Latin America and the Changing External Context: A Test for the New Immune System? Augusto de la Torre June 2008 World Bank Chief Economist Office Latin America and the Caribbean
Structure of presentation The worrisome external environment A financial crisis-driven recession in the U.S. Rising food and fuel prices The financial channel: decoupling, so far The real channels: cyclical coupling, trend decoupling? External demand Remittances Commodity prices The region s capacity to respond Beyond the cycle 2
The worrisome external environment A financial crisis-driven slowdown in the U.S. and Rising international prices of foods and fuels 3
Risk perceptions of major U.S. banks reached a peak just before the Bear Stearns bailout 300 250 CDS of the 5 biggest Banks in U.S. in basis points 16 de Marzo. acuerdo de fusion entre Bearns Sterns y JP Morgan Chase 200 Highest 150 CDS sobre deuda soberana de Brazil 5 años 100 50 0 Lowest Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Fuente: LCRCE, en base a datos de Bloomberg. Los 5 bancos mas grandes de EE.UU. Son Bank of America, JP Morgan Chase, Citibank, Wachovia, Weels Fargo 4
A U.S. recession (shallow and long?) for 2008 in the Consensus forecast, with significant downside risk 4.00 U.S. Prospects- 2008 Growth Forecast Distribution Consensus forecasts - GDP growth rate for 2008 3.50 Highest Forecast 3.00 2.50 Mean Growth +/- St.Dev. Highest 2.2 % 2.00 1.50 promedio 1.32 % 1.00 0.50 Lowest Forecast IMF 0.5 % 0.00 Jan07 Feb07 Mar07 Apr07 May07 Jun07 Jul07 Aug07 Sep07 Oct07 Nov07 Dec07 Jan08 Feb08 Mar08 Apr08 May08 Fuente: Consensus Forecasts. Proyecciones computadas como el promedio de las proyecciones relevadas por mas de 25 agencias privadas. 5
A different and major complication: sharp increases in international prices of foods and fuels 220 200 current US$ Basket of LAC currencies (simple average) Basket of LAC currencies (trade-weighted) Commodity Prices in LAC terms in US current dollars and LAC currencies 180 160 140 120 Short-run Commodity Price Performance index Jan02=100 - prices in current US$ 100 80 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 320 300 280 260 240 220 200 180 160 140 Corn Soybeans Sugar Beef Rice (rhs) 700 650 600 550 500 450 400 350 300 250 200 120 150 100 100 80 Jan02 Jul02 Jan03 Jul03 Jan04 Jul04 Jan05 Jul05 Jan06 Jul06 Jan07 Jul07 Jan08 50 Fuente: DECPG, Banco Mundial; Haver. Nota: la canasta de monedas de LAC incluye el tipo de cambio vis-à-vis el dólar estadounidense de Argentina, Brasil, Bolivia, Colombia, Costa Rica, Chile, Republica Dominicana, Jamaica, México, Paraguay, Perú, Uruguay y Venezuela. 6
The financial channel The region is less vulnerable to financial contagion than in the past this time, investors are not shorting Latin America 7
Following the sub-prime crisis, Latin EMBI spreads rose less than U.S. junk bonds spreads Latin America (NIG) EMBI & U.S. High Yield Spreads in basis points 1000 900 800 excluding Argentina CRISIS LAC NIG EMBI Spread US High Yield Spread 700 600 500 400 300 200 100 0 including Argentina Jan/04 Jul/04 Jan/05 Jul/05 Jan/06 Jul/06 Jan/07 Jul/07 Jan/08 Fuente: LCRCE en base a datos de Bloomberg US Credit Suisse High Yield Spread, Latin America JP Morgan EMBI Global Spread (NIG: noninvestment grade) 8
With lower volatility, Latin bonds add diversification benefits to a U.S. stock market portfolio Beta of LAC (NIG) EMBI w.r.t. US Stock Market Portfolio variables in axes in % 15 EMBI Latin Total Return (non inv. grade) y = 0.2472x + 0.6937 Jul06-Feb08 0-15 -10-5 0 5 10 15 % Change Correlation (39.42) LAC non inv. EMBI vol. (73.62) S&P vol. 21.79 10 5-5 -10-15 -20-25 -30 y = 1.2095x - 1.9897 Aug97-Aug99 Jul06-Current Aug97-Aug99 Beta (70.10) -35 S&P500 Total Return Fuente: LCRCE en base a datos de Bloomberg, JP Morgan EMBI Global Total Return & S&P 500 Total Return. Utilizando datos mensuales. 9
Latin currencies are not under attack; they are under appreciation pressures Currency Performance for Selected LAC countries bis-a-bis US dollars. Index 100=Jul2006 110 CRISIS PER ARG BRA CHI COL MEX 105 100 95 90 85 80 75 70 Jul/06 Sep/06 Nov/06 Jan/07 Mar/07 May/07 Jul/07 Sep/07 Nov/07 Jan/08 Mar/08 400 350 LAC Arg Bra Chl Col Per Ury International Reserves for Selected LAC coutries index: Jan2004=100 300 250 200 150 100 50 Jan04 Apr04 Jul04 Oct04 Jan05 Apr05 Jul05 Oct05 Jan06 Apr06 Jul06 Oct06 Jan07 Apr07 Jul07 Oct07 Jan08 Apr08 Fuente: LCRCE en base a datos de Bloomberg y Autoridades Nacionales. LAC incluye Argentina, Brazil, Chile, Colombia, Costa Rica, Ecuador, Guatemala, Mexico, Peru, Uruguay y Venezuela. 10
Behind the average fall in Latin EMBI, countries clustering into three groups High EMBI Spread LAC countries JP Morgan EMBI Global Spreads - in basic points Medium EMBI Spread LAC countries JP Morgan EMBI Global Spreads - in basic points Low EMBI Spread LAC countries JP Morgan EMBI Global Spreads - in basic points Arg Ven Pan SLV Per TTO Mexico Ecu Rep. Dom. 800 Belize 500 Col Bra Uru 300 Chile 700 600 450 400 350 250 200 500 400 300 200 300 250 200 150 100 150 100 50 100 Jan05 Jul05 Jan06 Jul06 Jan07 Jul07 Jan08 50 Jan05 Jul05 Jan06 Jul06 Jan07 Jul07 Jan08 0 Jan05 Jul05 Jan06 Jul06 Jan07 Jul07 Jan08 Fuente: LCRCE en base a datos de Bloomberg - Latin America JP Morgan EMBI Global 11
depending on the behavior of their EMBI spreads relative to high-yield U.S. bond spreads Latin EMBI & U.S. High Yield Spreads in basis points 1200 1000 LAC Low EMBI spread LAC Medium EMBI spread LAC High EMBI spread High Yield Spread excluding Argentina* 800 600 including Argentina* 400 200 0 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Fuente: LCRCE en base a datos de Bloomberg - US Credit Suisse High Yield Spread, Latin America JP Morgan EMBI Global. Datos semanales. * El EMBI Latino excluye Argentina hasta Oct2005 porque era un outlier durante el período 2001-05. 12
The real channels External demand a U.S. recession is an important concern, but less so if China maintains high growth 13
On one hand, past U.S. recessions dragged down the economy of the region 8 U.S. & LAC Gorwth annual GDP growth - U.S. recessions in shaded areas America Latina USA 6 4 2 0-2 -4 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Source: WDI World Bank 14
on the other,, Latin growth forecasts have remained high even as U.S. growth projections fall 2008 GDP Growth Forecast for Selected LAC countries consensus forecast, in % 9 LAC Arg Bra Chi Mex Pan Per US Col 8 7 6 5 4 Weighted average 4.4 % 3 2 1 Jan07 Feb07 Mar07 Apr07 May07 Jun07 Jul07 Aug07 Sep07 Oct07 Nov07 Dec07 Jan08 Feb08 Mar08 Apr08 May Fuente: Consensus Forecasts. Proyecciones computadas como el promedio de las proyecciones relevadas por agencias privadas. 15
The cyclical components of growth in LatAm and high-income countries are clearly coupled Cyclical component of growth in LAC and High-Income Countries Cyclical component of GDP annual growth 4% 3% High-Income Latin America 2% 1% 0% -1% -2% -3% -4% 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 Fuente: WDI Banco Mundial; Autoridades Nacionales. El componente cíclico del crecimiento es computado utilizando bandpass filter. 16
but do cyclically-adjusted growth paths suggest the beginning of trend decoupling? 7% Cyclical-adjusted Growth in Latin America and High-Income Countries Trend growth computed using the band pass filter 6% High-Income Latin America 5% 4% 3% 2% 1% 0% 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 Fuente: WDI Banco Mundial; Autoridades Nacionales. El componente cíclico del crecimiento es computado utilizando bandpass filter. 17
The co-movement of growth between Latin America and China has been on the rise Output Co-Movement between LAC and China 20 years rolling correlation of the Real GDP growth 0.7 0.6 0.5 Arg Bra Per Mex Pan Col 0.4 0.3 0.2 0.1 0-0.1-0.2-0.3-0.4 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Fuente: Autoridades nacionales. Nota: Los colores sólidos reflejan correlaciones significativas con un intervalo de confianza de 10%. 18
Much of the cyclical effect on LatAm will depend on growth in China and Europe 1 0.5 Impact of US, Euro Area & China in the Growth of LAC in percentage points Escenario "BASE" - Banco Mundial Year US Euro Area China 2007 2.2 2.7 11.3 2008 1.9 2.1 10.8 2009 2.3 2.4 10.5 0-0.5-1 -1.5-2 Growth in China Growth in Euro Area US Growth 2008 2009 2008 2009 2008 2009 "Base" Case "Low" Case "IMF" Case Escenario "Pesimista" - Banco Mundial Year US Euro Area China 2007 2.2 2.7 11.3 2008 0.9 1.6 9.8 2009 1.8 2.1 10.0 Escenario "IMF" Year US Euro Area China 2007 2.2 2.7 11.3 2008 0.5 1.4 9.3 2009 0.6 1.2 9.5 Fuente: WDI: Banco Mundial; Bloomberg; Autoridades nacionales. Elaborado por LCRCE Banco Mundial 19
The real channels Remittances their decline hurts a well-defined set of Latin countries 20
Remittances represent 10-20 percent of GDP in eight Caribbean and Central American countries 30% Remittances to LAC in 2006 (Remittances inflows as % GDP ) 25% 20% 15% 10% 5% 0% HND GUY HTI JAM SLV NIC GTM DOM ECU BOL BLZ GRD PRY MEX COL CRI PER DMA VCT PAN KNA URY BRA ARG LCA SUR VEN CHL Fuente: Migración y Remesas Factbook 2008 Banco Mundial 21
Latin migrants in the U.S. work in states and economic sectors that are hit hard by current crisis Inmigrantes de America Latina en EE.UU. Por estados de residencia e industrias All Industries Farm Government Leisure and hospitality Educ. and health services Prof. and Business services 35% 17% 2% 4% 16% 1% 5% 5% 2% 13% 100 % 7% 2% 5% 12% 16% (15 million) Retail trade Other Service - providing Other Good Producing Manufacturing Construction 18% 10% 7% 7% 16% CA TX NV AZ FL NM NJ IL CO NY US Fuente: IPUMS censo 2006. Población EEUU filtrada por lugar de nacimiento. Los estados presentados representan el 80% del total. El tamaño de las burbujas representa el tamaño de la población inmigrante. 22
It is thus not surprising that the growth rate in remittances to LatAm has been decelerating Remittances to Latin America annual variation, 3 month moving average 35% Mexico El Salvador Guatemala Dom. Rep. Jamaica 30% 25% 20% 15% 10% 5% 0% -5% Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Fuente: Autoridades Nacionales 23
The real channels Commodity price increases asymmetric effects across and within Latin countries 24
Changes in commodity prices have highly asymmetric effects on Latin economies VEN TTO CHL PER BOL ECU COL LAC ARG MEX BRA JAM PAR SLV GT DR NIC HND PAN HTI CRI URY Terms of Trade for Selected LAC countries change between 2002-2006 - in % -20 0 20 40 60 80 100 120 Fuente: ECLAC 25
For Latin American commodity exporters, food price increases constitute a net gain 3 Food Prices Long-run Performance relative to the Crude Oil Prices (index 1975=100) 2.5 2 1.5 1 0.5 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 Source: World Bank staff (LCRCE) calculations - Data source: WDI World Bank. 26
The region s s capacity to respond Latin America is better positioned this time, but some factors restrict the scope for countercyclical policies 27
Latin American vulnerability to sudden stops has fallen considerably A stronger immune system, associated with Higher FX liquidity cushions Lower public sector and external borrowing requirements Exchange rate flexibility Lower exposure to currency, interest rate, and rollover risks in public sector debt portfolios Significant increase in local currency-denominated loanable funds in domestic markets has reduced the beta of the region, on average 28
but there are constraining factors to the scope for policy maneuvering Dealing with the distributional implications of the pass-through of international to domestic prices Monetary policy facing a difficult dilemma 29
Inflationary & distributional pressures affect commodity exporters & importers alike 45% Consumer & Food Prices in Latin America annual variation, in % - as of March 2008 40% IPC Food 35% 30% 25% 20% 15% 10% 5% 0% BHS* MEX BRA BLZ* BRB* ECU PER COL SLV URY CHL PAN ARG GTM HND TTO* CRI PAR BOL HTI GUY* NIC JAM VEN Source: World Bank staff (LCRCE) calculations - National data sources. *countries where the inflation index is available only up to December 2007. Countries highlighted in red have had negative terms of trade changes in 2002-2006. 30
But the poorer Latin countries that import food and fuels are most vulnerable and suffer the most Weight of Food on the CPI basket against GDP per capita as of 2006, at 2000 US$ 18000 16000 BHS* 14000 GDP per capita 12000 10000 8000 6000 4000 2000 0 TTO* BRA MEX CRI CHL URY COL PAN ECU VEN BRB* SLV BLZ* PAR JAM GTM HND NIC GUY* PER BOL HTI 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% weigth of food (as % of CPI basket) Source: World Bank staff (LCRCE) calculations - National data sources. *countries where the inflation index is available only up to December 2007. Countries highlighted in red have had negative terms of trade changes in 2002-2006. 31
Monetary policy faces a dilemma: currency appreciation exacerbated by carry trades Returns of the Carry Trade for Selected LAC countries annual ex-post returns - 3M moving averages 80% 70% 60% 50% 40% 30% 20% 10% Brazil Peru Chile Colombia 0% Jan-07-10% Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08-20% -30% Fuente: Bloomberg Autoridades Nacionales 32
driven by the increasing spread between foreign and domestic interest rates Monetary Policy Rates in % Monetary Policy Rates in % 18 ARG BRA COL 9 CHI MEX PER US 16 8 14 7 6 12 5 10 4 8 3 6 2 4 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 1 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Source: Bloomberg National Authorities 33 33
which aims at holding inflation under control Consumer Price Inflation Rates for Selected LAC countries % YoY 14 Chile Colombia Costa Rica Peru Panama Ecuador Guatemala 12 10 8 6 4 2 0 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Fuente: Bloomberg y Autoridades Nacionales 34
Beyond the cycle Can Latin America raise and decouple its trend growth rate? 35
Historically, Latin America has not been able to generate convergence GDP per capita: LAC/US Ratio 0.6 0.5 0.4 0.3 0.2 0.1 0 Gold Standard Period 1900 1904 Interwar Period 1908 1912 1916 1920 1924 1928 1932 US recovers Alliance for Progress Imports Substitution 1936 1940 1944 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 United States 8 LAC 8LAC/US Asian Tigers/US LAC Debt Crisis Source: Angus Maddison Historical Statistics for the World Economy. The unit is 1990 International Geary-Khamis dollars Washington Consensus Note: The aggregated GDP per capita is a simple average of the countries in the region. GDP per capita for the United States and Latin America are in levels. 8 LAC: Argentina, Brazil, Chile, Colombia, Mexico, Peru, Uruguay and Venezuela; Asian Tigers: Hong Kong (China), Indonesia, Malaysia, Singapore, South Korea, Taiwan (China), Thailand. Before 1950, the Asian Tigers sample varies. From 1950 on, Asian Tigers comprise all the seven countries. 2000 2004 35000 30000 25000 20000 15000 10000 5000 0 GDP per capita (1990 International Geary- Khamis dollars) 36
And while the recent pace of growth in Latin America has been the best in decades... Growth of the GDP per capita for Selected Regions 8 Tigers China India 7 LAC HIOECD 6 5 4 3 2 1 0 1960-79 2003-2007 Note: The Regional growth is a simple average of the GDP per capita growth of the countries in the region. GDP per capita is PPP adjusted from Penn World Tables. From 2004 on, the data is from International Monetary Fund, World Economic Outlook Database 2007 37
much of it was due to the until recently favorable external environment Long Run Cumulative Growth- Actual and Predicted % variation 2002/06 35% Actual Predicted 30% 25% 20% 15% 10% 5% 0% VEN ARG PER BRA BOL ECU COL URY MEX PRY PAN DOM GTM SLV HND NIC LAC -5% Source:WDI - Regression: dlog(gdp)=f(dlog(tot),dlog(ind.prod.g7),dlog(us5y),dlog(highyield));1991-2002. Predicted: setting external factors to zero 38
Comparatively, the region has not fully capitalized on the recent benign external environment Incremento en la Productividad Total de los Factores incremento promedio de la productivadad entre 2001-2006 IDN CHL* PER PAN MYS KOR COL CHL BRA ARG BOL LAC PRY NIC GTM MEX SLV DOM HND CRI -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 39
Thanks 40