1. Crisis Averted—What’s Next? Rodrigo Valdés Western Hemisphere Department International Monetary Fund 22 October 2009

2. 2 Agenda I. External Shocks II. Policy Reactions and Outlook III. Short-term challenges ― Zooming in IV. Preparedness, vulnerabilities, and medium-term challenges ― Zooming out V. Conclusions

3. 3 I. External Shocks II. Policy Reactions and Outlook III. Short-term challenges ― Zooming in IV. Preparedness, vulnerabilities, and medium-term challenges ― Zooming out V. Conclusions

4. 4 4 WEO Baseline scenario for the world economy: slow recovery with downside risks Source: IMF staff estimates. 1/ For LA6, PPP-GDP weighted average. Real GDP Growth in LA6 and the World 1/ (Four quarter percent change, seasonally adjusted)

5. 5 5 Commodity prices are recovering as Asia rebounds Sources: Bloomberg, L.P.; and IMF staff calculations. Commodity Prices (Index 2002=100 of prices in U.S. dollars)

6. 6 6 Financial market turmoil has receded… Latin American Financial Markets: Heat Map Sources: Bloomberg, L.P.; and IMF staff calculations.

7. 7 Other external shocks to ease... …at different paces Remittances, Tourism, and External Demand 1/ (percent change, y/y) Source: IMF staff estimates. 1/ Remittances and Tourism are 4-qtr moving averages.

8. 8 I. External Shocks II. Policy Reactions and Outlook III. Short-term challenges ― Zooming in IV. Preparedness, vulnerabilities, and medium-term challenges ― Zooming out V. Conclusions

9. 9

10. 10 10 In contrast with the past, a number of countries implemented countercyclical fiscal policies… Source: IMF staff estimates. 1/ Simple averages of changes in primary balances Change in primary deficits excluding commodity-related revenues (Percent of GDP 1/)

11. 11 11 Interest Rate Changes (Differences between September 2008 and the most recent data) …and some countries also implemented expansionary monetary policies… Source: IMF staff estimates.

12. 12 12 Nominal effective exchange rate 1/ (Index 2008=100) Source: IMF staff estimates. 1/ Index constructed using the simple average of monthly growth rates within each group. An increase (decrease) denotes an appreciation (depreciation). 2/ Excludes Jamaica. Exchange rate adjustment buffered the shocks in countries with ER Flexibility

13. 13 13 Activity has started to pick-up in several countries Expanding and above or equal to trend (average) Expanding and below trend (average) Moving sideways Contracting at a moderate rate Contracting at a fast rate Data not available Source: IMF staff estimates. Regional “green shoots”

14. 14 14 Yet the path of recovery underscores regional heterogeneity GDP growth in Latin America and the Caribbean (percentage change; weighted average by GDP-PPP within groups) Source: IMF staff estimates.

15. 15 I. External Shocks II. Policy Reactions and Outlook III. Short-term challenges ― Zooming in IV. Preparedness, vulnerabilities, and medium-term challenges ― Zooming out V. Conclusions

16. 16 16 Challenges for commodity exporting and financially integrated countries Timing and sequencing: Start unwinding special financial facilities; Pace fiscal withdrawal depending on strength of recovery; Monetary policy normalization should follow fiscal. And, confront a likely scenario of capital inflows in search for yield: FX flexibility to avoid one-sided bets; If inflows scale is large and problematic, step-up financial regulation/supervision; Revisit the fiscal stance.

17. 17 17 Challenges for other commodity exporters Avoid procyclical fiscal policies: Take advantage of firmer commodity prices, implement clearer policies to limit procyclicality.

18. 18 18 Challenges for other net commodity importers Preserve fiscal resources: Avoid procyclicality, but… Preserve some stimulus for worse- case scenario.

19. 19 19 Challenges for commodity importing tourism intensive countries Stay in crisis mode: Prioritize spending. Focus on macroeconomic stability. Policy space limited by debt levels.

20. 20 I. External Shocks II. Policy Reactions and Outlook III. Short-term challenges ― Zooming in IV. Preparedness, vulnerabilities, and medium-term challenges ― Zooming out V. Conclusions

21. 21 Preparedness paid off – historical perspective A comparison of GDP in 2009 and in past crises (GDP index, 100 = year before the crisis) Source: IMF staff estimates.

22. 1/ Growth in Brazil, Chile, Colombia, Mexico and Peru; simple average of annual growth. Source: IMF staff estimates. Estimating the impact of the crisis suggests that… Growth in LAC-5 Real GDP 1/ (simple average, year on year percentage changes)

23. 1/ Growth in Brazil, Chile, Colombia, Mexico and Peru; simple average of annual growth. Source: IMF staff estimates. Latin American countries saved 4 percent of GDP during the current crisis Growth in LAC-5 Real GDP 1/ (simple average, year on year percentage changes)

24. 24 What explains the differences? Pre-crisis credit boom Bank leverage Inflexible exchange rates Lack of fiscal restraint Greater trade links International reserves are not found to have explanatory power 24 Relative performance of emerging economies Changes in expected growth for 2009 (Percentage points of revision in growth forecasts, before and after crisis) Macro policies during the boom & financial regulation and supervision Source: IMF staff estimates.

25. 25 The cost of reserves is not trivial… possibility for cooperative solutions IMF Credit and Reserves in percent of GDP (2008) Source: IMF staff estimates.

26. 26 26 The IMF in Latin America and the Caribbean IMF Lending, 2008-09 (Committed resources, millions of SDR) Source: IMF staff estimates.

27. 27 It is now necessary to rebuild fiscal space… Source: IMF staff estimates. Fiscal Adjustment (percent of GDP)

28. 28 It is now necessary to rebuild fiscal space… Source: IMF staff estimates. Fiscal Adjustment (percent of GDP)

29. 29 Concluding remarks – Limiting vulnerabilities and replenishing buffers Fiscal policy should get better prepared. Aim at lower debt levels, larger automatic stabilizers, and systematic calculation of structural positions. Financial regulation agenda should keep up with new learning. Examples: Consider capital charges for systemic risk contribution, clearer mandates for financial stability and enlargement of perimeter of regulation, and limiting procyclicality (eg, dynamic provisioning) If consistent with FX regime, adopt more exchange rate flexibility. Strike a balance on FX liquidity buffers. While apparently useful, they are costly.