World Bank: Latin America’s Economy Is Decelerating but, in a Historic Shift, Currencies Now Provide Lift

October 9, 2013

  • Exchange rate acts as shock absorber and economic booster  
  • In spite of 2.5 % expected growth, pessimism over LAC’s future unwarranted
  • Small countries with less flexible currencies need to find fiscal buffers

WASHINGTON, OCTOBER 9, 2013 – For the first time, currencies in Latin America and the Caribbean (LAC) are absorbing some of the shocks derived from a less friendly global environment, according to the latest report by the World Bank Chief Economist Office for Latin America and the Caribbean, Latin America’s Deceleration and the Exchange Rate Buffer. Depreciated currencies not only lower the cost of exports but also raise the cost of imports, making the export and local industries more competitive and boosting job creation. 

LAC, together with other emerging markets, is entering a new phase of lower growth dynamics, as the tailwinds that blew so favorably in its direction in the recent past continue to recede. Growth rates in middle-income countries in Eastern Europe, East Asia, and LAC, as well as China have declined by about 3 percentage points from their 2010 peaks to the present. In the case of LAC, the growth rate has fallen from about 6 percent in 2010 to around 3 percent in 2012 and to an estimated 2.5 percent in 2013, with a predictable heterogeneity within the region.

Forecasts go from rates at or below 1 percent for Jamaica and Venezuela, to Asian-style growth rates of 5.5 and 8 percent for the two best performers in the region in the past decade, Peru and Panama, respectively. Reassuringly, a good number of mid-sized LAC countries (such as Argentina, Chile, Colombia, Costa Rica, Ecuador, Guatemala, and Uruguay) are beating the regional average, with growth rates in the 3-4 percent range. Regrettably, the region’s giants, Brazil and Mexico, are growing below the average, with Mexico’s growth falling below 2 percent despite the ongoing wave of reforms fueling investor optimism.

But low growth, coupled with a less supportive global environment, will not, as skeptics warn, translate into 1990s-style financial distress, the report concludes.

When you look at the ability of the region’s economies to buffer the effects of this less friendly international environment, you realize that the days when currency depreciation spelled disaster are today virtually gone,” said Augusto de la Torre, World Bank Chief Economist for Latin America and the Caribbean. “That is why we believe that it is wrong to analyze today’s trends through the lens of the past and assume that Latin America will inevitably fall in the same traps as before.”

Back in the 1990s, exchange rate adjustments as those seen in recent months, would translate into high inflation, and financial pain due to large private and public foreign currency debts. This situation changed dramatically in the 2000s, according to the report, thanks to two important structural changes: De-dollarization and more credible monetary regimes. Therefore, contractionary depreciations of the 1990s turned into buffering depreciations of the 2000s, with a low incidence on domestic inflation that is today anchored by central bank targets.  

While economies with flexible regimes that can benefit from the exchange rate buffer now account for 70 to 80 percent of LAC´s population and GDP, a significant number of countries in Central America and the Caribbean are too small and open to be able to develop an independent monetary policy. Others in South America, such as Bolivia, without the financial flexibility, are less exposed thanks to strong fiscal savings.

The report argues that the recent wave of LAC skepticism is not warranted.  Social progress registered in LAC over the last decade—some 70 million Latin Americans left poverty and some 50 million joined the middle class -- is very tangible and unlikely to revert. Among the factors behind that optimism are the region’s vigorous investment expansion, (at East Asian rates), the flows of foreign direct investment that replaced short-term portfolio inflows, and a stronger regulatory environment.

Looking forward, the report argues, LAC needs to focus on generating productivity gains to ensure solid growth now that global tailwinds recede. To do so, it will require addressing structural deficits such as those in infrastructure or education. The good news is that the depreciation of LAC currencies that will likely accompany the ongoing changes in the external environment should provide the short-run cushion to plan for the long run.

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