Bloomberg News

IMF Says Latin America Must Be Ready to Inject Stimulus

October 05, 2011

(Updates to add IMF official’s comment in ninth, 10th paragraphs.)

Oct. 5 (Bloomberg) -- Latin American policy makers must be prepared to use interest rate cuts and consider fiscal measures to protect their economies in the event that the global economy stalls, the International Monetary Fund said.

Should recessions in Europe and the U.S. materialize and spill over to Asia, commodity producers in the region may face a “triple shock” from weaker terms of trade, declining exports and tighter global credit markets, the Washington-based lender said in a report released today.

Fiscal easing should only be utilized if the “severe downside risks” of lower crude oil and metal prices is induced by a slowdown in Asia, and Europe’s debt woes unleash a credit crunch similar to that which followed the 2008 bankruptcy of Lehman Brothers Holdings Inc., the report said.

“Given the complexity and uncertainties surrounding the global economy, policy makers must stand ready to adjust policies should downside risks materialize,” according to the 93-page report. “In countries with credible monetary frameworks, where inflation pressures have abated, monetary policy can be more flexible, serving as a first line of defense.”

Increased risk aversion, which wiped $10 trillion off global equities in the third quarter, has had a limited effect on the region’s growth prospects so far, and it’s premature for governments to loosen policies, as fiscal positions weakened by the 2008 crisis need to be rebuilt, the IMF said.

GDP, Europe Effect

The fund predicts Latin American economic growth will slow to 4.5 percent this year and 4 percent in 2012, compared with a 5 percent expansion in the first half of this year.

The economies of Mexico and Brazil will each grow 3.8 percent this year, down from forecasts of 4.5 percent and 4.6 percent in the fund’s April report. Mexico, Brazil and Venezuela will lag behind the rest of the region in 2012, with 3.6 percent growth each, while Panama will post the fastest expansion of 7.2 percent.

Venezuela will probably have inflation of 24 percent next year, more than four times the regional average, while in Argentina prices will rise 11 percent. Peru and Belize will have the lowest inflation at 2.5 percent each.

“Strong” growth in Latin America and “relatively high” commodity prices are likely provided Europe contains its debt crisis, the U.S resolves its budget problems and Asia avoids a slowdown, Nicolas Eyzaguirre, director of the International Monetary Fund’s Western Hemisphere department.

China, Commodities

“China has the capacity to keep stimulating its economy in the short term and therefore we think the raw material prices will remain relatively interesting,” Eyzaguirre said today at an event in Lima. “In the medium term, if the U.S. and Europe don’t bounce back, nor China’s exports to these markets, raw material prices could go belly up.”

Latin America would be among regions most affected by the spillover from a banking crisis in Europe, the IMF said. Chile would be the most affected if Europe’s banks take higher-than- expected losses on loans from the European periphery, followed by Brazil and Mexico, the report said.

The IMF urged governments to maintain their guard against overheating. While slower global growth has reduced such a risk, there’s still danger that near-zero interest rates in advanced economies could spur capital flows to Latin America if the European debt crisis is contained.

Credit, Macroprudential measures

Credit expansion in the region is showing little sign of slowing, with 12 percent average annual growth in June, while banks rely increasingly on wholesale operations to finance lending.

“Although these trends are not an immediate threat to stability, they need to be closely monitored to avoid problems down the road,” the report said.

Macroprudential measures such as changes to reserve requirements should remain part of the region’s armory against destabilizing capital flows, although the IMF found they result in a “moderate” slowdown in credit growth that lasts only four months.

“Despite their increasing use, the effectiveness of macroprudential policies in leaning against credit growth and protecting financial stability remains an open question,” the report said.

Scenarios

Commodity exports represented 10 percent of South America’s gross domestic product in 2010, up from 6 percent in 1970, according to the report.

Though the region is better placed to withstand a decline in commodity prices than in the past, the outlook for Mexico and much of Central America is bleaker because of their dependence on U.S. activity.

“A sustained crisis of sovereign and financial confidence in Europe could disrupt global credit markets and lead to a sudden stop of trade and bank financing,” the report said. “Another recession in the United States, triggered by woes in Europe or persistent weaknesses in private domestic demand coupled with an overly large up-front fiscal adjustment, could lead to a considerable slowdown in emerging Asia and much lower oil and metal prices.”

--With assistance by Matthew Bristow. Editors: Richard Jarvie, Robert Jameson

To contact the reporter on this story: John Quigley in Lima at jquigley8@bloomberg.net

To contact the editor responsible for this story: Joshua Goodman at jgoodman19@bloomberg.net


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