Latin America is growing at a pace above its historical average, within the context of a strong global economy. The International Monetary Fund (IMF) estimates that real growth in the Gross Domestic Product (GDP) will reach an average of about 4.75% for 2006. If so, that would make this period “the most significant three-year expansion since the 1970s,” notes the IMF’s annual report, “Economic Perspectives in the Americas.”
The region grew at an average rate of 2.2% between 1995 and 2003, recording an inflation rate of 13.2%. In 2004, growth amounted to 5.7%, while inflation was 6.5%. And in 2005, the economy expanded by 4.4%, as prices grew by 6.3%.
Juan Carlos Martínez, professor at the Instituto de Empresa business school in Madrid, says that the Latin American economy is in “exceptional” condition. “Unlike earlier periods, the growth is taking place at just the right rate, and the same thing has happened with other macroeconomic variables. Inflation is under control, salaries are improving, some countries have a trade surplus, the structure of the public debt is more solid, there are no foreign exchange pressures and financial institutions are stronger,” says Martinez.
An equally optimistic voice is David Tuesta, professor at the Pontifical Catholic University of Peru, as well as a member of the Econolatin Network. “In macroeconomic terms, the situation is very positive. First of all, you can observe a clear trend toward low inflation, which is a result of more independent management by central banks and more responsible fiscal policy. Apparently, the sources of growth appear to be more solid, and they are supported by reforms that took place during the first part of the 1990s,” Tuesta says.
Determining Factors
Strong global demand for basic commodities has sustained regional growth, and prices have closely followed the same path as economic activity in recent years. Between the end of 2002 and the third quarter of 2006, prices for both fossil fuels and non-fossil fuels increased by 150% and 80%, respectively. Nevertheless, the impact of these increases has been uneven within the region: The terms of trade improved by an average of 23% in South America [as a whole], and about 9% in Mexico between 2002 and 2005. However, they deteriorated by 4% in Central America, and by 9% in the Caribbean.
Despite sustained growth in the price of basic commodities in recent years, inflation has generally remained moderate, and forecasts call for it to continue dropping. In 2006, the average annual inflation rate in Latin America and the Caribbean will be about 5.25%, which is about 1% lower than in 2004. “Clearly, this provides credibility to the notion that current monetary policy in most of the countries of the region has contributed to keeping inflationary expectations under control,” praises the IMF in its report.
The organization also praises the “strengthening” of indicators that reveal the region’s financial strength. “The improvement in the quality of assets is reflected in a drop in loans that are in default,” notes the IMF. The IMF calculates that only 4.4% of loans remain currently unpaid, compared with 10.6% in 2002. “The larger volume of credit and the stability of margins have contributed to raising the profitability of banks in the 2005-6 period,” say the IMF experts.
The recovery the region has experienced in recent years has helped to raise employment levels and improve social indicators. In many countries, including Argentina, Brazil, Chile, Mexico and Venezuela, job growth accelerated in 2005 and during the first half of 2006. The official rate of unemployment has significantly declined to an average rate of 10%. At the same time, poverty has also declined, according to preliminary forecasts of the Economic Commission for Latin America and the Caribbean (ECLAC).
Caution
“Nevertheless, there are important divergences when it comes to evaluating the economies as a whole,” notes Hugo Macías, professor at the Nacional University of Colombia in Medellin, and a member of the Econolatin Network. “The high growth that has occurred in recent years is concentrated in those countries that faced very a serious crisis at the beginning of this decade, including Argentina and Uruguay which faced serious problems from 1999 through 2002. For its part, Venezuela confronted another economic crisis of a similar character in 2002 and 2003. Its high growth rate reflects a recovery toward previous levels of production. There are no important economic indicators that would suggest a lasting wave of expansion,” he explains.
In its annual report, “Economic perspectives in the Americas,” the IMF stresses that, unlike previous economic peaks, the current advance does not contain any seeds of its own destruction. “This expansion is being favorably compared with earlier periods when the Latin American economy recovered,” the report says. Traditionally, growth in Latin America has suffered through cycles of peaks and breakdowns. Thus, the growth financed by debt during the 1970s gave way to the debt crisis of the 1980s. Later, the recovery during the early 1990s ended with the Tequila crisis of 1994. The subsequent recovery came to an end in 1998 because of the crisis of emerging markets.
For 2007, the IMF, headed by Spaniard Rodrigo Rato, forecasts growth in the region will be 4.3%. That figure would be below the 4.75% growth rate that the IMF predicted for this year [2006]. This forecast for next year is for a growth rate that is one-tenth higher than the increase announced during the annual meeting of the IMF two months ago. The forecast for 2006 is not going to be changed. In any case, estimated growth rates for 2006 and 2007 are double the average growth rate in the region during the 1990s, which was about 2%.
Forecasts
As for individual countries, the IMF has revised downward its 2007 growth forecast for Mexico, from 3.5% to 3.3% because forecasts call for lower growth in the United States. Nevertheless, the IMF is maintaining its 4% forecast for Brazil. Argentina is expected to grow by 6%; Chile by 5.5%; Colombia by 4.5%, and Venezuela by 3.7%.
Regional economic growth over the next year will be exposed to some of the same risks that threaten the overall global economy. The IMF anticipates that those risks will become more serious. Latin America could suffer, especially Mexico and Central America, if the economy of the U.S. slows down even more anticipated. That’s because of Mexico’s dependence on exports to its northern neighbor. Another risk for Mexico is that prices could drop for [its exports of] primary products such as crude oil, coffee and soy beans.
The IMF report also points out the possible deterioration of global financial markets. There has already been a marked decline in margin interest in the bonds issued in the region, which reached historic lows in recent years. This was produced, in part, by [high] liquidity levels in developed financial markets. Any abrupt decline in global liquidity or abrupt change in [investors’] aversion to risk could create a financial environment that is much less favorable. Nevertheless, the IMF stresses that the region “is not as vulnerable to this risk as it was in recent years. That’s because of the improvement in financial balances; current account surpluses in many countries; and a more appropriate debt structure.”
Reforms
Despite the optimistic tone of its comments, the IMF warned that, in the absence of more reforms, growth will slow down in the future. The IMF warned that Latin America is falling behind other emerging regions such as those in Asia. The IMF is also worried about the medium-term impact of nationalistic policies on the energy sectors of Bolivia, Venezuela and Ecuador.
The great challenge facing Latin American economies is to carry out reforms that not only prolong the current buoyant conditions, but also reduce obstacles to future growth. The IMF believes that the current economic expansion offers an historic opportunity to secure the recent reduction in macroeconomic volatility, and to move decisively forward toward introducing additional structural reforms.
Martinez cites three areas where Latin American countries need to commit to making reforms. “In the first place, they have to modify their tax and customs policy, since tax collections are at a very low level, and that leads to low budgets, which are tied to the problem of rigidity, which does not allow them to apply appropriate spending policy.” In Latin America, the allocation of revenues toward specific goals and the obligatory nature of certain expenses jointly absorb a substantial proportion of the public deficit — from two-thirds of governmental revenues in Chile to more than 80% [of revenues] in Brazil. Governmental revenues from taxation (which do not include revenues of public sector enterprises and the central bank) average about 23% of the GDP compared with 26% in other emerging economies. In some countries, the impossibility of collecting enough revenue from taxes makes it impossible to use tax policy as a tool for rectifying macroeconomic imbalances. This limits spending on public infrastructure, and impedes efforts to develop human capital to levels that are required for sustainable and equitable growth.
“In addition, some governmental reforms are necessary in order to achieve more stable, and less corrupt political systems,” notes Martinez. The IMF believes that growth in many Latin American countries will continued to be limited by the weaknesses of the State. The consequences of this weakness include deficient public services; a fragile judicial system; high rates of crime and corruption; tax evasion, and a sizable informal economy. “Many of these deficiencies have survived earlier attempts to reform specific institutions. In order to make institutional reform efforts more fruitful and lasting, it is probably necessary to move forward in several different directions. These include the following: increasing the level of human capital in the region (within the government and within society in general); changing political rules and key incentives in order to improve the quality of political planning; and building an electorate that supports institutional reform,” explains the IMF.
Social Inequalities
“In the third place, it is necessary for South American economies to undertake reforms aimed at achieving financial institutions that are stable and solvent, both in the public and private sectors,” notes Martinez. These reforms “must attempt to rid the region of the cancer of social inequality.”
Macías agrees. He says, “The most serious problem in Latin America continues to be the poor distribution of wealth.” Macias believes that the major reforms to be undertaken will “deal with social security, pension systems and, above all, urgent mechanisms” for getting poor people involved in the political and social systems in Latin America.
“The situation is not positive when it comes to poverty,” says Macías. “Although poverty rates are declining, they remain extremely high.” He adds, “ECLAC estimates that for 2006 the number of poor people in Latin America and the Caribbean will exceed 205 million people or 38.5% of the population. The number of people who are extremely poor will be 79 million, or 14.7% of the total population. Although these numbers are below the 209 million and 81 million figures reported in these respective categories for 2005, there is no reason for us to celebrate. The most meaningful improvements in poverty indicators have been in Argentina and Venezuela, where conditions had deteriorated more significantly in recent years.”
Tuesta sees a great deal of activism among politicians when it comes to intervening in markets. He cites, especially, the examples of Argentina, Bolivia and Venezuela. “Economies have a greater propensity to intervene [in markets] when the institutional framework is not appropriate, and I believe that the major reforms will be in this area,” Tuesta affirms.
The data about the region’s contribution to global GDP are patently clear, and demonstrate just how much Latin America has fallen behind other emerging regions. During the 1980s, Latin America’s contribution to global wealth was 6.2% while China’s contribution was 2.6%. In 2003, Latin America’s contribution fell to 4.3%, while China’s grew to 3.9%.
Macías agrees that Latin America has been falling behind other emerging regions. He says, “The most important thing is to sustain and improve levels of economic growth, and to make progress in improving income distribution. That’s the only way the region can improve its levels of development.” Nevertheless, Tuesta points out, more negatively, “to the extent that these reforms make progress, we can grow, but we will always be lagging behind.”
