these flows represent a very small percentage of the portfolio assets of institutional investors in their countries of origin, their absolute size means they have a crucial impact on capital markets and the foreign-exchange markets of many emerging countries and are placing growing pressure on their macroeconomic policy decisions.

4. Improved terms of trade for Latin America

In spite of the weak economic recovery in the developed economies, the ongoing decoupling of large emerging countries and increasing global liquidity have helped to push up raw material prices on the international market. Prices for metals and minerals in particular have surged, as have those for oil, accentuated by the political and social crisis in Middle Eastern and North African countries. In these circumstances, many of the region’s countries (especially exporters of hydrocarbons, metals and minerals) have benefited from significant gains in terms of trade.

Figure II.11 shows the quarterly terms of trade for countries that publish such information.

This terms-of-trade upturn has led to trade balance surpluses for commodity exporters, which has in turn expanded supply of foreign exchange and driven appreciation of local currencies. Better terms of trade have swelled national incomes, and this has boosted domestic demand, thus fuelling imports of goods and services while higher international prices for food, fuel and raw materials push up domestic prices. All of these factors add to the issues involved in striking the right macroeconomic policy mix, since it must take account of the risk of external price shocks or sudden capital outflows from the region (as has happened in the past).

However, not all Latin American and Caribbean countries have benefited from rising international commodity prices. In Central America, terms of trade deteriorated steadily from 2003, improving slightly in 2009 as international commodity prices dipped. Like in South America, though, rising international food and fuel prices have resulted in inflationary pressures on the back of higher domestic prices for these products.

FIGURE II.11

LATIN AMERICA (SELECTED COUNTRIES): QUARTERLY TERMS OF TRADE, 2000-2011

(Index for first quarter of 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

5. Inflationary pressure in several Latin American countries

amid fast-rising domestic demand

As noted in the previous section, inflation has increased in most Latin American countries as a result of higher international commodity prices, which have in turn pushed up domestic food and fuel prices. In several South American economies, this is occurring amid rapidly expanding domestic demand and activity levels, with little room for bringing actual GDP closer to potential GDP. Accordingly, some countries (Brazil, Chile, Colombia, Guatemala, Paraguay and Peru) have raised their monetary policy interest rate.[7] Nevertheless, benchmark rates remain low and in many cases have yet to return to pre-crisis levels.

7 The exceptions are Argentina, Bolivarian Republic of Venezuela, Honduras, Mexico and Plurinational State of Bolivia, where benchmark interest rates have remained the same since 2009, and Costa Rica, where they have been kept at the same level since September 2010.

B. Challenges for designing and implementing

macroeconomic policy in the region

The five developments described in section A entail major macroeconomic policy challenges for Latin America and the Caribbean. The nature of these challenges may change depending on how long the current international situation remains the same. Continued rapid growth in the main emerging economies (particularly China and India) would keep international commodity and raw material prices high, which would sustain the terms of trade of the region’s exporters of these products in the short term. However, the widening trade surplus resulting from these terms of trade generates policy dilemmas, as expanding inflows of foreign exchange put pressure on local currencies and stimulate spending.

Policy decisions become more complex amid inflationary pressures. In the current economic conditions, the authorities have to face burgeoning domestic demand, which has been reflected in a surge in imports, as well as inflationary pressure caused by supply shocks. Higher interest rates, driven mainly by inflationary pressures, have widened the interest rate spread between Latin American and Caribbean, on the one hand, and the United States and Japan, on the other (and even in relation to the euro area and the United Kingdom). This has diverted financial flows towards the region, including carry trade operations. These surging inflows of rent-seeking foreign capital have driven local current appreciation in several countries of the region, especially in commodity-exporting countries. Brazil has experienced this phenomenon particularly acutely.[8]

8 Australia is another country in this position, with currency appreciating partly as a result of carry trade operations originating in Japan.

The growing financial integration of several Latin American and Caribbean countries must be taken into account when considering these challenges. Financial integration provides benefits but impose restrictions as well. Foreign capital inflows open up opportunities to access international financial markets by facilitating the funding of investment projects and the expansion of domestic economic activity. But when a change occurs in international economic conditions or financial agents’ expectations regarding the performance of a particular economy, integration is also a source of vulnerability and may lead to financial flight.

Countries also need to examine the following two fundamental factors that influence policy decisions. The first relates to effects that policy action aims to offset; in the current business cycle, policies aim to: (i) reduce exchange-rate volatility (making a distinction between the nominal and real exchange rates);[9] (ii) ease the upward trend of local currency (distinguishing between nominal and real appreciation); and (iii) prevent overheating of the domestic credit market and over-extension of

asset prices.

9

The second factor is the type of measures and instruments to be used to reduce these impacts. In some of the region’s countries, the excess currency supply is

mainly attributable to the improved terms of trade, which implies that these flows are entering mainly through the balance-of-payments current account. In other countries, increased inflows of foreign exchange reflect excessive capital inflows, suggesting that they are entering mainly through the capital and financial account. That said, in most of the countries which have experienced strong currency appreciation, both factors are at work in driving foreign-exchange inflows.

As in other areas of economic policy, there can be no single response to a change in the variables that influence the nature and momentum of economic growth. Such is the case with the rise in global liquidity, which is having a dramatic impact on the relative value of currencies of developed and developing countries alike. This is partly because changes have both positive and negative effects —some immediate, some in the future— that affect well-being and the allocation of resources (and thus the capacity for sustained growth) and vary by income group and productive factors. It is therefore very difficult to evaluate these elements simultaneously and allocate them a present value.

The impacts of changes depend on an economy’s structure and shock transmission mechanisms, so differences there will slant the assessment differently and lead to different policy proposals. Lastly, possible responses must be analysed in the current and foreseeable context, which at the moment is defined by growth problems in the most advanced economies (United States, the euro area and Japan), the strategies adopted by the largest emerging countries (mainly China) and the need to rebalance the external accounts at the

global level.

The next section describes the main channels of transmission for external liquidity shocks, before discussing policy options that could be used to tackle such an eventuality in the short term. The aim is not to provide single responses, but rather propose criteria to guide the analysis of the problem based on the conditions in each country. The various policy options are therefore described in no particular order.

C. Channels of transmission and macroeconomic

policy responses for high external liquidity

As discussed in chapter I, the effects of increased global liquidity on a country’s economy will depend on its macroeconomic policy regime and the development of its financial transmission channels. Heightened global liquidity impacts through two routes: financial transmission channels and global prices (particularly those of a country’s commodity exports and imports). This chapter looks at the first of these routes, and chapter III considers the second. The main financial transmission channels for external liquidity fluctuations are considered to be:

(a) Changes in the level and composition of banks’ external financing resulting from decisions they take regarding new external loans or bond issuance on external financial markets.

(b) Cross-border financial inflows into stock exchanges (equity and debt) and bank deposits, resulting from the actions of non-banking financial actors (such as investment and hedge funds, pension funds, insurance companies, resident and non-resident agents). Some of these flows are long-term (such as FDI), while others go into temporary holdings of national assets as part of a diversification strategy or interest rate arbitrage (carry trade operations), or may be motivated by exchange-rate expectations.

(c) Net flows among non-financial actors and resident financial institutions, as a result of foreign-exchange hedging (including derivatives such as futures).

(d) The central bank’s efforts to achieve monetary and exchange-rate policy objectives, reflected in flows between central banks and financial institutions (usually banks).

The depth of integration into foreign financial markets will be determined by the ease or difficulty of implementing the operations mentioned in the first three points above. This in turn depends on the policies adopted by the regulatory authority and the level of development of the domestic markets concerned. Domestic market development may be represented by the countries’ relative position on the vertical axis of table I.2 (see chapter I). As noted earlier, the probability of shifts in liquidity conditions of international financial markets spreading within domestic markets increases in direct proportion to their level of development.

The financial flows mentioned under (a), (b), (c) and (d) do not impact on the foreign-exchange market in the same way, nor can they all be said to have any one particular effect. The key is to determine the extent to which the net supply in national currency is increasing or decreasing compared with the supply of assets in foreign currency. Certain short-term operations aimed solely at tapping interest rate spreads are likely to use foreign-exchange hedging (i.e. avoiding speculative or open positions) using foreign-exchange futures or other currency insurance schemes, which tend to reduce the net impact on foreign-exchange supply. Other agents, however, will have different perspectives on foreign-exchange developments, which will not necessarily coincide with the aims or expectations of monetary authorities or the rest of the market, and they will maintain open currency positions in the hope of achieving capital gains. This has a greater impact on the net supply of foreign exchange and thus on the exchange rate, unless the monetary authority or another agent offsets this effect by adopting the opposite position.

Banks are usually subject to regulations that limit their exposure to mismatches between the currency denominations of their assets and liabilities. Accordingly, the direct foreign-exchange effect of variations in their level of external financing is not immediately clear and depends on the extent to which the regulatory authority allows such mismatches. Similar provisions are applied to resident insurance companies and pension funds. Other more long-term funds such as FDI or medium-term portfolio investments can bypass foreign-exchange hedging, either because the investment activity is hedged by nature (for instance, exportable production) or because hedging would only be required for specific transactions and at the end of the investment period. In this case, the net supply of assets in foreign currency will vary (as will the exchange rate) on the basis of the sums to be invested or divested, as well as on the intended level of hedging.

In summary, depending on the implications for each country of persistent high external liquidity and the characteristics of its financial system,[10] the authorities may decide to adopt measures to avoid or mitigate negative impacts. These measures include the build-up of

10 Each country’s position in table 1.2 of chapter I shows which characteristics it shares with others. In the table, countries are listed in order of their level of exposure to the current international financial market cycle, and the extent to which the effects may be transmitted to their domestic economies. That said, this does not mean that policy recommendations are the same, as other factors such as exchange-rate regime, degree of dollarization, financial regulations and capital inflows and outflows must also be considered.

international reserves, the introduction of capital controls, the implementation of macroprudential measures, the adaptation of regulatory frameworks in the financial sector and, in the last instance, adoption of a more flexible exchange-rate regime.

1. Build-up of international reserves

As well as mitigating currency appreciation, building up international reserves also helps to reduce a country’s vulnerability to international shocks and to cushion the effect of sudden stops in capital flows. If need be, it also enables monetary authorities to open timely and credible liquidity lines well stocked with foreign currency for the domestic financial system, which softens the impact of external shocks.

Implementing this policy comes at a cost, however, inasmuch as it may become necessary to partially or totally sterilize interventions, depending on the economy’s absorption capacity, which depends on money demand. And sterilization pushes up domestic interest rates, which in turn tends to offset the local currency depreciation effect by attracting capital inflows.

These interventions also have net costs, resulting from the interest rate spread between external assets and national assets issued by the central bank. When the interest rates for monetary absorption operations are similar to international rates, there is greater scope for carrying out sterilized interventions. Where there is a large spread, on the other hand, sterilized monetary interventions create a quasi-fiscal deficit that can become large enough to erode the central bank’s capital base.[11] Although in the short term this may not produce major problems in a State with robust fiscal accounts (given that the State is

11 See discussions on the costs and benefits of such operations in Feldstein (1999), Rodrik (2006), Adler and Tovar (2011) and Frenkel (2008).

the ultimate guarantor of the central bank’s liabilities), it does affect public debt sustainability when the treasury has to finance these quasi-fiscal deficits. In any event, as with other public policies, the cost in terms of net public resources used for such interventions (the equivalent of real income transfers from the rest of the economy to export sectors and import substitution sectors) should be compared with alternative uses of the same resources.

This policy has been implemented in many Latin American and Caribbean countries, and in recent years considerable international reserves have been built up in the region (see figures II.12 and II.13). The largest increases in international reserves in absolute terms were recorded in Argentina, Brazil, Chile, Colombia, Mexico and Peru, but as a percentage of GDP the greatest rises were observed in Plurinational State of Bolivia (from 16% to 46%), Paraguay (from 17% to 23.4%), Peru (from 18% to 27%) and Nicaragua (from 15% to 27%). In Brazil and Mexico, between 2004 and 2010 international reserves expanded from 8% to 13.8%, and from 8% to 11.6%, respectively.[12] As a result, in most Latin American and Caribbean countries international reserves represent over 40% of total external debt (and in some cases more than 80%). Many of the countries that publish this information have international reserves holdings far in excess of their short-term external debt.

12 These two countries account for around two thirds of the international reserves built up by countries in the region.

FIGURE II.12

LATIN AMERICA: INTERNATIONAL RESERVES, 2004 AND 2010

(Millions of dollars as percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures and information from the International Monetary Fund.

FIGURE II.13

SELECTED COUNTRIES: RATIO BETWEEN INTERNATIONAL RESERVES AND SHORT-TERM DEBT, 2010

(Multiples)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures and information from the International Monetary Fund.

2. Applying capital controls

Another policy option that has been intensely debated in recent years is the introduction of restrictions on inflows of foreign capital. This can be a useful complement to a reserves-accumulation policy, for which it provides backstopping if the local currency appreciates in real terms. Several of the region’s countries, especially those that are the most integrated into international financial markets, have taken this road. Regulating (discouraging) capital inflows —i.e. taking steps to curb inflows or change their composition (including carry trade)— becomes a realistic and pragmatic way to reduce the unwanted effects of excessive inflows of short-term foreign exchange.

In several of the region’s countries which have a highly flexible exchange-rate policy stance, monetary policy has two objectives (even if they are not overtly stated): to control inflation and keep the real exchange rate at a level favourable to tradable production. Capital controls may thus be viewed as another instrument at the disposal of the authorities (along with the interest rates) for formulating and running an effective policy aimed at achieving both those objectives.

The application of capital controls usually distinguishes between the types of inflows to be taxed, be they bank loans, bonds and shares issued abroad or FDI. Specific measures include the use of taxes (in the remit of the fiscal authority) or reserve requirements (which are the responsibility of the monetary authorities) for capital inflows. These taxes or reserve requirements may vary in accordance with the desired spread between external and domestic interest rates and with the time the capital remains in the country.

The main limitation of this policy is that it can be bypassed by creative financial engineering. Robust institutional and technical capacities are therefore required in order to design and operate such policies.

Several countries in the Latin American and Caribbean region have adopted capital controls as a policy option during the current economic cycle. Argentina applies a two-year 30% reserve requirement on non-FDI capital funds. Brazil increased the tax on financial transactions by non-residents from 2% to 6% for fixed-rate investments, derivatives and lending operations (to residents) up to 720 days, and imposed a 2% tax on capital investment and initial public offers. Colombia requires a compulsory 40% deposit for portfolio and debt disbursements. Lastly, Peru applies a 30% tax on the currency market profits of non-residents, and a reserve requirement of 120% on the foreign-currency deposits of non-residents.

Some countries, including Chile and Peru, have implemented measures to facilitate greater investment abroad by institutions such as pension funds, insurance companies and mutual funds. Between October 2008 and August 2009, Chile increased the ceiling for investment abroad by private pension funds from 40% to 60% of total assets and widened the allowable unhedged margin for those holdings, thereby reducing the net supply of external assets. In Peru, the ceiling for private investment funds investing abroad was raised to 30% in 2010.

The main observation here is that, given the systemic importance of banks and other institutional investors, a decision to introduce capital controls should be based on strategic considerations of contribution to domestic saving, prudential risk and portfolio diversification, not short-term exchange-rate or cyclical considerations. What is more, even with capital controls in place, agents will not necessarily prefer the international market over the national market, given the differences in return. Paradoxically, in countries that are heavily integrated with international financial markets, the implementation of capital controls sends a signal of confidence that often leads, in fact, to heavier inflows, thereby diluting the desired effect to some extent.

3. Macroprudential measures

Macroprudential policies are aimed at protecting financial stability by identifying sector vulnerabilities and introducing timely regulatory and policy measures to reduce systemic financial risk. Macroprudential measures, which came to the fore following the international crisis in 2008, aim to offset the effect of large capital inflows on bank credit and the resulting excess of domestic borrowing, and on asset prices (which become misaligned with their fundamental determinants).

One of the main indicators to observe is the phase of the economic cycle, specifically the link between the credit cycle and the asset price cycle. This is because of the high correlation between the expansionary (or contractionary) phase of the cycle and excessively high (or low) asset prices, as well as low (or high) risk assessments and measurements on the part of markets. The endogenous behaviour of economic agents tends to amplify the cycle. Furthermore, during the expansion (or contraction), institutions and financial instruments are perceived as safer (or riskier) than they really are.

Macroprudential regulation is based on the premise that, for financial institutions, capital requirements (to cover unexpected losses) and provisions (to cover expected losses) should include a countercyclical component.

The aim is to introduce forward-looking banking provisions applicable upon extension of loans, as risks often tend to increase subtly and undetected during a boom period, only to materialize during the downswing. Such “dynamic” provisions act as automatic stabilizers and help to mitigate the procyclical nature of standard provisions. As for the capital requirements of banks, these should be linked with the growth of bank credit (comparing the real increase in credit with a value consistent with the inflation target or some other macroeconomic anchor or objective).

When misaligned asset prices are identified (and where reversion to trend could endanger the stability of the financial system), macroprudential policy could increase the capital requirements for risk-weighted assets. Such requirements could be imposed for financial activities (more capital required in portfolio activities and off-balance sheet transactions, which tend to be procyclical); lending to some specific sectors (the property sector is the most likely to generate price bubbles); and direct borrowers (reducing maximum loan-to-value ratios for commercial and residential mortgages).

In addition, in countries that are integrated into the world economy, financial institutions are not always the channel for short-term financial inflows, which sometimes take the form of direct external debt in non-financial sectors. Therefore, even when a country’s financial intermediaries are not over-borrowed abroad or over-expanding their lending operations, a surge in domestic spending may push up asset prices or widen the balance-of-payments current account deficit. When the boom phase ends and capital outflows replace capital inflows, local currency devaluation then erodes the payment capacity of banks’ debtors.

In this instance, even when financial intermediaries are not direct borrowers from abroad and show no currency mismatch between their assets and liabilities, a heavy local currency devaluation can (and often does) have repercussions on the quality of loan portfolios and therefore on the stability and solvency of the financial system (insofar as some of their clients do have direct liabilities abroad). Experience shows that this is especially likely to occur when those clients are producers of non-tradable goods and services and hold foreign-currency-denominated debts with the banking system. To minimize this effect, macroprudential regulation must include not only a limit on term mismatches, but also on foreign currency mismatch in financial intermediaries (given the sensitivity of bank debtors to sudden changes in the exchange rate).

4. Adoption of more flexible exchange-rate regimes

Of all the measures adopted to reduce the impacts of high external liquidity, this tends to be the most controversial. Nevertheless, in practice many of the region’s countries have adopted a more flexible approach to their real exchange rate target by allowing a certain level of appreciation, while others have reduced implicit guarantees or permitted greater uncertainty over nominal exchange rate trends as a disincentive to external capital inflows. The earlier observations on the advisability of certain policy measures also apply here. There is currently a debate on the advantages of persevering on this path, given that the level of appreciation is already significant and might erode the competitiveness of non-traditional export sectors and import-substitution sectors.

In summary, recent trends in the international economy —expansionary monetary and fiscal policies in the United States, fiscal and banking crises in several euro area countries, the decoupling of emerging countries from developed countries and the strong terms of trade for Latin America (that make it vital to continue dampening domestic demand to avoid a surge in inflation)— pose major macroeconomic policy challenges for the Latin American and Caribbean region. The challenges are more significant for countries with a greater degree of integration in world financial flows and more developed financial systems. Accordingly, measures such as those described here should be implemented even more broadly and strenuously to avoid excessive appreciation that would harm the production structure and avert spending surges driven by capital inflows originating amid high liquid conditions on the global markets.

9 In Peru, for instance, the main aim of the authorities has been to reduce exchange-rate volatility, rather than altering the exchange-rate trend.

11 See discussions on the costs and benefits of such operations in Feldstein (1999), Rodrik (2006), Adler and Tovar (2011) and Frenkel (2008).

Chapter III

Fiscal policy challenges in a context of high, fluctuating commodity prices

International commodity price patterns pose several macroeconomic policy design

challenges, especially for fiscal policy in Latin America and the Caribbean. But not all countries in the region are affected in the same way since their position as net commodity exporters or importers is key to determining the type of problems faced by each country and the strategies for addressing them.

In countries that are net commodity exporters, the relative abundance of foreign currency resulting from higher export revenue is exerting pressure towards real currency appreciation, which will impact the profitability of other export and import-substitution activities, an effect known as Dutch disease.1 The challenge here in terms of macroeconomic policy lies in finding mechanisms to contain the drop in the real exchange rate and minimize fluctuations. The capacity to tackle these pressures will also depend on the extent to which public finances are affected by international commodity price movements.

1 The consequences of Dutch disease for the productive structure, as well as the policy responses, are covered in chapter IV, which discusses the long-term effects of these external shocks.

By contrast, countries that are net importers will face real depreciation pressures as their trade balance deteriorates. In both cases domestic food and fuel prices will rise, but net importers will be harder hit because the surge in international prices will be amplified

by currency devaluation.

The public sector’s share of windfall revenue from the exploitation of natural resources is a relevant topic for discussion because the factors that drove commodity prices above the levels posted in previous decades could indeed persist. However, a comprehensive exploration of this issue would cover many areas that are not properly within the scope of macroeconomic analysis, so the debate is not addressed exhaustively here and what follows is instead a general discussion of this issue in so far as it relates to fiscal policy.

A. The current commodity price cycle and its

effects on the terms of trade

The low commodity prices of the 1990s were followed by a period of sustained rises starting in mid-2003. The magnitude and duration of the surges and the number of commodities concerned suggest that the current context has specific features that could last longer than in previous cycles.

Several factors contributed to these trends. First, commodity prices were driven up by strong demand from countries in Asia that have undergone rapid economic growth involving the urbanization of population groups and their incorporation into the mass consumption of goods, services and infrastructure as their income has grown. Temporary supply constraints, especially for food, were also a factor, and until the global financial crisis broke out in mid-2008, surging food prices had sparked considerable concern among governments in several regions of the world due to their effects on living standards and poverty levels.2 Before the financial bubble burst in 2008 and hit the financial and real estate sectors in several developed countries, ballooning commodity prices were already unlike those in previous upswings in ways that hindered their absorption by the global economy. For example, in terms of the number of months of sustained rises, the average cycle duration more than doubled, if not tripled, compared with previous cycles for almost all the raw materials and commodities

whose prices rose.3

2 The impact of these spikes has varied between countries. Aside from hitting the lowest-income groups hardest (given that, in general, these groups spend a larger proportion of their total household budget on food than higher-income groups do), these surges pose challenges for countries that are more dependent on food imports. This can be seen in several Central American and English-speaking Caribbean countries where food imports account for more than 5% of GDP, compared with the regional average of 4.3%.

3 Bello, Heresi and Zambrano (2008).

Second, with regard to the onset of the boom phase, the average price rise before the financial crisis broke out was also greater than during previous episodes, although it was similar to those recorded in the 1970s. However, the duration of the spikes, i.e., the number of consecutive quarters of price increases, has been significantly longer in the current cycle: 14 quarters on average in the first decade of the twenty-first century to 2009, versus an average of 6 to 7 consecutive quarters in the 1970s.4 Thus, since 2000, several aggregate price series have posted cumulative real increases of over 100% during surges. For example, the general commodity price index showed a real increase of 140% over a period of 25 consecutive quarters. Some of the sharpest upswings have been in the prices of oil (312%), steel (302%), copper (273%), silver (247%) and gold (192%).5

4 Bello, Cantú and Heresi (2011).

5 Jiménez, Jiménez and Kacef (2008).

Third, the number of markets where prices spiked at the same time was also higher than in previous boom periods and involved an increasingly broad range of products and markets. Towards the third quarter of 2008, plummeting global demand because of the financial crisis temporarily halted this trend, as shown in figure III.1. In 2009 and 2010, however, the continuing buoyancy of the major Asian economies pushed these markets upwards again in both intensity and magnitude. In addition, post-crisis uncertainties have only served to further exacerbate the volatility of international markets, which was a major factor underlying the uneven growth in the region in the past.6

6 Mayer (2010) and Carneiro (2011).

FIGURE III.1

GLOBAL COMMODITY PRICE INDICES, 2003-2011

(Index: 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of World Bank, The Pink Sheet.

Furthermore, the jump in global liquidity resulting from the expansionary monetary policies implemented to tackle the crisis, especially in the United States, also took its toll. Several reserve currencies and the main foreign currencies used in international trade slipped in value compared with other store-of-value real and financial assets, which in turn triggered a rise in commodity prices. The interest rate slump combined with continued expectations of rising global inflation prompted a flight to profitability and to other assets that could also store value, such as commodities and financial securities in emerging countries. This shift sharpened the strong upward pressures that already existed and drove commodity prices even higher, to record highs in some cases such as industrial metals. The spikes then spread to other goods such as food, causing exogenous inflationary pressures. As the real value of the dollar fell, the commodity markets were flooded with financial agents seeking profitability and value protection, heightening the correlation between the prices of these goods as they increasingly moved together.

BOX III.1

WHAT IS BEHIND THE SUSTAINED RISES IN COMMODITY PRICES?

The prolonged rises in commodity prices, the growing number of commodity markets involved, the intensity of the surges and recent developments in international financial markets have raised a number of questions concerning the role played by fundamentals in determining commodity prices and the role of elements such as derivatives markets and hedge

fund indices.

Fundamentals

When explaining the price dynamics of any good, the determinants of supply and demand must be examined. On the demand side, the focus has been on the role of emerging economies, especially China, as the main engines of global growth and sources of demand for raw materials (Gilbert, 2010a).

Recent studies, including by Yu (2011), have highlighted the importance of the Chinese market as a driving force behind the evolution of raw material prices, noting both the impact and the widespread nature of price growth. The study by Yu shows that, between 1992 and 2009, Chinese iron imports grew by 25 times; between 1997 and 2008, its imports of manganese grew by 5.7, copper by 5.5, chromium by 7.7 and aluminium by 3.8. In addition, China’s consumption of crude oil more than tripled between 1992 and 2010, turning the country from a net exporter of crude oil (105,000 barrels per day in 1992) to a net importer (around 5 million barrels per day in 2010).a

With regard to food prices, new determinants of demand have emerged in addition to traditional ones such as the growth of the Asian economies and supply restrictions caused by climate-related disasters. For example, demand for alternative sources of energy such as biofuels has played a role through competition for the use of agricultural land (see Abbott, Hurtr and Tyner, 2008, and Mitchell 2008).

On the supply side, there seems to be consensus that, although many commodities have responded to price incentives, the development of new mining centres, the difficulties encountered in incorporating broader production capacities in the oil market, political tensions within a number of major crude oil producers and adverse natural conditions in several key agricultural production areas, such as the Russian Federation and the United States, have prevented the supply of commodities from keeping pace with the growth in demand. Even in cases where the gap between supply and demand appears to have narrowed, it could be doing so at increasingly heavy costs due to falling yields in the extractive sectors.

Financial factors

Several analysts and researchers have suggested that the significant growth in commodity prices in recent years is closely linked to a new type of demand arising from speculation in the financial derivatives market by agents who are not end consumers of these goods.b

The evidence for this hypothesis would be found in the large sums recently invested in purely financial activities relating to commodities, which have grown apace with commodity prices, and in the recent sharp upturn in commodity indices. According to this reasoning, raw material suppliers are using the prices in these derivatives markets as a reference for determining their prices, thereby moving away from fundamentals and responding more to artificial demand driven by financial speculation. Empirical studies such as those by Gilbert (2009) and Einloth (2009) provide evidence of a possible positive correlation between the evolution of commodity indices and prices in futures markets for these goods.c

These findings have recently been questioned, however. Irwin and Sanders (2010) maintain that the link between commodity index positions and futures market prices is not statistically significant. They hold that, in fact, based on Granger causality, speculative activity could even be dampening commodity price volatility. Gilbert and Morgan (2010) conclude that, although it is plausible that financial activities —both hedging and speculation— were partly responsible for the rises in commodity prices in the period 2006-2008 by stimulating demand for inventories, there is not sufficient empirical evidence that this made prices more volatile. Another study (Gilbert, 2010b) concludes that “it would be incorrect to argue that high oil, metals and grains prices were driven by index-based investment but index investors do appear to have amplified fundamentally-driven

price movements”.

A study conducted by UNCTAD (2011) found that commodity markets do not behave as predicted by the efficient market hypothesis. This is partly because insufficient information concerning fundamentals results in herd behaviour by investors as a rational strategy when reliable information is hard to come by, which in turn causes bubbles as commodity prices move far from levels justified by the fundamentals for extended periods. Consequently, the study proposes measures designed to improve information on these determinants, especially on stocks, and to increase the transparency of positions adopted by investors, as well as regulations to prevent sharp fluctuations in these markets.

In short, discussions in this field have not yet delivered conclusive results.

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Hamilton (2009) shows that the income elasticity of demand for crude oil is higher than the price elasticity and that the latter tends to narrow as a country’s income grows. This suggests that emerging economies with the capacity to go on growing will continue to demand significant quantities of crude oil and possibly other

natural resources.

b The testimony of Michael Masters, manager of a major international investment fund, before the United States Senate has been used as a principal argument by those who support this hypothesis and has prompted the enactment of bills designed to regulate speculative activity b The testimony of Michael Masters, manager of a major international investment fund, before the United States Senate has been used as a principal argument by those who support this hypothesis and has prompted the enactment of bills designed to regulate speculative activity in commodity markets.

c These findings have been questioned because of possible inconsistencies between the conclusions and the evidence. It is argued that if trends in prices were determined chiefly by speculative factors, there should be a negative correlation between changes in futures prices and changes in inventories, but this is not the case. Moreover, speculative activity levels in these markets remain similar to those seen historically. Finally, with regard to price movements and volatility, the markets subject to the most financial speculation are not significantly different to those in which there is no speculation (Irwin and Sanders, 2010).

In a longer view, oil, mineral and metal prices have fluctuated the most in real terms. This is due to structural characteristics relating to falling yields from existing operations and the incorporation of lower-grade, higher-extraction-cost deposits (in the case of non-renewable natural resources), together with soaring energy costs for the extraction and refining of metallic minerals. All of these contribute to spiralling costs in the long term. Food prices, following sharp drops in the last two decades of the twentieth century, have been trending upwards in the twenty-first century to date, although they have not yet matched previous relative highs. The substantial productivity gains in agricultural commodities have helped to stem the long-term growth in agricultural prices. However, the burgeoning global demand for food (spurred by the greater consumption capacity of certain population groups that used to live in rural areas of major Asian countries), together with soaring demand for cereals and other agricultural products for the production of biofuels, have contributed to partly reversing this trend.7

7 See Gilbert (2010a)

These developments have affected the countries of Latin America and the Caribbean differently, depending on their position as net importers or exporters of these goods (see figure III.2). As net importers of metals, hydrocarbons and food, the countries of Central America and the Caribbean were hurt by the current price cycle as reflected in current account balance behaviour. By contrast, the disposable gross national income of the countries of South America, which are net exporters of such goods,8 jumped on the strength of improving terms of trade. This translated into a current account surplus in several years during the period 2004-2008, a trend that continued into 2010 in some cases such as Argentina, the Bolivarian Republic of Venezuela, Chile and the Plurinational State of Bolivia. The boost in national savings enabled these countries to slash their debt in relation to GDP, as well as in absolute terms in some cases, and even build up savings in sovereign funds. Mexico is in the middle in this sense since it has benefited from the jump in oil export prices, but its terms of trade have not improved as much as in the South American countries because such a large share of its exports are manufactures, whose prices have remained stable or fallen, partly due to competition from Asian countries (see figure III.3).

8 Trinidad and Tobago is also a net exporter of these goods.

FIGURE III.2

LATIN AMERICA: TERMS OF TRADE, 1990-2010

(Index: 1990=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

FIGURE III.3

LATIN AMERICA: GROSS DOMESTIC PRODUCT AND DISPOSABLE GROSS NATIONAL INCOME, CUMULATIVE

GROWTH RATES BETWEEN 2003 AND 2010

(Percentages and constant dollars at 2005 prices)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

Thus, the subregions of Latin America and the Caribbean have tackled the consequences of the global financial crisis from very different macroeconomic positions. Although in general the region has so far successfully weathered the crisis, the recovery of economic activity and the consequences of the ensuing global economic environment, with high global liquidity and soaring external prices triggering inflationary pressures, entail different policy challenges that the countries are set to address in very different ways.

B. Macroeconomic consequences of commodity

price shocks

In Latin America and the Caribbean fiscal revenue from natural resources expanded considerably between the 1990s and the first decade of the twenty-first century (see figures III.4 and III.5).9 Compared with high-income countries that also have abundant natural resources, the region is more dependent on its export earnings and tax receipts from the exploitation of natural resources. This is mainly because the region’s production structure is less diversified. Although in recent years its goods and services exports have become more diversified, commodities continue to account for a substantial share of total exports. This is especially the case in the countries of South America, whose economies are highly concentrated in commodities and are therefore very sensitive to commodity price shocks (see figure III.6). By contrast, in Mexico and the countries of Central America, manufactures account for a larger share of total exports, mainly owing to the growth in maquila exports to the United States and in manufactured exports within the Central American Common Market. Commodity exports account for just over 70% of the total in the Bolivarian Republic of Venezuela, Ecuador, Paraguay and the Plurinational State of Bolivia, between 40% and 60% in Argentina, Colombia, Peru and Uruguay, between 20% and 40% in Brazil, Chile, Costa Rica, Guatemala, Honduras and Nicaragua, and less than 20% in El Salvador, Mexico and Panama.

9 See also table I.2 in chapter I.

FIGURE III.4

LATIN AMERICA: FISCAL REVENUE FROM

COMMODITIES, SELECTED YEARS

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

FIGURE III.5

LATIN AMERICA: FISCAL REVENUE AND EXPORT

PRICES, 1950-2010

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of Juan Pablo Jiménez and Osvaldo Kacef, “Volatilidad macroeconómica, espacio fiscal y gobernanza”, La política fiscal para el afianzamiento de las democracias en América Latina: Reflexiones a partir de una serie de estudios de caso, Project document No. 409 (LC/W.409), Alicia Bárcena and Osvaldo Kacef (eds.), Santiago, Chile, Economic Commission for Latin America and the Caribbean (ECLAC), July 2011, and official figures.

a Projections.

FIGURE III.6

LATIN AMERICA (17 COUNTRIES): COMPOSITION OF

EXPORTS, AVERAGE FOR 2005-2010 a

(Percentages of total exports)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures and United Nations Commodity Trade Statistics Database (COMTRADE).

a The data for Mexico and the countries of Central America include the maquila sector.

As mentioned above, surging commodity prices have hit the economies of the region in different ways. In theoretical terms, the short-term effects of a terms-of-trade shock can be outlined briefly as follows:10

10 This exercise focuses on surges in international prices instead of slumps, since, as explained above, this has been the dominant external trend for the countries of the region since 2003.

(a) In the case of a net exporter of a good whose relative price rises consistently, national income grows, prompting increased domestic spending. Within a normal range for the price elasticity of supply and demand, that is, the Marshall-Lerner condition, the current account balance improves. There will be a trend towards currency appreciation, which tends to offset the improvement in the current account, owing to an increase in the nominal value of the currency or in the price of non-tradable goods resulting from increased spending. This lessens the profitability of other tradable-goods sectors, including import substitutes, especially if they use the good whose price rose as an input. Furthermore, these sectors face a relative rise in the costs of non-tradable inputs compared with their production price, which falls owing to appreciation.

The transition from one short-term equilibrium to another tends to involve a certain degree of inflation, with real income losses for anyone with a fixed nominal income and for intensive consumers of the good whose price rose and of non-tradable goods. By contrast, real income gains can be posted by groups whose consumption pattern is focused more on tradable goods with lower prices due to appreciation. Unemployment levels may be affected, possibly temporarily, if production in the substitute sector is more labour-intensive than in the sectors (export and non-tradable goods) whose production expands. In short, an expansionary adjustment takes place, with improvements in the external balance, higher production levels and a certain degree of inflation, to the extent that significant downward price inflexibilities are present. Based on current economic conditions, this group of countries includes several in South America.

(b) In the case of a net importer of a good whose relative price rises consistently, the impact is not exactly symmetrical with that of the previous case. In practice, the goods, financial services and factor markets, and the regulations that affect them, exhibit many behaviour patterns that give rise to rigidities and hinder the process of adjusting to declines in real income resulting from worsening terms of trade. The differences partly lie in the fact that surges in the price of the imported good, together with subsequent devaluation, tend to spread (or uncover) inflationary pressure and may trigger individual and collective measures to protect real income levels. This is especially the case when the external prices that surge are for food or widely-used inputs such as hydrocarbons, since the direct repercussions on living standards and production costs are rapidly and widely felt.

Within plausible ranges for the price elasticity of foreign trade supply and demand, the external accounts balance deteriorates. Real income losses may lead to a contraction in spending and falling activity and employment levels, which will be all the more severe if there is limited substitute production and the imported good is used widely for consumption or production. A contractionary adjustment therefore takes place, entailing inflation, real depreciation, shrinking activity levels and growing unemployment. This is the scenario in most countries in Central America and the Caribbean.

C. Channels of transmission and policy challenges

This summary of the effects of changes in the terms of trade has not touched on the consequences of their distributive impact in terms of income levels or production factors or between the private and public sectors; these consequences are particularly significant in the current climate. One of the most notable effects involves the repercussions on public finances, via two main channels. The first is their direct impact on tax and non-tax public revenue. The second is the pressure to spend in order to cushion the effects of rising external prices on standards of living and production costs.

As shown in tables I.2 and I.3 in part 2, public revenue related to commodities accounted for a significant proportion of total fiscal revenue in eight countries in the region between 2007 and 2009, ranging from an average of 11% in Peru to 45% in the Bolivarian Republic of

Venezuela.11 Moreover, as the prices of these goods rose, the percentage rose considerably, from an average of 18.2% in 2002, the year before external prices began to surge, to a maximum average of 27.6% before the global financial crisis broke out. By contrast, as shown in table I.3 in part 2, in a many countries —mostly in Central America— this revenue has little or no impact.

11 According to the information available, the eight countries are Argentina, the Bolivarian Republic of Venezuela, Chile, Colombia, Ecuador, Mexico, Peru and the Plurinational State of Bolivia. Pending further data, this group could also include Trinidad and Tobago.

The fiscal position of the first group of countries has tended to improve in response to rising commodity prices whereas the opposite has occurred in the second group (ECLAC, 2008). In the first group, policy dilemmas revolve around how to manage a relative, albeit at times uncertain, abundance of revenue while compensating for the negative effects that rising external prices could have on real personal income and on the profitability of other activities that produce tradable goods. In the second group, the dilemmas are more acute: aside from the negative distributive effects and declining activity levels mentioned previously, when the country is a net importer of these goods it may lose some fiscal space to tackle these challenges because of the drop in tax revenue that tends to go hand in hand with contractionary processes. Moreover, when the negative impact of rising external prices is combined with fiscal deterioration in a context where the tax burden is already low, the structural weaknesses of the State are all the more visible as it tries to address the economic repercussions of external shocks. So, although short-term measures such as the reallocation of spending and borrowing help to secure the necessary resources to mitigate these consequences, the real challenge in the long term lies in adjusting the tax burden and modernizing public sector institutions to meet development needs within the framework of sustainable public debt.

When it comes to tackling a negative shock, fiscal policy is enhanced by a well-developed national financial system. On numerous occasions in the past, several countries in the region have turned, to varying degrees, to their domestic capital market to meet their financing needs, developing a public debt market with varying degrees of success. In other cases where countries are less developed financially, these possibilities have not existed or were more limited and they have had to resort to semi-voluntary placements in the financial investment portfolios of banks or other institutions, such as insurance companies and public and private pension funds. The existence of a developed domestic financial system allows macroeconomic shocks to be absorbed more easily and contributes to stable growth.12 Otherwise, the burden of dealing with negative shocks will fall almost entirely on fiscal policy, whose margin is restricted by the drop in tax receipts caused by sluggish activity levels.13 This limitation could be counteracted by tapping the multilateral or private international financial system —an area in which the region has made uneven progress.14

12 Aghion and Marinescu (2007) and Aghion, Hemosu and

Kharroubi (2009).

13 According to the classification set out in chapter I, these countries appear in the two upper left boxes of table I.3 of chapter I, meaning less financial development within the region.

14 Between 1994 and the first half of 2011, countries in the region issued bonds on the international bonds market the following number of times: Brazil, 112, Mexico, 74, Argentina, 37, Colombia, 29, Chile, 24, Jamaica, 17, and Peru, 16.

D. Policy objectives and dilemmas

1. Temporary versus permanent external shocks

From the fiscal point of view, managing a period of relative abundance of revenue caused by rising commodity prices entails significant challenges. As is always the case with boom periods, the first challenge consists of establishing the duration of the favourable external scenario to determine whether long-term adjustments to the amounts and composition of expenditure and taxes are justified. Based on the public finance principle that it is unwise to use temporary income flows to finance permanent spending programmes, temporary increases in revenue should be used to cut debt and boost savings, while temporary losses should be covered using borrowing or dissaving. Structural increases in revenues should translate into expenditures rises, but in stages according to the cyclical position of the economy in relation to potential output, to avoid overheating. Sustained deteriorations should result in cuts in spending and the revision of the tax burden to preserve economic and social development programmes. Given the uncertainty that tends to surround commodity price movements, the policies adopted generally combine these responses, but this can result in the adoption of fiscal positions that are unsustainable in the long term and will need to be adjusted later at the expense of growth and well-being; accordingly, caution must be exercised.

As indicated previously, global market trends have lasted longer than in previous episodes and most medium-term projections point to commodity prices remaining high, especially for non-renewable natural resources, whose supply is less elastic than agricultural goods. In the base scenario, prices of these goods will be lower than the recent highs due to the gradual, albeit slow, normalization of global liquidity conditions and as the euro zone economies’ risk indicators react to the fiscal consolidation policies under way. Thus, although commodity prices are not expected to return to the lows of the 1990s, they are expected to gradually converge below current levels in the medium term. If developed countries continue to struggle to achieve fiscal sustainability, there could then be a flight to more liquid assets that could in turn cause commodity prices to crash.

The materialization of the base scenario could lead to greater fiscal space for countries with significant public revenue related to commodities (see table I.2, chapter I). However, this has to be contrasted with the current and projected fiscal deficit in these countries in order to assess the extent to which that leads to sustainable public debt levels, that is, debt that can be serviced without drastic changes to other aspects of fiscal policy such as taxation and spending programmes.

The consequences of this outlook for commodities are very different when commodities account for only a small proportion of public revenue, especially for countries that are net importers. In this case, demands for resources to counteract the negative effects on the real income of the poorest strata can be considerable and long-lasting, which can in turn lead to a sustained deterioration in the fiscal position and to macroeconomic instability. Consequently, the appropriateness of the tax burden in these cases should be reviewed in line with development needs.

As shown in figure III.7, the situation of the countries of Latin America varies. On the one hand, most countries in Central America, which are net commodity importers, have lower tax burden levels than the other countries. They are therefore faced with a two-fold challenge: meeting the needs of compensatory policies and increasing the tax burden enough to provide the public goods needed for development while ensuring the equitable distribution and composition of that burden. On the other hand, fiscal revenue from commodities is in other cases significant, which makes these countries vulnerable in the event of a reversal of the price trends observed since 2003.

FIGURE III.7

LATIN AMERICA (18 COUNTRIES): CENTRAL GOVERNMENT FISCAL REVENUE, 2008

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Refers to general government or non-financial public sector.

2. Controlling the procyclicality of public spending and

unsustainable private spending

A second factor that also has to do with how long the external shocks will last concerns the extent to which macroeconomic policy allows their effects to spread to the domestic economy by means of various mechanisms, including procyclical public and private spending.

The procyclical behaviour of public spending stems in part from liquidity or budgetary constraints that limit spending according to the level of public revenue in a given period, in a context of increasing social demands for policies that would entail higher spending. In these circumstances, when public revenue grows (shrinks) due to a surge (fall) in inflows as a result of rising (falling) export prices, spending for the period expands (contracts). Fiscal spending thus transmits external variability directly and immediately to the domestic economy. Furthermore, legal provisions and practices tend to expressly link spending in certain areas to the amount of income generated by commodity exports or the prices of certain imported goods, as is the case with gasoline subsidies.

One policy response implemented in the region in such circumstances has been to adopt multi-year public budgeting methods to ensure sustainable growth in spending in line with the trend evolution of income. This means that in the event of variations in public income due to changes in export prices, spending will increase (decrease) as the trend component of income grows (shrinks). The task of identifying permanent and temporary components in the evolution of variables which, like international commodity prices, are characterized by high volatility, is not without its difficulties.

Such a strategy for managing public finances should be combined with the creation of instruments enabling saving (or dissaving) according to fluctuations in the temporary components of public revenue, supported in turn by public borrowing strategies that allow constant access to resources from the domestic and external financial systems when the macroeconomic situation so warrants.

Since the mid-1990s, several countries of Latin America and the Caribbean have extended their use of fiscal rules.15 While the initial aim of these rules was to improve the solvency of public accounts, in some cases they have also made spending less dependent on the stream of resources. The fiscal rules adopted have taken a variety of forms, ranging from quantitative limits to the fiscal balance rule and including spending and borrowing, often combined with the creation of contingency or stabilization funds (see box I.1 on fiscal policy in chapter I). Table III.1 outlines the main characteristics of these funds in the region.

15 In the region’s more decentralized countries, such as Argentina, Brazil and Colombia, one of the main objectives of these rules was to coordinate fiscal policy (spending, deficit and borrowing) across the different levels of government.

A key aspect of such funds relates to their contribution to preventing the negative effects of the abundance of external resources arising from raw material price booms (an effect known as the Dutch disease). The resulting expansion of domestic spending, ballooning non-tradable goods prices and real currency appreciation lead to loss of competitiveness and hinder the development of other tradable industries.

As indicated by Gylfason (2001), in Norway one of the factors that enabled the country to sustain long-term growth was the creation of a fund for accumulating oil and gas revenue and investing it in assets maintained abroad. But Norway’s experience is not easily transferable to Latin America and the Caribbean because when the former’s oil and gas wealth was discovered it already had very well developed institutions, broad public policies and a per capita income that, among other things, easily met the needs of the population. To one extent or another, these factors set Norway apart from any of the countries of Latin America and the Caribbean. Nonetheless, several countries in the region have created sovereign funds; the one created by Trinidad and Tobago most closely fulfils the role of preserving the wealth implicit in the country’s natural resources.

Procyclical private spending caused by rising export prices is mainly the result of euphoric expectations concerning the future growth of private wealth, supported by credit expansions that boost spending and trigger sustained asset price gains and real appreciation pressures, creating a self-perpetuating cycle. As discussed in the previous chapter, this vicious circle is based on credit mechanisms that underestimate risks in boom periods. Several instruments have been suggested to provide macroprudential control of bank lending, such as provisions for expected losses that take into account risk behaviour throughout the entire cycle (following the example of Spain), dynamic capital requirements and the reintroduction of instruments previously used to prevent unsustainable credit expansions, such as limits on bank leverage levels regardless of their portfolio risk.16

16 See the review of these proposals in the light of the recent global financial crisis in Correia, Jiménez and Manuelito (2009).

TABLE III.1

LATIN AMERICA AND THE CARIBBEAN: MAIN CHARACTERISTICS OF STABILIZATION FUNDS

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of Juan Pablo Jiménez and Varinia Tromben, “Política fiscal en países especializados en productos no renovables en América Latina”, Macroeconomía del desarrollo series, No. 46 (LC/L.2521-P/E), Santiago, Chile, Economic Commission for Latin America and the Caribbean (ECLAC), 2006. United Nations publication, Sales No. S.06.II.G.48 and information from official organizations.

BOX III.2

MANAGING THE IMPACT OF COMMODITIES ON PUBLIC REVENUES: THE HERITAGE AND STABILIZATION

FUND IN TRINIDAD AND TOBAGO

Countries exporting non-renewable natural resources are faced with two key macroeconomic and fiscal management dilemmas: (i) depletion of those resources in the long term; and (ii) fluctuation of international market prices for those resources in the short and medium term. From the point of view of fiscal policy, the more dependent fiscal revenue is on income from the exploitation and export of natural resources, the sharper this dilemma will be.

The Caribbean country of Trinidad and Tobago, where the oil and gas sector accounts for 85% of goods exports and 50% of fiscal revenue, recognized the need to address both issues. To this end, the Heritage and Stabilization Fund was created in 2007 and the proceeds from the Interim Revenue Stabilization Fund, in existence since 2000, were transferred to it.

As its name suggests, the Heritage and Stabilization Fund is a dual-purpose fund. It is used to deposit surpluses generated by the exploitation and export of non-renewable natural resources in order to ensure reserves for future generations. And it serves to insulate fiscal policy against fluctuations in international prices. Furthermore, the fund is designed to generate a stream of revenue to fund government spending as non-renewable natural resources are gradually depleted. Recognizing the potential management conflicts between these objectives (with regard to investment terms and types of assets, for example), the country opted for a single fund with different objectives in order to minimize organization costs.

That said, the rules on deposits and withdrawals more closely resemble those of a stabilization fund since they make these operations dependent on how far fiscal revenue from the energy sector (oil and gas) deviates from the amount set in the public budget. With regard to the building up of reserves, the rules provide that a minimum of 60% of the surplus revenue above the budgeted amount will be deposited every fiscal year. Funds may be withdrawn if the revenue falls short of the budget in a given fiscal year by more than 10%. In the latter case, withdrawals of up to 60% of the estimated shortfall or up to 25% of the fund assets, whichever is smaller, are allowed. Furthermore, to guarantee the fund’s nature as a wealth fund, no withdrawals may be made if they would drive the fund’s value below US$ 1 billion (the fund is denominated in United States dollars).

The fund is managed by a five-member board of directors appointed for three-year terms, including a representative of the Central Bank and another from the Ministry of Finance. The Central Bank is entrusted with its operational management and is required to submit quarterly reports to the board. The board in turn submits quarterly and annual reports to the Minister of Finance, who reports to parliament once a year. The fund accounts are audited each year by the Office of the Auditor General. To ensure that the projections of fiscal revenue from the energy sector are independent, international crude oil and natural gas price projections must be based on an 11-year rolling average covering the five years leading up to a given fiscal year, that fiscal year and the following five years.

Between March 2007 and December 2010, deposits were made in every fiscal year except 2008/2009, which marked the height of the global economic and financial crisis. But no withdrawals were made in that period either, thus preserving the fund as a wealth fund. Fiscal stabilization was achieved residually, with deposits made when revenue was high and no deposits when revenue was low. As of December 2010, the total net assets of the fund stood at US$ 3.702 billion, equivalent to 15.8% of GDP and more than three times the US$1 billion floor set by law to guarantee its status as a wealth fund.

Five-year reviews are an important feature of the fund’s design. The first review, scheduled for 2012, will provide an ideal opportunity to review the fund’s performance since inception. The authorities consider that the fund has performed well so far but are contemplating making some changes when it is reviewed, such as measures to more clearly segregate the heritage and stabilization components to ensure that both objectives are fulfilled efficiently and sustainably, and to strengthen transparency and accountability requirements. This would include more formal crude oil and natural gas price projections as a basis for budgeting fiscal revenue in order to keep them from being used for

political purposes.

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of Michael Méndez, “Coping with oil price volatility”, paper presented at the Workshop on macroeconomic policies, external integration and international financial markets, Santiago, Chile, Economic Commission for Latin America and the Caribbean (ECLAC), 13-14 April 2011.

Here is a dilemma entailing an especially difficult choice, particularly for countries whose public revenue is positively correlated with commodity export prices. In general, spending pressures arise when external prices surge, which in turn tends to trigger nominal and real currency appreciation and hinder the development of other export and import-substitution sectors.

Managing this trade-off between increasing current spending and real currency appreciation is particularly complex and depends on a series of temporary and structural factors.17 In the short term, the balance point between the two depends on the capacity of the productive apparatus to respond to the rise in demand without fuelling inflation. This in turn depends on the availability of idle capacity. Thus, if the economy is at a stage in its cycle that is very close to its potential capacity, it is more likely that rising export prices will result in real appreciation when the boom also drives public or private spending up. In these cases, fiscal saving can be an effective macroeconomic tool for easing pressures towards real appreciation of the local currency, especially if those savings are in

foreign currency.

17 This discussion relates to growth in spending based on the trend components of revenue in line with the previous section.

The dilemma also entails a choice between giving priority to spending on measures to improve current living conditions (for example, by means of subsidies, transfer programmes and pay rises) or to spending and investing more to promote future human and productive capacities. Although this is an ongoing issue in any discussion of the composition of public spending, it tends to be exacerbated in times of booming revenue, when there is greater pressure to step up current spending. These issues cannot be addressed without considering the incidence of poverty and the urgency of measures to improve social conditions in individual countries, as well as the current and potential level of development and diversification of its productive apparatus. But two basic considerations can guide decision-making: (a) increases in recurrent spending should be supported by growth in trend revenue, not only to ensure fiscal sustainability but also to actually improve quality of life; and (b) investment in productive development, whether in infrastructure, human capacity building or credit support for tradable industries, can be the key instrument for turning the external price boom into a capacity for sustained, long-term growth.

Lastly, an especially important aspect of this dilemma is public debt strategy, which should be based on predictability and sustainability. At a time when fiscal revenue is subject to volatility and uncertainty due to commodity price trends, establishing a sustainable debt profile is increasingly important for two reasons: first, to allow public spending programmes to remain in place in the event of adverse shocks, and second, to prevent or minimize the effects of possible disruptions in capital flows and ensure regular access to external financial market resources by both the public and the private sector. As indicated previously, to that end it is essential that structural income and expenditure trends

be aligned.

4. Participation in extraordinary income generated by surges

in external prices

A hotly debated issue is the extent to which the public and private sectors are entitled to an appropriate share of the extraordinary external revenue generated during export price booms. In a time of sharp growth in income from the exploitation and export of commodities, this debate has become increasingly relevant in the countries of Latin America and the Caribbean that specialize in these products. The discussion includes elements such as the tax structure applicable to these sectors, the capacity to collect taxes on the exploitation of commodities and even the ownership structure of this sector.

The debate is not limited to developing countries, however. Several developed countries have expanded the public sector’s participation in income from activities generating extraordinary profits by means of special windfall taxes that were not limited to revenue relating to non-renewable natural resources.18

18 A well-known case was the enactment, during the presidency of James Carter, of a windfall tax on United States oil companies following the sharp increase in prices brought about by the Organization of the Petroleum Exporting Countries (OPEC) oil embargo. The tax was repealed during the presidency of Ronald Reagan amid lower oil prices. Also in the United States, the administration of the State of Alaska approved a similar tax in 2007. Australia announced that from 2012 a new tax regime will apply to iron, coal and oil operations, which includes a tax on windfall profits. Finland, Norway and Sweden also established a similar tax in 2008, which is applicable to extraordinary profits by electric power generators. In 1997 the United Kingdom established a tax on extraordinary capital gains by public utilities that had been privatized.

In Latin America, where the exploitation of natural resources is largely in private hands, the countries have introduced collection mechanisms and specific taxes on the income generated by these resources. These include exploration and exploitation licences, production royalties and taxes on profits with progressive rates according to profitability. For example, the Bolivarian Republic of Venezuela taxes exports of liquid hydrocarbons and derivatives, with a range of rates according to international oil prices. Oil industry royalties and ownership structure underwent changes throughout the period 2003-2008. Similar measures have been implemented in the Plurinational State of Bolivia, and several countries have recently revised their tax rates on the extraction of non-renewable natural resources. Royalties in Chile are an example, as are special export taxes such as withholding taxes in Argentina.

All these instruments can without a doubt help to moderate the procyclical behaviour of private spending, but they also enhance the legitimacy of the tax system by enabling the benefits of rising external prices to be shared more widely and facilitating the creation of institutions such as sovereign savings funds that ensure intergenerational equity. Furthermore, in the case of the exploitation of non-renewable natural resources, whether private or public, part of the profits generated reflect the gradual depletion of deposits and oilfields, that is, of the country’s natural capital. Under the legal system of several countries, both in the region and elsewhere, the State owns the subsoil resources and therefore is entitled to a share in any benefits derived from them, either by means of taxes or through profit participation. This is in addition to the normal income tax on all activities, since in this case a publicly-owned resource is being depleted and the owner should be compensated. This additional portion should be deposited in a special fund to preserve the country’s wealth and invested so as to compensate for the depletion of non-renewable natural resources in the future, as is the case in Norway and Trinidad and Tobago.19

19 As the bibliography shows, this matter has been the subject of discussion for some time, at least since Gray (1914) and subsequently Hotelling (1931). See Otto and others (2006) for a review of the tax regimes currently applicable to mining in several parts of the world. See Hamilton and Clemens (1999) for a discussion of the consequences of the depletion of natural resources for

sustainable development.

TABLE III.2

LATIN AMERICA (8 COUNTRIES): CHARACTERISTICS OF THE TAX REGIMES APPLICABLE TO THE EXPLOITATION

OF NON-RENEWABLE NATURAL RESOURCES

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of G. Brosio and J.P. Jiménez, “The intergovernmental assignment of revenue from natural resources: a difficult balance between centripetal and centrifugal forces”, unpublished 2010, and official figures.

a Supreme decree of 1 May 2006 on the nationalization of hydrocarbons.

Chapter IV

Summary and concluding remarks on the challenges of the medium-term

external outlook

A. Summary

The preceding chapters focused primarily on the economic consequences, both short- and medium-term, of an external environment characterized by abundant liquidity and high commodity prices, and on the challenges these pose for macroeconomic policy.

Since the mid-1990s, the significant changes that have taken place internationally have had profound repercussions on the external accounts of Latin American and Caribbean countries, affecting the components of the current account as well as the composition of its financing. At the same time, several countries have made significant changes to their macroeconomic frameworks and their financial systems. Those changes have greatly modified their capacity to withstand external shocks and resist their spread to the domestic economy.

Among the changes that affect the current account, the most influential factors have been commodity price trends and the improvement in trade balances, shifts in the composition of the balance on the income account, with greater weight corresponding to profit outflows from foreign direct investment (FDI), and higher remittance flows from emigrants. In turn, the components of the capital and financial account balances have also shown significant changes. With the integration of countries of the region into the international economy (if to varying degrees), FDI has become one of the main sources of external financing and has shown itself more stable than other financial flows. At the same time, the attractive returns offered by some Latin American economies, together with the expansion of local financial markets and improved indicators of fiscal and financial soundness, have made the region’s countries more attractive as destinations for foreign capital. The improved terms of trade in South America, external debt reductions under the Heavily Indebted Poor Countries (HIPC) Initiative, progress on the fiscal front and the replacement of external debt by domestic borrowing have all helped to improve the region’s external public debt indicators in recent years.

An important change with regard to macroeconomic frameworks in the region has been the adoption of fiscal policies with a greater emphasis on balancing the public finances, including the creation of countercyclical capacities in some cases. At the same time, the thrust of monetary policy has tended to emphasize inflation control, with some countries setting explicit targets or objectives for that variable. In several cases the central bank has been given independence vis-à-vis the government, and more countries have opted for relatively flexible exchange regimes, even if the monetary authority tends to intervene frequently in some of them.

Several countries (Brazil, Chile, Colombia and Mexico) have fostered the development of their domestic financial markets and sought deeper integration into international financial markets, two of the main channels for the transmission of external financial shocks to the rest of the economy. In fact, while development of the various segments of the financial market still falls far short of the levels achieved in more advanced economies or in the newly industrialized countries, the market in the region is now deeper and banking services are more widely available than in previous decades. As well, the successive years of economic growth which the region enjoyed until the outbreak of the global crisis in 2008 boosted the development of the countries’ financial systems and of banking penetration in particular. Nevertheless, only a few countries have a deep capital market (for equity and debt): the most developed markets are those of Brazil, Chile and Mexico, and to a lesser extent Colombia and Peru.

Nevertheless, the region continues to betray sharp cleavages in these aspects and fiscal imbalances persist in several countries of Central America and the Caribbean. In the first case, a low tax burden worsens the disequilibria, whereas the Caribbean countries generally have a higher tax burden than the regional average. These countries are only shallowly integrated into external financial markets and almost exclusively through FDI, in part because of the lack of domestic financial development that would enable greater financial interaction with the outside world. Both factors produce differences in the channels that transmit external shocks and in the intensity of their effects, as well as in response capacities, in comparison to countries with greater financial development and participation in international financial markets.

The intensity with which shocks sparked by fluctuations in external liquidity and commodity prices are transmitted to the region’s domestic economies and the policy alternatives for dealing with their consequences depend essentially on three structural features that are especially important in the current setting: the relative weight of government revenues from commodity production and exports (taxes, royalties and the profits of State enterprises); the degree of exposure to international financial markets (in other words, the openness of the balance-of-payments financial account); and the depth and scope of domestic financial systems as a channel for domestic transmission of those external shocks (see tables I.1 and I.2). These are not the only characteristics of the region’s economies that make for external vulnerability but they —and especially their interaction— are particularly important for the present analysis, because they condition to a considerable extent the countercyclical capacity of fiscal and monetary policies in the context of high liquidity and external volatility.

The world economy in the wake of the international financial crisis has a number of traits that pose significant challenges for formulating and implementing macroeconomic policy in the countries of the region, which vary according to their degree of integration into international financial markets. Among the factors mentioned in the chapters are the highly expansionary monetary and fiscal policies of the United States, the fiscal and banking crises of some countries in the euro area, the small share of the emerging economies in international financial markets, the improvements in the terms of trade in various Latin American countries, and mounting inflationary pressures due primarily to external supply factors in the context of surging domestic demand.

Rising interest rates in the region, primarily in response to mounting inflationary pressures, have widened the

pre-existing risk-adjusted interest rate spread between Latin American countries and developed economies. For several years running, the region has shown a downward trend in its sovereign risk, which was temporarily interrupted in the depths of the recent global crisis. Together with recent interest rate hikes in the region and growing debt risks in euro area countries, this has drawn even greater financial flows into the region, exerting upward pressure on local currencies. This effect has been felt particularly strongly in those economies of the region specialized in commodity exports.

A second channel through which the current spike in global liquidity and exported commodity prices can distort the domestic balance is offered by financial and real mechanisms that induce unsustainable spending behaviour. In the case of private spending, these mechanisms lie in procyclical lending patterns and the wealth effects derived from changes in the nominal exchange rate and the prices of financial assets.

In responding to these challenges, policymakers must bear in mind the differing degrees of financial integration shown by the countries in the region (see table I.5 of part 2). Broader access to external capital offers opportunities to tap international financial markets, which helps to finance investment projects and underpins domestic economic activity. Yet in the event of a shift in the international economy or a reversal in international financial agents’ expectations regarding the performance of the domestic economy, this integration can become a source of vulnerability, as it may produce sudden capital flights. Moreover, countries must conduct a rigorous assessment of two fundamental aspects that condition the kind of policies to be pursued. The first involves identifying the effects that policy will target (reducing exchange-rate volatility, easing upward pressure on the local currency, controlling the growth in domestic credit, containing the asset price bubble). The second aspect is to define the type of measures and instruments that will be used to target those effects.

In turn, rising international commodity prices create several macroeconomic policy challenges for the countries of the region, especially in the fiscal domain. First, it is important to distinguish between net exporters and net importers of commodities. For net commodity exporters, relatively abundant foreign exchange flowing from higher export revenues exerts upward pressure on the currency in real terms, which will erode the profitability of other exports and of import substitution activities. The challenge for macroeconomic policy is to adopt mechanisms that will contain the fall in the real exchange rate and lessen its variability, so as to mitigate the impact of the real appreciation of domestic currencies on resource allocation in the economy. The capacity to weather these pressures will depend on the extent to which the public finances are hostage to international commodity prices (see table I.1). Conversely, net importing countries will find their currencies under downward pressure exerted by a worsening trade balance. Domestic food and fuel prices will rise in both cases, but with a more severe impact in the second, where the surge in international prices will be intensified by local currency devaluation.

On the other hand, there is an important issue for the region with respect to public sector participation in the windfall profits derived from natural resources, given the likely continuity of the factors that have driven commodity prices above their levels of previous decades. Given this outlook, several countries of the region have made changes to the provisions whereby government and the private sector share the profits from non-renewable natural resource extraction.

As in other areas of economic policy, there is no single response to a given change in the variables determining the nature and pace of economic growth. Depending on the implications for each country of persistent high external liquidity and depending on the characteristics of its financial system, the authorities may decide to take steps to avoid or moderate negative fallout from such liquidity, with a particular eye to the exchange rate. These measures may include the build-up of international reserves, the introduction of capital controls, the adoption of macroprudential measures, the adjustment of financial sector regulatory frameworks and, as a last resort, the adoption of a more flexible exchange rate regime. At the same time, depending on the impact of commodities on government revenues, there are various policy options for cushioning the social effects of higher international prices and avoiding the unsustainable expansion of public expenditure and its effects on the productive structure, as analysed in the following section.

B. The medium-term regional outlook

and policy challenges

1. Possible medium-term external conditions

The most likely medium-term external context for the region, and the one that is already gradually taking shape, is dominated by the following trends:

(i) Continued rapid growth in the large emerging economies of Asia, which will keep prices high for the region’s commodity exports, at least over the medium term.

(ii) Persistent uncertainty over fiscal consolidation both in Europe and in the United States, as well as slow progress in cleaning up banking portfolios, especially in Europe. As a result, Latin America could continue to enjoy relatively better risk ratings than in previous decades, amid ongoing uncertainty over the dollar-euro exchange rate.

(iii) A correction, even if only partial, of global imbalances —especially the twin deficits of the United States— will require (among other things) real depreciation of its currency with respect to the rest of the world, and especially against the currencies of emerging countries with which it has a sizeable trade imbalance.

The external scenario could turn out to be worse than described above, if the international economic situation were to follow the less optimistic forecasts. There are three main areas of risk:

(i) Lack of progress with fiscal consolidation in Europe: this would translate into uncertainty about the solvency of some countries, erode the growth prospects of Europe as a whole, and fuel doubts about the viability of the euro zone in its current size and makeup. These impacts would be exacerbated by failure to resolve unsustainable public debt situations in

certain countries.

(ii) Difficulties in achieving public debt sustainability in the United States, requiring swifter fiscal consolidation. If that situation also produced greater uncertainty, it could induce higher private savings in that country. Both factors would tend to give a contractionary bias to spending in the United States, which would have a global impact on commodity prices, exchange-rate parities and the growth prospects of the

world economy.

(iii) A heavy slowdown in growth in the large emerging economies of Asia, given the need to control inflationary pressures resulting from high global liquidity and the pace of domestic expenditure growth.

2. Policy challenges in a setting of external turbulence

and tensions in the process of global rebalancing

The scenario described as most likely in the previous section implies that the policy challenges mentioned in the preceding chapters (that is, upward pressure on currencies in the region, unsustainable growth in expenditure and credit, financial asset bubbles, demands to offset the social impacts of rising raw material costs, and so forth) will persist over the medium term. Accordingly, they must also be considered from the standpoint of economic growth.

From the viewpoint of net commodity-exporting countries, a trend towards real local currency appreciation due to spikes in external liquidity or in export prices would reduce the profitability of other exports and of import substitution activities, particularly where costs are heavily influenced by non-tradable inputs and factors of production. In the short term, this would have repercussions on output of tradable goods and services, causing what could be termed “static” growth losses, inasmuch as they would be only one-time losses. Over time those growth losses could be offset by the reallocation of resources to activities that benefit from real currency appreciation.

A real appreciation would boost demand for imports, which would worsen the external balance. Yet, given the level of international reserves in the region and the low level of external indebtedness of most countries, this would not pose an imminent threat to their external solvency.

Nevertheless, a further analysis suggests that, beyond these static growth losses, there would be losses in future growth rates caused by a shift back towards primary production and exports (Ocampo, Bajraj and Martin, 2001; Frenkel and Repetti, 2011). This is because natural-resource-based activities, which tend to be capital-intensive and which produce high Ricardian economic rents, would be better placed to survive a prolonged appreciation. This is either because their profitability would be less affected or because the existence of such rents would allow them to remain in business, especially with a cycle of commodity prices such as that forecast for the medium term. By contrast, export-oriented manufacturing and services (which have greater productive linkages and are more intensive in non-tradable inputs than natural resource-based production) would suffer greater profitability losses as a result of real currency appreciation, and this would hurt their output. Moreover, manufacturing —even import substitution— offers a more enabling setting than primary production for innovation and for the generation, adoption and dissemination of technical progress through horizontal and vertical linkages. As a result, slacker activity and a fall-off in investment in manufacturing would represent a loss of systemic competitiveness and would thus carry a “dynamic” loss or cost.

The empirical evidence on the growth effects of changes in the real exchange rate is almost unanimous in suggesting that excessive real appreciation of currencies damages long-term growth.1 Moreover, experience and analysis both show that, while real appreciation is to be avoided, this alone will not drive the competitiveness of the sectors producing tradable goods and services that are not based on natural resources. Enhancing the competitiveness of these sectors also requires active development policies designed to boost their productivity and foster linkages with the rest of the productive apparatus. ECLAC has on various occasions warned against seeking competitiveness solely though high real exchange rates and low real wages, which it refers to as “spurious competitiveness” (ECLAC, 1990). Those sectors must over time rise to the challenge of seeking productivity through technical progress and innovation, instead of exerting pressure to bias macroeconomic prices in their favour, thereby transferring real income to themselves from the rest of society. Industrial policies, rather than macroeconomic policies, are what is really needed to make progress on these fronts.

1 There is a wealth of theoretical literature positing a positive relationship between export growth and economic growth, based on a high real exchange rate. The empirical literature, however, is less conclusive on the subject. The consensus suggests that significant and sustained real appreciations are harmful to growth. See Easterly (2005), Eichengreen (2008), Fischer (1993) and (1991), Bleaney (1996), Servén (2002), Plümper and Graff (2001), Frankel and Romer (1999).

These arguments may in fact be more applicable to large and medium-sized economies that are net exporters of commodities and of a diversified range of products, and have a large domestic market (such as Argentina, Brazil, Chile, Colombia, Mexico and Peru) and reasonably developed sectors producing for domestic demand, import substitution or non-traditional exports. In economies which are smaller or have little productive diversification, or both, and have a large natural-resource-based export sector, sectors producing tradable goods for the domestic market will carry less relative weight in the economic structure —perhaps even less than the sectors producing non-tradable goods and services, whose relative position will be enhanced by real appreciation. Consequently, for these economies the negative impacts of real appreciation will be outweighed by the real income gains for sectors whose consumption or output includes imported inputs or final goods. That, of course, should not prevent them from pursuing productive diversification, as well. Nevertheless, because the domestic tradable production base is, in relative terms, smaller than that of medium and large economies, targeted industrial development policies may be preferable to macroeconomic tools such as the exchange rate, which affects the entire economy and has potential greater undesired collateral effects in terms of distribution and price levels.

In Central American and Caribbean countries which are net exporters of services and net importers of commodities, continued high commodity prices will pose additional hurdles for improving living standards and economic growth, as was already occurring before the financial crisis of 2008. At the same time, their rather limited participation in international financial markets will preclude taking sufficient advantage of the relatively benign external liquidity conditions foreseen for the region. In contrast to the previous group, these countries’ currencies will come under downward pressure and their problems will revolve around the effects on living standards of declining real incomes, with the consequent need to formulate compensatory fiscal expenditure policies. This will be a major challenge for a number of Central American countries whose tax burden is very low.

A second aspect of the external scenario described above that will condition growth over the medium term in Central America has to do with the continuing challenge of maintaining positions in their export markets. They are facing stiff competition in those markets from countries outside the region, especially China and other Asian exporters of manufactures that rely on intensive use of unskilled labour, and this poses a strategic threat to their productive specialization. In this case, the risk inherent in a shift back to primary production for export comes not from real-exchange-rate trends but rather from the threats of competition from other countries with abundant low-cost labour which have greatly increased their productivity in recent years.

The principal response here must lie in industrial development and infrastructure programmes designed to boost productivity as quickly as possible, recognizing that the possibilities of remaining competitive in certain export areas are diminishing with the passage of time in view of the rapid growth in competing countries. Accordingly, the principal obstacle to raising productivity must be identified in each case, making it impossible to offer generalizations.

While workers’ remittances have been a very important source of external financing in this subregion, growth in these flows may hit a ceiling in the event of a downturn in the United States labour market.

In short, Central America will face major challenges, ranging from the need to strengthen the foundations of its public finances to deploying industrial development policies to underpin rapid growth in productivity. Lastly, efforts to create an expanded economic area on the basis of a revitalized Central American Common Market and convergence in macroeconomic policies are probably the most promising alternative for taking advantage of the synergies of integration and building an internal market of significant size that will enable the emergence of a subregionally-oriented industry.

In the case of the services-exporting countries of the Caribbean, as well as some that export raw materials, the dilemmas are similar in terms of the need for fiscal consolidation, given the heavy levels of debt some of these countries are carrying. This is no easy proposition, especially in countries with low per capita incomes. Thus, external financial assistance will continue to be needed to support growth in this subregion, especially if a halting economic recovery in developed economies keeps demand for their exports sluggish.

If the risks surrounding this medium-term scenario should materialize, the prices of the region’s commodity exports and the demand for its services exports would suffer sharply and the resulting decline in national income would deflate aggregate demand. This, in turn, would hurt growth prospects and narrow the region’s access to external liquidity.

These considerations shift the policy discussion from the national sphere addressed hitherto into the realm of the global economy. Individual countries take their policy decisions in a complex external setting characterized by global imbalances that need to be at least partially corrected. The fact is that the global financial crisis and the responses to it worsened growing public indebtedness in developed countries, in some cases to levels that threaten fiscal solvency and are bordering on the maximum tolerable limits. If their situations worsen, the repercussions will depend on the route those countries choose to regain solvency, and this could have very significant impacts for the region.

As in any process of debt reduction, the highly indebted developed countries have four routes for resolving the situation. The first, available to countries that issue reserve currencies, in particular the United States, is the non-cooperative option of reducing the real debt burden through unilateral monetary expansion, which imposes on the rest of the world higher levels of inflation and reduces the value of the currency in the country engaging in the mechanism. This in practice forces real appreciation of the currencies of other countries. The second route is to increase debt servicing capacity through drastic fiscal reforms. If they are to be successful, however, such measures may have to be supplemented by a third alternative: debt restructuring, which ranges from an agreed relaxation of agreed financial conditions (maturities and interest rates) to outright default. The objective may range from gaining time to undertake reforms in order to restore fiscal solvency to unilaterally reducing the present value of the liabilities in order to restore debt servicing capacity. A fourth option —and a key short-term goal which complements the previous three paths— is to prevent a drop in economic output, which would increase the debt service burden and making the initial situation even worse. Therefore, governments tend to implement measures designed to reduce the debt burden over the medium term by accelerating economic growth, which should lead to increased public revenues.

These approaches to reducing debt tend to be adopted in combination, and the choice of formula has major distributive impacts in developed and developing countries alike as well as implications for their global competitiveness and their economic growth.

Of the alternatives mentioned, an upturn in economic growth in developed countries is the only route with positive long-term consequences for developing countries. As noted earlier, however, this scenario is not very probable. The other routes, especially when taken in a unilateral and uncoordinated way, carry with them a threat to global stability and growth. The monetary expansion under way in developed countries is threatening to fuel inflation worldwide and interfere with real-exchange-rate trends in developed countries, and it creates uncertainty over the future course of growth. At the same time, reducing the debt burden through unilateral cuts in the value of liabilities (for example, default), especially if the defaulter were a developed country of systemic scale, would create financial market turmoil—and that too would damage growth prospects and global export demand for developing countries. Then again, a hasty fiscal consolidation, especially without the domestic consensus needed to be lasting, could tip the developed countries and the world economy overall into recession. On the other hand, a debt reduction exercise in which the consequences are shared domestically and externally —though very difficult to achieve— could create a sustainable scenario that would underpin a restoration of confidence and a better outlook for future growth.

The fact that the process of global rebalancing now in progress has tended towards unilateral and non-cooperative solutions is a matter of concern for the global economy and for the developing countries in particular, whose growth may suffer in an uncertain scenario. It is moreover a testament to the difficulties of macroeconomic coordination between the world’s largest economies. In these conditions of uncertainty and risk of global economic slowdown, the less developed countries, and the Latin American and Caribbean region in particular, must tread very carefully when taking decisions that affect the depth and the form of their international financial market integration. Careful judgement is needed, as well, in handling the fiscal effects and the social impacts of higher commodity prices. The preceding chapters have sought not to offer any single solutions to these dilemmas, but to suggest some criteria for assessing them, bearing in mind the way in which exogenous shocks interact with certain structural characteristics of economies. This interaction, more than anything else, forms a basis for gauging consequences and choosing among alterative responses.

Statistical annex

TABLE A-1

LATIN AMERICA AND THE CARIBBEAN: MAIN ECONOMIC INDICATORS

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Based on official figures expressed in 2005 dollars.

c December-December variation.

d The data for Argentina have been adjusted to allow for changes in methodology in 2003.

e Estimates based on figures denominated in dollars at current prices.

f Does not include Cuba.

g Includes errors and omissions.

h A minus sign (-) indicates an increase in reserve assets.

i Central government, except for the Plurinational State of Bolivia, where coverage corresponds to general government.

simple averages for 19 countries.

TABLE A-2

LATIN AMERICA AND THE CARIBBEAN: GROSS DOMESTIC PRODUCT

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Based in the new quarterly national accounts figures published by the country, base year 2005.

TABLE A-3

LATIN AMERICA AND THE CARIBBEAN: GROSS DOMESTIC PRODUCT

(Annual growth rates)

Source: Economic Commission for Latin America and the Caribbean (ECLAC). on the basis of official figures.

a Preliminary figures.

b Based on official figures expressed in 2005 dollars.

c Based in the new quarterly national accounts figures published by the country. base year 2005.

TABLE A-4

LATIN AMERICA AND THE CARIBBEAN: PER CAPITA GROSS DOMESTIC PRODUCT

(Annual growth rates)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Based on official figures expressed in 2005 dollars.

c Based in the new quarterly national accounts figures published by the country, base year 2005.

TABLE A-5

LATIN AMERICA AND THE CARIBBEAN: COMPONENTS OF TOTAL DEMAND a

(Indices 2005=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Based on official figures expressed in 2005 dollars. Includes information on 20 countries of Latin America and the Caribbean: Argentina, Bolivarian Republic of Venezuela, Brazil, Chile, Colombia, Costa Rica, Cuba, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Plurinational State of Bolivia and Uruguay.

b Preliminary figures.

TABLE A-6

LATIN AMERICA AND THE CARIBBEAN: GROSS DOMESTIC PRODUCT BY ECONOMIC SECTOR a

(Indices 2005=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Based on official figures expressed in 2005 dollars. Includes information on 33 countries of Latin America and the Caribbean.

b Preliminary figures.

TABLE A-7

LATIN AMERICA AND THE CARIBBEAN: GROSS FIXED CAPITAL FORMATION a

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Based on official figures expressed in 2005 dollars.

b Preliminary figures.

TABLE A-8

LATIN AMERICA AND THE CARIBBEAN: FINANCING OF GROSS DOMESTIC INVESTMENT a

(Percentages of GDP))

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Based on values calculated in national currency and expressed in current dollars.

b Preliminary figures.

TABLE A-9

LATIN AMERICA AND THE CARIBBEAN: BALANCE OF PAYMENTS

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Preliminary figures.

b Includes errors and omissions.

c A minus sign (-) indicates an increase in reserve assets.

TABLE A-10

LATIN AMERICA: EXPORTS OF GOODS, F.O.B.

(Indices 2005=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Preliminary figures.

TABLE A-11

LATIN AMERICA: IMPORTS OF GOODS, F.O.B.

(Indices 2005=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Preliminary figures.

TABLE A-12

LATIN AMERICA: TERMS OF TRADE FOR GOODS F.O.B. / F.O.B.

(Indices 2005=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Preliminary figures.

TABLE A-13

LATIN AMERICA AND THE CARIBBEAN: NET RESOURCE TRANSFER a

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a The net resource transfer is calculated as total net capital income minus the income balance (net payments of profits and interest). Total net capital income is the balance on the capital and financial accounts plus errors and omissions, plus loans and the use of IMF credit plus exceptional financing. Negative figures indicate resources transferred outside the country.

b Preliminary figures.

TABLE A-14

LATIN AMERICA AND THE CARIBBEAN: NET FOREIGN DIRECT INVESTMENT a

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Corresponds to direct investment in the reporting economy after deduction of outward direct investment by residents of that country. Includes reinvestment of profits.

b Preliminary estimate. Includes an adjustment due to a lack of data.

TABLE A-15

LATIN AMERICA AND THE CARIBBEAN: INTERNATIONAL BOND ISSUES a

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund, Merrill-Lynch and JP Morgan and Latin Finance.

a Includes sovereign, bank and corporate bonds.

TABLE A-16

LATIN AMERICA AND THE CARIBBEAN: TOTAL GROSS EXTERNAL DEBT a

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Includes debt owed to the International Monetary Fund.

b Preliminary figures.

c Does not include Cuba.

d Refers to external public debt.

e As from 2004 refers only to active external debt; excludes other external debt, 60.2% of which is official debt owed to the Paris Club.

f The figure for 2002, corresponds to external public debt.

TABLE A-17

LATIN AMERICA AND THE CARIBBEAN: GROSS INTERNATIONAL RESERVES

(Millions of dollars)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Net international reserves.

b Freely available International reserves.

c Balance as of January.

d Balance as of April.

e Does not include gold.

TABLE A-18

LATIN AMERICA AND THE CARIBBEAN: STOCK EXCHANGE INDICES

(National indices to end of period, 31 December 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of information from Bloomberg.

TABLE A-19

LATIN AMERICA AND THE CARIBBEAN: REAL EFFECTIVE EXCHANGE RATES a

(Average annual Index, 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures from the International Monetary Fund and national sources.

a Annual averages. A country’s overall real effective exchange rate index is calculated by weighting its real bilateral exchange rate indices with each of its trading partners by each partner’s share in the country’s total trade flows in terms of exports and imports. The extraregional real effective exchange rate index excludes trade with other Latin American and Caribbean countries. A currency depreciates in real effective terms when this index rises and appreciates when it falls.

b Preliminary figures, weighted by trade in 2009.

c January-May average.

d Simple average of the extraregional real effective exchange rate for 20 countries.

e Preliminary figures. Yearly calculation by ECLAC, based on consumer price data and nominal exchange rates provided by the National Statistical Office of Cuba.

TABLE A-20

LATIN AMERICA AND THE CARIBBEAN: PARTICIPATION RATE

(Average annual rates)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b The data relating to the different countries are not comparable owing to differences in coverage and in the definition of the working age population. The regional series are simple averages of national data (excluding Nicaragua and the Plurinational State of Bolivia) and include adjustments for lack of information and changes in methodology.

c New measurements have been used since 2003; the data are not comparable with the previous series.

d New measurements have been used since 2010; the data are not comparable with the previous series.

e New measurements have been used since 2009; the data are not comparable with the previous series.

f In Cuba, the working-age population is measured as follows: for males, 17 to 59 years and for females, 15 to 54 years.

g New measurements have been used since 2007; the data are not comparable with the previous series.

h Up to 2009, nationwide total.

i Up to 2005, urban total.

TABLE A-21

LATIN AMERICA AND THE CARIBBEAN: OPEN URBAN UNEMPLOYMENT

(Average annual rates)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of household surveys.

a Preliminary figures.

b The data for Argentina have been adjusted to allow for changes in methodology in 2003.

c New measurements have been used since 2003; the data are not comparable with the previous series.

d Includes hidden unemployment.

e Up to 2008, urban areas.

f First semester.

g New measurements have been used since 2010; the data are not comparable with the previous series. For 2002-2005, the series were adjusted to splice with the series applicable as of 2006.

h Excludes hidden unemployment. Includes an adjustment to the economically active population statistics.

i New measurements have been used since 2009; the data are not comparable with the previous series.

j Preliminary estimate.

k Up to 2009, urban total.

TABLE A-22

LATIN AMERICA AND THE CARIBBEAN: EMPLOYMENT RATE a

(Average annual rates)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Employed population as a percentage of the working-age population.

b Preliminary figures.

c Weighted average adjusted for lack of information and changes in methodology.

d New measurements have been used since 2003; the data are not comparable with the previous series.

e Up to 2008, urban areas.

f First semester.

g New measurements have been used since 2010; the data are not comparable with the previous series.

h New measurements have been used since 2009; the data are not comparable with the previous series.

i New measurements have been used since 2007; the data are not comparable with the previous series.

j Up to 2009, urban total.

k Up to 2005, urban total.

TABLE A-23

LATIN AMERICA AND THE CARIBBEAN: FORMAL EMPLOYMENT INDICATORS

(Indices 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Dependent workers paying into pension schemes.

c Workers covered by social and labour legislation.

d Workers with social security coverage.

e Workers of medium-sized and large firms.

f Workers in small, medium-sized and large businesses, in manufacturing, commerce and services. Up to 2009, refers to workers with social security coverage.

g Employement positions generating social security contributions.

TABLE A-24

LATIN AMERICA: VISIBLE UNDEREMPLOYMENT BY HOURS

(Percentages of employed workers)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Employed persons who work less than 35 hours per week and wish to work more hours; urban total.

c Employed persons who work less than 40 hours per week and wish to work more hours; six metropolitan areas.

d New measurements have been used since 2010; the data are not comparable with the previous series. Employed persons who work up to 30 hours per week and wish to work more hours; national total. Up to 2009, employed persons who work less than 35 hours per week and who wish to work more; national total; third quarter of each year. The figures up to 2005 and as from 2006 are not comparable since the sample changed.

e Employed persons who work less than 48 hours per week and wish to work more hours; 13 metropolitan areas.

f Employed persons who work less than 47 hours per week and wish to work more hours; national total. New measurements have been used since 2009; the data are not comparable with the previous series.

g Employed persons who work less than 40 hours per week and wish to work more hours, urban total; up to 2006, Cuenca, Guayaquil and Quito.

h Employed persons who work less than 40 hours per week and wish to work more hours; urban total. New measurements have been used since 2007; the data are not comparable with the previous series.

i Employed persons who work less than 36 hours per week and wish to work more hours; total urban areas.

j Employed workers wishing to work more than their current job permits, national total.

k Employed persons who work less than 40 hours per week and wish to work more hours; urban total.

l Employed persons who work less than 30 hours per week and wish to work more hours; Asunción and urban areas of the Departamento Central; up to 2009, total urban areas.

m Employed persons who work less than 35 hours per week and would like to work more, Lima metropolitan area.

TABLE A-25

LATIN AMERICA: REAL AVERAGE WAGES a

(Índices 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Figures deflated by the official consumer price index of each country.

b Preliminary figures.

c Registered private-sector workers.

d Private-sector average wage index.

e Private-sector workers covered by social and labour legislation. In 2002 includes public-sector workers.

f General index of hourly wages.

g Manufacturing.

h Average wages declared by workers covered by social security.

i Gross salary.

j Workers in small, medium-sized and large businesses, in manufacturing, commerce and services. Up to 2009, refers to workers with social security coverage.

k Private-sector workers in the Lima metropolitan area.

l Estimate based on data from June.

TABLE A-26

LATIN AMERICA AND THE CARIBBEAN: REAL MINIMUM WAGE a

(Indices 2000=100)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Figures deflated by the official consumer price index of each country.

b Preliminary figures.

TABLE A-27

LATIN AMERICA AND THE CARIBBEAN: MONETARY BASE

(End-of-year balances as percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

TABLE A-28

LATIN AMERICA AND THE CARIBBEAN: MONEY SUPPLY (M3) a

(End-of-year balances as percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a According to the ECLAC definition, this corresponds to M1 plus savings and time deposits in national currency plus foreign-currency deposits.

b Corresponds to M2.

TABLE A-29

LATIN AMERICA AND THE CARIBBEAN: FOREIGN CURRENCY DEPOSITS

(End-of-year balances as percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Series corresponding to harmonized monetary indicators.

TABLE A-30

LATIN AMERICA AND THE CARIBBEAN: DOMESTIC CREDIT TO THE PRIVATE SECTOR

(End-of-year balances as percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Credit granted to the private sector by the banking sector.

TABLE A-31

LATIN AMERICA AND THE CARIBBEAN: REPRESENTATIVE LENDING RATES

(Annual average of monthly annualized rates)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Weighted average of the system lending rates.

b Local-currency loans at fixed or renegotiable rates, signature loans of up to 89 days.

c Prime lending rate.

d Nominal dollar rate for 60-91-day banking operations.

e Preset lending rates for legal persons.

f Lending rates for periods of 90-360 days, non-adjustable operations.

g Average lending rate.

h Corporate lending rate in convertible pesos.

i Effective benchmark lending rate for the corporate commercial segment. Unitil 2003, reference lending rate in dollars.

j Basic lending rate for up to 1 year.

k Average of minimum and maximum lending rates.

l Lending rate published by the International Monetary Fund.

m Weighted average of the weekly lending rate for loans in national currency in the system.

n Interest rate on 1-year trade credit.

o Market lending rate, average for transactions conducted in the last 30 business days (FTAM).

p Business credit, 30-367 days.

q Average rate for loan operations for the six major commercial banks.

TABLE A-32

LATIN AMERICA AND THE CARIBBEAN: CONSUMER PRICES

(Percentage variation December-December)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Twelve-month variation to May 2011.

b The only English-speaking Caribbean countries included are Barbados, Jamaica and Trinidad and Tobago.

c Twelve-month variation to January 2011.

d Twelve-month variation to February 2011.

e Refers to national-currency markets.

f Twelve-month variation to March 2011.

g Twelve-month variation to April 2011.

TABLE A-33

LATIN AMERICA: WHOLESALE PRICES

(Percentage variation December–December)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Twelve-month variation to May 2011.

b Twelve-month variation to March 2011.

Note:

WPI: Wholesale price index;

IPA-M: Wholesale price index (acronym in Portuguese);

PPI: Producer price index;

IND-PPI: Industrial producer price index;

NPPI: National producer price index;

WPI-NP: Wholesale price index, national products;

PPI-NP: Producer price index, national products;

WPI-VAT: Wholesale price index, includes value added tax.

TABLE A-34

LATIN AMERICA AND THE CARIBBEAN: PUBLIC-SECTOR BALANCE

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Simple averages of the figures for 33 countries.

c Simple averages. Includes information on 19 countries of Latin America and the Caribbean: Argentina, Bolivarian Republic of Venezuela, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Plurinational State of Bolivia and Uruguay.

d Simple averages. Includes information on 13 Caribbean countries: Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Saint Lucia, Suriname and Trinidad and Tobago.

e The central government coverage corresponds to national public administration.

f The central government coverage corresponds to the non-financial public sector.

g The central government coverage corresponds to general government.

h The figures are derived from the primary balance based on the below-the-line criterion and nominal interest.

i The central government coverage corresponds to the central national government. The central government balance does not include the cost of financial restructuring.

j The central government coverage corresponds to the central administration.

k The central government coverage corresponds to the federal government. The coverage of the non-financial public sector corresponds to the public sector.

l The overall balance includes the residue.

m The central government coverage corresponds to the federal government.

TABLE A-35

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT FISCAL REVENUE

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Simple averages of the figures for 33 countries.

c Simple averages. Includes information on 19 countries of Latin America and the Caribbean: Argentina, Bolivarian Republic of Venezuela, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Plurinational State of Bolivia and Uruguay.

d Simple averages. Includes information on 13 Caribbean countries: Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Saint Lucia, Suriname and Trinidad and Tobago.

e Non-financial public sector.

f General government.

g Total revenue corresponds to revenue plus sales of physical assets.

h Total revenue includes special funds and incorporates accrued revenues.

i Federal government.

TABLE A-36

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT FISCAL EXPENDITURE

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Simple averages of the figures for 33 countries.

c Simple averages. Includes information on 19 countries of Latin America and the Caribbean: Argentina, Bolivarian Republic of Venezuela, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Plurinational State of Bolivia and Uruguay.

d Simple averages. Includes information on 13 Caribbean countries: Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Saint Lucia, Suriname and Trinidad and Tobago.

e Non-financial public sector.

f General government.

g Total expenditure refers to expenditure plus investment, capital transfers and fixed capital consumption.

h Includes accrued expenditure and floating debt.

i Current expenditure, capital expenditure and interest correspond to federal government expenditure.

j Federal government.

k Total expenditure includes extrabudgetary.

TABLE A-37

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT TAX BURDEN

INCLUDING SOCIAL SECURITY CONTRIBUTIONS

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Simple averages of the figures for 33 countries.

c Simple averages. Includes information on 19 countries of Latin America and the Caribbean: Argentina, Bolivarian Republic of Venezuela, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Plurinational State of Bolivia and Uruguay.

d Simple averages. Includes information on 13 Caribbean countries: Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Saint Lucia, Suriname and Trinidad and Tobago.

e Does not include social security contributions.

f General government.

g Corresponds to non-petroleum sector.

TABLE A-38

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT TAX BURDEN AND COMPOSITION OF TAX REVENUES

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Simple averages of the figures for 33 countries.

c Simple averages. Includes information on 19 countries of Latin America and the Caribbean: Argentina, Bolivarian Republic of Venezuela, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Plurinational State of Bolivia and Uruguay.

d Simple averages. Includes information on 13 Caribbean countries: Antigua and Barbuda, Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Jamaica, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Saint Lucia, Suriname and Trinidad and Tobago.

e Does not include social security contributions.

f General government.

g Corresponds to non-petroleum sector.

TABLE A-39

LATIN AMERICA AND THE CARIBBEAN: CENTRAL GOVERNMENT GROSS PUBLIC DEBT

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Simple averages.

c National public administration. As from 2005, does not include debt not presented for swap.

d Does not include publicly guaranteed private debt.

e Net public debt. Federal government and central bank.

f Consolidated.

g Central national government.

h Does not include public sector commitments to commercial banks.

i Federal government.

j Does not include domestic floating debt.

k Non-financial public sector.

TABLE A-40

LATIN AMERICA AND THE CARIBBEAN: NON-FINANCIAL PUBLIC-SECTOR GROSS PUBLIC DEBT

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b Simple averages.

c Consolidated figures. In 2002 the figure refer to national public-sector debt plus provincial debt.

d Refers to the external debt of the non-financial public-sector and central-government domestic debt.

e Net public debt. Public sector.

f Consolidated.

g Consolidated non-financial public sector.

h Public sector.

i Does not include public sector commitments to commercial banks.

j Includes public sector external debt and federal government domestic debt.

k Includes local and regional government debt owed to Banco de la Nación.

TABLE A-41

LATIN AMERICA AND THE CARIBBEAN: SUBNATIONAL GOVERNMENT FISCAL INDICATORS

(Percentages of GDP)

Source: Economic Commission for Latin America and the Caribbean (ECLAC), on the basis of official figures.

a Preliminary figures.

b The primary and overall balances do not include financial resources (credit operations and disposal of assets).

c Includes states and municipalities.

d Includes federal and municipal entities.

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Table of Contents

Maintitle

Copyrights

Contents

Foreword

Executive summary

Part 1

The economic situation in Latin America and the Caribbean in 2010-2011

Chapter I

Regional overview

Part 2

International integration and macroeconomic policy challenges amid global economic turmoil

Chapter I

Changing external financing sources and macroeconomic regimes in the region: the uneven impacts of external shocks and response policies

Methodological annex

A. Criteria for table I.3

B. Criteria for table I.5

Chapter II

Integration into international financial markets in the current context of high external liquidity

Chapter III

Fiscal policy challenges in a context of high, fluctuating commodity prices

Chapter IV

Summary and concluding remarks on the challenges of the medium-term external outlook

Bibliography