The Latin American and Caribbean region has rebounded strongly from the global crisis of 2008-09, growing 6.0 percent in 2010 compared with a 2.1 percent contraction in 2009. Strong growth in Argentina, Brazil, and Peru boosted growth in South America to 6.5 percent after a mild contraction in 2009. Central America (including Mexico), the area in the region most affected by the crisis has yet to reach the level of output recorded before the crisis, having expanded 5.2 percent in 2010 after a 5.5 percent contraction in 2009. The rebound in growth in Central America reflects mainly a strong rebound in the Mexican economy, which is closely linked to the United States. The Caribbean region recorded the weakest growth in Latin America at 3.8 percent, after a modest 0.5 percent in 2009 (see the Regional forecast table.
Industrial production growth picked up in the first quarter of 2011, growing at more than a 10 percent seasonally adjusted annualized rate (or saar) boosted by strong domestic demand and import demand from other developing countries, China in particular, and more recently from high-income countries where consumer spending has started to recover at a moderate pace. The recovery has been supported to a great extent by strong increases in output and employment in non-traded sectors, including services.
In seasonally adjusted annualized terms acceleration in industrial production growth was particularly pronounced in several resource-rich, globally integrated economies, including Argentina (close to 11 percent), and Mexico (close to 9 percent). Growth in Central America strengthened to close to 9 percent, boosted by strong external demand. In other countries the recovery is more muted or industrial production remains stagnant.
Reflecting both differences in initial conditions going into the crisis and in the pace of recovery, output gaps across the region vary widely. Manufacturing capacity utilization is now above trend levels for the region as a whole, with the recovery entering a new more-mature phase, where additional investment in productive capacity will be necessary to sustain growth ahead. Spare capacity has been completely re-absorbed in Uruguay, Peru, Brazil and Colombia due to strong growth in 2010 and relatively shallow slowdowns in 2009. Industrial output gaps have closed in Mexico, and remain positive in Argentina, but are expected to close in the course of 2011. Economic slack remains an issue in the Caribbean economies and Central America, partly because of their reliance on remittances and tourism from the United States and—to a lesser extent—Europe, where the recovery has been relatively slow. Although output in the region as a whole is now 2.2 percent below its pre-crisis peak level, in a few countries it has exceeded that benchmark.
The rebound in industrial production has been mirrored in trade volumes, which have also strengthened in the three months ending in March 2011. The biggest rebound was in regional import demand, which preceded the pickup in exports. Latin American imports now stand 4 percent above earlier pre-crisis peaks, reflecting a strengthening in regional domestic demand--retail sales were up year-on-year 15.3 percent in Argentina, 8.5 percent in Brazil, 5.5 percent in Colombia in February, and momentum is particularly strong in some of these economies. Widespread currency appreciation (notably in Brazil and Mexico) has contributed to this result, as have stronger wages in some cases.
The rebound in imports was followed by an acceleration in regional export growth to a 9.2 percent annualized pace in the three months to March 2011, mainly reflecting strong exports by Argentina, Brazil, Colombia, and Mexico. Export volumes are now roughly 1.1 percent above pre-crisis peaks, and exceed the pre-crisis peak by 9.2 percent in Brazil. In Central America, including Mexico, volumes are closing on pre-crisis peaks. The increase in both export revenues and imports is much stronger on account of rising commodity prices for some main export and import commodities.
Capital flows have returned to selected economies in search of higher yields and are putting upward pressures on select currencies see discussion on Impacts of and policy responses to strong capital inflows and strong real credit growth). Net private inflows rose to 4.8 percent of GDP in 2010, after falling to 3.7 percent of GDP in the year of the crisis, but are still shy of the 6.0 percent of GDP recorded in 2007. The largest increase was recorded in FDI inflows, up 57.4 percent, while net portfolio equity inflows increased by almost 30 percent to $54 billion. Net lending by banks totaled $7.4 billion, after an outflow of $5.6 billion the previous year, while short-term debt flows amounted to $16.6 billion (see the Capital flows table.
A large pipeline of sovereign and commercial bond issuance has run through the region in the first months of 2011. Mexico took advantage of historically low U.S. interest rates and sold $1.5 billion of bonds due in 2040 during April, its second dollar issue in two months, pushing its share of regional offerings to 65 percent.
Furthermore international investors bought $21 billion of peso-denominated debt in the six months through March. And Argentina’s companies and provinces sold $1.5 billion worth of bonds in the first quarter, a record since 2001 when the government defaulted on $95 billion of obligations and more-than double the $597 million sold a year ago.
Inflationary pressures are rising in several economies on higher food and fuel prices, strong domestic demand, rising wages, and increasingly limited spare capacity. Headline inflation rates are near the upper ends of central bank target ranges in many inflation-targeting economies. Indeed, inflation accelerated to 6.5 percent during April in Brazil (year-on-year) matching the upper-limit of the inflation target range. In Peru, inflation accelerated to the fastest pace in almost three years, while Uruguay’s consumer price inflation picked-up to 8.6 percent, the fastest pace in four years, and well above the upper limit of the inflation target range of 3 to 7 percent.
In most economies the build-up in inflationary pressures stems from significant increases in international fuel and food prices. Additionally, Brazil, Peru, and Argentina are operating at almost full capacity, and face the risk of cost-push inflation. Indeed, wages in Argentina were rising at a record pace in January. Demand-pull inflation is also a source of concern in countries like Brazil, where domestic demand remains buoyant. Moreover, la Nina-related supply side shocks have compounded the effects of imported food inflation, in countries like Colombia and Venezuela. Inflation remains relatively subdued in many economies, including in Mexico, Chile, and Peru.
Most inflation-targeting countries in the region have begun to normalize monetary policy (Mexico is a notable exception). Brazil’s central bank hiked its benchmark rate 125 basis points to 12.00 percent over the past three meetings as inflation is nearing the upper limit of the targeted range; while Peru raised policy rates ten times to 4.25 percent. Nevertheless, in many cases policy has not kept pace with inflation and how effective these measures will depend critically on what has happened to inflationary expectations. At the moment, despite hikes in nominal interest rates, real interest rates deflated by actual inflation remain low and even negative in some countries. The task of adopting the appropriate monetary policy is being complicated in selected economies by the surge in capital inflows, which is putting pressure on currencies to appreciate and which lead to increased liquidity in the economy to the extent that these flows are intermediated by the financial sector.
Relative to the pre-crisis period, the currencies of Ecuador, Colombia, Chile, Peru and Brazil have appreciated in nominal effective terms, between 2.5 and 11 percent, while Venezuela and Argentina recorded some of the strongest depreciations. Meanwhile real effective exchange rates have appreciated by more than 10 percent relative to the pre-crisis period in Bolivia, Brazil, Costa Rica, Guyana, and Uruguay, while depreciating in Mexico and Argentina. Nevertheless given relatively stable nominal exchange rate and high inflation rates the Argentine peso appreciated strongly in 2010 and in the early months of 2011. In the first four months of 2011 the currencies of Brazil, Colombia, and Mexico have appreciated in nominal effective terms by between 3.5 and 4.5 percent. In some cases like Brazil and Colombia, the currencies are considered overvalued, while in others like Argentina currencies are estimated to be weaker than warranted by medium-term fundamentals.
Many countries that saw increased pressures on currencies intervened in the exchange markets, including Argentina, Brazil, Chile, Colombia, and Mexico. International reserves rose $37.6 billion to reach $657.1 billion by the end of the first quarter. Some countries have also introduced higher ceilings to foreign investment of pension funds, including Chile, Colombia, Mexico, and Peru (Crowe et al. 2011, Moreno 2011). Several countries, including Brazil and Peru have resorted to capital controls to ease the pressure on currencies.
After deteriorating on average by nearly 3 percent of GDP in the crisis year, as governments engaged in counter-cyclical spending, fiscal balances improved last year in most developing Latin American and Caribbean countries, on average by more than 1 percent of GDP. Government balances deteriorated more in small economies and island economies. General government balances are expected to continue to improve this year, by an estimated 0.8 percentage points of GDP, helped in large part by commodity windfall for commodity exporters. General government balances are expected to deteriorate in Paraguay and Ecuador among others, as growth decelerates and/or prices of main commodity exports weaken.
In Argentina’s government balances are expected to deteriorate as government spending grows faster than government revenues, particularly in 2011, an election year. In Haiti the government deficit is projected to deteriorate sharply to 5.3 percent of GDP in 2011, after a surplus of 2.2 percent of GDP in 2010. Continued weak growth and increased discretionary spending is expected to cause deficits in some countries to deteriorate further in 2011.
Nevertheless fiscal policies are becoming pro-cyclical in some countries,1 and tightening is required especially in countries that have very little spare capacity and that show signs of overheating. For these countries, but even for those where deficits have receded, policy will need to take special care to ensure that the fiscal space that allowed policy to respond counter-cyclically in the most recent crisis is recreated. This, such that should another crisis arise, fiscal policies will once again be in a position to respond. Corrected for cyclical impacts on spending and revenues, the structural deficit in Argentina is estimated to be above 3 percent of potential GDP, in Brazil it is estimated at 2.5 percent, while in Guyana it is more than 5 percent of GDP. Structural deficits are lower in Chile and Peru, at around 1.5 percent of GDP.2
Brazil has signaled that it will rebalance its policy mix to help fight inflation. Quasi-fiscal expenditures remain a problem for Brazil however, and public banks need to contain loan expansion to help anchor inflationary expectations. The government announced a 50 billion reais spending cut for 2011, with 68 percent to come from reductions in discretionary spending, and the remainder to come from limiting increases in mandatory expenditure.
Improved economic performance in high-income countries and higher employment helped tourism and remittances recover from the 2009 slump. The recovery in remittances was modest in 2010, but due to the depreciation of the U.S. dollar, in local currency terms, remittances have fallen slightly in many countries. Strong economic performance in Latin America has also boosted tourist arrivals and to a lesser extent, tourism revenues, which tend to lag in a recovery. Still, this has been a positive for growth, especially in countries that rely heavily on tourism revenues. Tourism arrivals increased the most in South America, up 10.4 percent to 23.5 million, followed by Central America, where arrivals rose 8.3 percent to 8.3 million, while growth in the Caribbean region lagged at 3.9 percent, with a total of 20.3 million tourist arrivals.3 In the first quarter of 2011 tourism arrivals were up 15 percent in Latin America and the Caribbean.
Current account balances deteriorated in the Latin America and Caribbean region by 0.9 percent of GDP in 2010 to a deficit of 1.5 percent of GDP. Current account balances remained relatively stable in the Caribbean region and deteriorated by 0.24 percentage points in Central America. Stronger currencies and rapidly growing domestic demand help explain in part the deterioration in current account balances. In selected economies the deterioration in the services balance has played a significant role in the deterioration of current account positions (for example in Brazil).
1 World Bank, LAC Success put to the test, April 2011.
2 IMF, World Economic Outlook, April 2011.
3 UN World Tourism Organization, January 2011.