BY CLAUDIO LOSER
WASHINGTON — The last few weeks have been very tough for financial markets around the world in reaction to the "meltdown" in the sub-prime mortgage market in the US. As usual, attention has turned to the impact of the current volatility on emerging economies, and particularly those in Latin America.
Contrary to many financial crises in the past quarter century, Latin America has not been at the center of this storm. The debt crisis of the 1980s, and the Mexican, Brazilian, and Argentine shocks in the 1990s came about or seriously affected the region because of institutional and policy weaknesses. In the recent episode, certain countries, like Argentina, Ecuador, and Venezuela, were hit hard, but in general the region has shown great resilience. Interest rate spreads have increased, but remain below the levels observed only 18 months ago; stock market values declined (in dollar terms), but are about 40 percent ahead of a year ago, outperforming the US and Europe; and international reserves are at a record $400 billion, about $100 billion above end-2006.
CHINA HELPS EXPORTS
There are two main explanations for this resilience: international conditions provided a strong base for growth for most emerging economies, and Latin American countries have pursued generally better economic policies, with lower fiscal deficits or higher surpluses, low inflation, and flexible exchange rates. All these events strengthened the balance of payments, helping increase foreign reserves and reduce foreign borrowing. Moreover, the rising presence of China and India in international markets, and the economic recovery of Europe and Japan have helped diversify regional export markets, even as they have become strong competitors.
However, these favorable conditions have given a sense of security that is unwarranted and in the end may have adverse consequences. Fiscal surpluses have been eroded by increasing government expenditures; currencies have strengthened, reducing competitiveness; and lower borrowing costs have been reflected in a rapid rise in consumer spending. These developments may have placed the region on an untenable path that requires further moderation.
While current events might not evolve into a major crisis, there are several other factors that will certainly jeopardize the observed rapid economic growth. The most important is the dependence in most countries on the performance of the external sector.
The limited financial contagion in Latin America reflects in part the effectiveness of the Federal Reserve and other central banks to stop the run on capital markets, which may be only a short-term phenomenon. In addition, since 2003 the accumulation of reserves in Latin America has closely followed the increase in export prices. With world economic growth likely to slow down, the reversal in commodity prices could lead to a decline in reserves, or require an adjustment in policies. Interest costs will increase for most countries in the region as lenders become less inclined to take risks regarding emerging economies. Even though public finances are stronger, there is still a need for significant financing. Finally, with tougher conditions, investors will be less willing to engage in new projects, with adverse consequences for economic growth.
None of these factors is catastrophic for the region. However, they will require considerable fine-tuning by policy makers. Countries like Brazil, Chile, Colombia, Peru, and possibly Mexico seem well prepared to confront unpleasant surprises in this regard. In contrast, countries where policies are weak, like Argentina, Ecuador, and Venezuela, have already been hit by the financial market concerns, and need to act promptly to avoid serious damage from the current turmoil, as had been the case so often in the past.
Claudio Loser is a Senior Fellow at the Inter-American Dialogue and former Head of the Western Hemisphere Department at the International Monetary Fund. Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.