LAC s Decade: Ending or Beginning?

LAC s Decade: Ending or Beginning? LAC RLT Retreat Washington, DC 13 September 2011 Chief Economist Office Latin America and the Caribbean The World Bank 1

Structure of the presentation LAC s successful past decade The maturing recovery cycle Rising global uncertainty and risks Whither LAC s growth in the short and long run? 2

LAC s Successful Decade and the Maturing Recovery Cycle 3

LAC s success Non-inflationary growth decoupling from rich countries 7% 6% Cyclical-adjusted Growth in Latin America and High-Income Countries Trend growth computed using the band-pass filter High-Income Latin America 5% 4% 3% 2% 1% 0% 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 The trend growth of real GDP growth is computed using the band-pass filter (Baxter and King, 1999). LCRCE staff calculations. Source: WDI World Bank; National Authorities. 4

LAC s success Reduction in poverty and income inequality Per Capita GDP Growth and Poverty LAC Countries Gini Coefficient Cumulative Change From 2009 to 1995 Moderate Poverty Rate US$ 4 a Day 45 40 35 30 25 20 1994 Poverty Headcount 1996 1998 2000 2002 2004 GDP Per Capita 2006 2008 2010 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 GDP Per Capita US Dollars Costa Rica Dominican Republic Colombia Uruguay Honduras Bolivia Chile El Salvador Argentina Panama Latin America Mexico Brazil Peru Paraguay -0.1-0.05 0 0.05 0.1 Source: LCSPP based on Socio-Economic Database for Latin America and the Caribbean (CEDLAS and The World Bank). 5

LAC s success An expanding middle class Source: LAC Chief Economist Office, World Bank. 6

LAC s success Stellar performance during the 2009 global downturn 0.04 Growth in Real GDP Middle Income Countries 0.04 Growth in Real GDP Latin America and the Caribbean 0.00 0.00-0.04-0.04-0.08-0.08-0.12-0.12-0.16-0.16 T-6 T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+5 T+6 T-6 T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+5 T+6 Previous Cycles Current Cycle Previous Cycles Current Cycle LAC came out of the global crisis without balance sheet damage Notes: The figures represent the deviations from regional/group trend growth in real GDP on 13-quarter windows centered on previous and current troughs on real GDP. This figure depicts the behavior of real GDP in previous and current recession-recovery cycles. Sources: IMF s International Financial Statistics IFS, National Statistical Institutes and Central Banks, Haver Analytics. 7

LAC s success Region comes out of the crisis without systemic damage Financial Crises Around the World 8

LAC s success Joining the dynamic EMs in the recovery phase 120 115 110 105 100 95 90 85 80 World Industrial Production Index Apr-08 = 100 Crisis Advanced Economies Emerging Economies Emerging economies with strongest recoveries include Brazil, China, India, Korea, Malaysia, Philippines and Thailand They represent 52% of emerging economies GDP Jan-06 Aug-06 Mar-07 Oct-07 May-08 Dec-08 Jul-09 Feb-10 Sep-10 Apr-11 Note: The group of developed countries refers to OECD countries excluding Turkey, Mexico, Republic of Korea, and Central European countries. Source: CPB (Netherlands Bureau for Economic Policy Analysis). 9

LAC s success Joining the EM family in the recovery phase 100% 80% Contribution to World Economic GDP as a % of World GDP increase (PPP) 8% 11% 8% 8% 7% 8% 60% 34% 44% 57% 40% 20% 51% 38% 27% 0% 1996-2001 2001-2006 2009-2011 Others Other Advanced Economies EM - 20 Euro (15)+US+Japan+Canada+UK Note: The EM-20 economies are the 20 Emerging Economies with higher GDP PPP in 2011 within the Emerging Economies. They explain 81.9% of the Emerging Economies total GDP. The 20 economies are: China, India, Russia, Brazil, Mexico,Indonesia,Turkey, Iran, Poland, Argentina, Saudi Arabia, Thailand, South Africa Egypt, Pakistan,Colombia, Malaysia, Nigeria, Philippines and Venezuela. 10

LAC s uneven success Mutating regional heterogeneity 170 160 150 Slow-Growth Countries within LAC GDP Index 2002 = 100 Actual Potential 170 160 150 Medium-Growth Countries within LAC GDP Index 2002 = 100 Actual Potential 140 140 130 130 120 120 110 110 100 100 90 90 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 170 160 150 High-Growth Countries within LAC GDP Index 2002 = 100 Actual Potential 140 130 120 110 100 90 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: Potential GPD is computed as the average rate of growth between 2007 and 2003. Simple averages are used to construct the composite. The categorization of each group is as follow: Slow-growth are those countries that showed a less than 3.5% in their 2011-2008 GDP real growth rate; Medium-growth are those between 3.5% and 10%: High-growth are those with 10% or more. For 2011 we used the last available forecast (Consensus Forecast June-2011). Sources: Consensus Forecast (June 2011); WEO (April 2011). 11

LAC s uneven success Where you are matters less than to whom you are connected Cumulative Number of countries Mean growth 2003-2007* Mean Growth 2003-2011 Mean Growth 2008-2011** Max. 2008-2011 Min. 2008-2011 Low growth 13 4.4% 2.3% -0.3% 3.3% -12.3% Medium growth 7 4.4% 3.5% 2.4% 7.9% 4.1% High growth 12 5.4% 5.2% 4.9% 18.8% 10.0% Total 32 4.8% 3.7% 2.2% 18.8% -12.3% * This is the measure used to construct the "Potential GDP" ** This is the measure used to define the classification as "Low", "Medium" and "High". Low growth (<4%): St. Kitts and Nevis, Antigua and Barbuda, Grenada, Barbados, Jamaica, Bahamas, Venezuela, Trinidad and Tobago, St. Vincent and the Grenadines, El Salvador, St. Lucia, Dominica and Mexico Medium growth (4%-10%): Honduras, Belize, Haiti, Nicaragua, Guatemala, Costa Rica and Ecuador High growth (>10%): Chile, Colombia, Brazil, Guyana, Bolivia, Suriname, Paraguay, Dominican Republic, Peru, Argentina, Uruguay and Panama Sources: World Bank s World Development Indicators WDI (December 2010), IMF's World Economic Outlook WEO (April 2011), and Consensus Forecasts (June 2011) Latest available forecasts. Potential GDP is calculated computing the annual average real growth rate for the 2002-2007 to 2007 GDP. Weighted averages (2007 Nominal GDP in USD Billions). 12

LAC s maturing cyclical recovery Overheating and endogenous inflationary pressures 30% Output Gap and Inflation LAC Countries CPI Inflation Rate (at June-11) 3 Months Moving Average, YoY 27% 24% 21% 18% 15% 12% 9% 6% 3% 0% JAM VEN HTI HND SLV DMA CRI BRB BOL DOM BRA ECU MEX CHL COL PAN PER ARG 2 ARG PRY URY -8% -6% -4% -2% 0% 2% 4% 6% 8% Output Gap 2011 GUA Notes: The area inside the box represents the range between the lowest and highest midpoints among inflation targeting countries. Sources: National Statistical Institutes and Central Banks, Haver Analytics. 13

LAC s maturing cyclical recovery Double tail spin push: commodity prices & capital inflows 400 350 300 250 200 150 100 50 0-50 -100 Gross Capital Inflows to LAC-7 Countries US$ Billions, Annual Flows Gross Inflows Non-FDI Gross Inflows FDI Mar-02 Aug-02 Jan-03 Jun-03 Nov-03 Apr-04 Sep-04 Feb-05 Jul-05 Dec-05 May-06 Oct-06 Mar-07 Aug-07 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 Wheat, Copper and Soybean, Index 01-Jan-05=100 350 300 250 200 150 100 50 Oil Copper Commodity Prices Most Relevant for LAC countries Soybean Wheat 150 130 110 90 70 50 30 Jan-05 Feb-06 Mar-07 Apr-08 May- 09 Jun-10 Jul-11 Oil WTI, Current US$ Notes: Banks. Annualized capital inflows to LAC-7. Sources: IMF s Balance of Payments Statistics, National Statistical Institutes, and Central 14

Demands on domestic macro-financial policy Maintain inflation expectations well anchored 16% 14% 12% Food and Overall CPI Inflation : LAC-7 + URY YoY Variation, Medians Food Inflation Overall CPI Inflation 10% 8% 6% 4% 2% 0% Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Notes: There is a change in the methodology of calculation for both food and overall PCI index for Chile since January 2009. For the figure on the right, we used the latest available figure for each country. Weighted averages (2007 Nominal GDP in USD Billions) were used in the case of the regional numbers. Sources: Bloomberg, Instituto Nacional de Estadísticas de Chile INE, and Food and Agriculture Organization FAO (2010) and IMF's World Economic Outlook WEO (October 2010). 15

Demands on domestic macro-financial policy Avoid excessive currency appreciation 120 115 110 105 100 95 90 85 80 Real Effective Exchange Rate Weighted Averages, Index Jan-05 = 100 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 China East Asian Tigers ECA High Income LAC Euro Area May-11 Notes: Weighted averages were calculated using the 2007 nominal GDP in USD Billions. An increase means an appreciation of the REER. Sources: IMF s International Financial Statistics IFS and IMF's World Economic Outlook WEO (April 2011). 16

Demands on domestic macro-financial policy Curb systemic risk buildup (financial excesses) 45% Real Credit Growth in LAC-6 Countries YoY Growth, % Total Housing Personal 35% 25% 15% 5% -5% Feb-05 Jul-05 Dec-05 May-06 Oct-06 Mar-07 Aug-07 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 Notes: The figure depicts the (PPP-GDP) weighted average of the growth rates of (total, personal and housing) credit to the private sector for the six largest LAC countries (Argentina, Brazil, Chile, Colombia, Mexico, and Peru). Sources: National Statistical Institutes, Central Banks, and Superintendence of Banking. 17

Adjusting the macro-financial policy response Monetary-fiscal policy mix and macro-prudential policies 1,600 1,400 1,200 1,000 Monetary Policy Interest Rate Differential Spread w.r.t FED Funds Rate, In Basis Points Brazil Chile Colombia Peru Mexico 800 600 400 200 0 20% 19% Primary Expenditure % of GDP, LAC-6 Countries -200 18% Jul-07 Feb-08 Sep-08 Apr-09 Nov-09 Jun-10 Jan-11 Aug-11 17% 16% 15% 2004.04 2005.02 2005.04 2006.02 2006.04 2007.02 2007.04 2008.02 2008.04 2009.02 2009.04 2010.02 2010.04 Notes: The figures in Panels B is the cyclically-adjusted primary expenditure and primary balance for the major six LAC countries (Argentina, Brazil, Chile, Colombia, Mexico, and Peru). Sources: Bloomberg, Haver Analytics, National Statistical Institutes, and Central Banks. 18

Rising Global Uncertainty and Risks 19

The European Epicenter Deeper and broader concerns about debt viability 120% General Goverment Gross Debt and Fiscal Stance As a % of GDP and as a % of Potential GDP General Goverment Gross Debt (% of GDP) 100% 80% 60% 40% 20% Ireland US Portugal UK Spain France Brazil Peru Argentina 0% -12% -10% -8% -6% -4% -2% 0% 2% 4% General Goverment Structural Balance (% potential GDP) Chile Source: IMF WEO (April 2011) 20

The European Epicenter From drama to trauma 1800 1600 1400 1200 1000 France UK CDS (5 years) in Europe In Basis Points Ireland+Greece+Portugal Spain Italy 800 600 400 200 0 Aug-10 Aug-10 Sep-10 Oct-10 Nov-10 Nov-10 Dec-10 Jan-11 Jan-11 Feb-11 Mar-11 Mar-11 Apr-11 May-11 May-11 Jun-11 Jul-11 Aug-11 Note: The average CDS is computed for Ireland, Greece and Portugal. Source: Bloomberg 21

The European Epicenter Reversal of fortune! Greece Portugal Venezuela Argentina Ukrain Spain Italy Hungary Vietnam Croatia avg Romania Bulgaria Belgium Tukey Poland Kazakhastan Russia France Indonesia Phillipines South Africa Slovak Rep Peru Thailand Brazil Colombia Mexico Korea Panama Malaysia Chile Germany Sweden Global Sovereign CDS Aug-2011, in basis points Argentina Venezuela Ukrain Kazakhastan Tukey Phillipines Indonesia Colombia Panama Peru Vietnam Brazil Avg Russia Romania South Africa Bulgaria Mexico Croatia Thailand Hungary Korea Malaysia Chile Poland Italy Greece Slovak Rep Portugal Spain Belgium France Germany Sweden Global Sovereign CDS Dec-2007, in basis points 0 500 1000 1500 2000 0 500 1000 1500 2000 Source: Own calculation based on Bloomberg 22

The U.S. Epicenter Still well below potential and a risk of a double dip 130 US Economic Activity GDP Index base 100 = Iq - 2003 125 120 115 110 105 100 95 GDP Index 2003-2007 Trend 90 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Source: National sources 23

The U.S. Epicenter A threat of a double dip? Keynes or Fischer? 6.0% GDP and Unemployment in the US GDP QpQ SAAR %, Unemployment as a % of 12.0% 4.0% 10.0% 2.0% GDP QoQ SAAR 0.0% -2.0% -4.0% -6.0% -8.0% -10.0% Mar-06 GDP QoQ SAAR % Unemployment (rhs) Oct-06 May-07 Dec-07 Jul-08 Feb-09 Sep-09 Apr-10 Nov-10 Jun-11 8.0% 6.0% 4.0% 2.0% 0.0% Unemployment Rate ISM Index 70 60 50 40 30 20 10 0 Industrial Production and ISM Index Industrial Production (YoY %) ISM Index Industrial Production (% YoY, rhs) 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% -20.0% Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Industrial Production (YoY) Source: National sources. 24

The U.S. Epicenter Narrowing room for policy maneuvering 3,000 Other The FED Balance Sheet - Assets Side Factors Affecting Reserve Balances, US$ Billion 2,500 Central Bank Liquidity Swaps New Program Portfolio 2,000 1,500 Loans and Discounts Including Float Term Auction Facility (TAF) Treasury Securities 8.0% FED Funds Rate and Taylor Rule Estimation 1,000 6.0% 500 4.0% 0 2.0% Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 0.0% -2.0% -4.0% -6.0% Spread Taylor Rule Rate Estimation (Bloomberg Model) FED Fund Rate Jul-91 Oct-92 Jan-94 Apr-95 Jul-96 Oct-97 Jan-99 Apr-00 Jul-01 Oct-02 Jan-04 Apr-05 Jul-06 Oct-07 Jan-09 Apr-10 Jul-11 Source: National sources. 25

The U.S. Epicenter The downgrade and the swing in market sentiment 90 80 70 60 50 40 30 20 10 0 Lehman Briothers Market Trends and Volatility VIX Index and S&P 500 QEI VIX Index S&P 500 (rhs) US Flash downgrade Crash/ PIGS Japan Jackson Hole (QEII) 1800 1600 1400 1200 1000 800 600 400 200 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Source: Bloomberg 26

The U.S. Epicenter The downgrade and global financial coupling Stock Markets: 2011 In USD, Index base 100 = Jan - 2011 120 110 100 90 80 70 Jan-11 Jan-11 Brazil S&P 500 Japan UK Germany France Jan-11 Feb-11 Feb-11 Mar-11 Mar-11 Apr-11 Apr-11 May-11 May-11 Jun-11 Jun-11 Jul-11 Jul-11 Jul-11 Percent 100% 90% 80% 70% 60% 50% Emerging Market Asset Returns and Common Factors Average R-Squared from Country Regressions Early Period (2000-2005) Late Period (Jan-05 to Jul-08) Crisis (Aug-08 to Apr-09) 40% 30% 20% 10% 0% Equity Foreign Exchange CDS Spreads Source: Bloomberg 27

The U.S. Epicenter Downgraded but still the safe haven 1800 Gold and US T10 2011 4.0% 1700 1600 Gold US T10 (rhs) 3.5% 1500 1400 3.0% 115 2.5% Japan Currencies: 2011 Index base 100 = 1-Jan-2011 UK 1300 110 US-EUR Brazil 1200 Jan-11 Jan-11 Feb-11 Feb-11 Mar-11 Mar-11 Mar-11 Apr-11 Apr-11 May-11 May-11 Jun-11 Jun-11 Jul-11 Jul-11 Aug-11 2.0% 105 100 95 90 Dec-10 Jan-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Source: Bloomberg 28

Whither LAC? 29

Benign scenario: real decoupling continues Can LAC turn cyclical recovery into higher trend growth? Successful management of the cycle is essential to break free from the historical boom-bust pattern LAC bumps against structural speed limits at low growth rates Productive capacity in LAC lacks the efficiency and flexibility to accommodate robust long-run growth rates Could the region avoid the natural resource curse The volatility trap The enclave trap The rent seeking trap and turn natural resources into a blessing? It is all about saving (for stabilization and asset building), diversification, and institutions 30

LAC has experienced 100 years of growth solitude 60% 50% Gold Standard Period One Hundred Years of Solitude GDP Per Capita Relative to the US, Weighted Averages Interwar Period Import Substitution Lost Decade Washington Consensus Washington Dissensus 40% 30% 20% LAC 10% East Asian Tigers / US 0% 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Notes: Note: The was group. Source: of East IFM s Asian IFS tigers includes Hong Kong (China), Indonesia, Malaysia, Republic of Korea, Singapore, Thailand, and Taiwan (China). Maddison (2007-2009) was used from 1900 to 2006. We used the Real Per Capita GDP growth from WDI to calculate the levels from 2006 to 2010. Source: LCRCE Staff calculations based on Maddison (2007, 2009) and WDI 31

Post-WWII growth in LAC, by country groups 80% Diverging 50% Semi-Converging 70% 45% 60% 40% 35% 50% 30% 40% 25% 30% 20% 20% 15% 10% 10% 5% 0% 0% 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Venezuela, RB Argentina Uruguay Chile Dominican Republic 60% Non-Converging 40% Fluctuating 50% 35% 30% 40% 25% 30% 20% 20% 15% 10% 10% 5% 0% 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 0% 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Colombia Guatemala El Salvador Bolivia Paraguay Mexico Brazil Note: Maddison (2007-2009) was used from 1900 to 2006. We used the Real Per Capita GDP growth from WDI to calculate the levels from 2006 to 2010. Source: LCRCE Staff calculations based on Maddison (2007, 2009) and WDI 32

Bad scenario: global downward re-coupling How much can LAC s new immune system resist? Robust monetary policy frameworks in LAC, mostly First line of defense in shock absorption: e-rate flexibility and countercyclical monetary policy (LAC has earned it!) How good are LAC s fiscal buffers? Comfortable public debt levels but now is the time for more fiscal savings How good are LAC s financial system buffers? Strong capital and liquidity positions but have systemic risks been brewing in the past year or so? How good are LAC s social safety nets? Ability to scale up social assistance programs varies widely in the region Social insurance frameworks are the weak link 33

Thank you 34

constrained by insufficiently redistributive fiscal 35