Ernesto Talvi, CERES Alejandro Izquierdo, IADB Coordinators Prepared for Presentation at the XXIX...

Ernesto Talvi, CERESErnesto Talvi, CERESAlejandro Izquierdo, IADBAlejandro Izquierdo, IADBCoordinatorsCoordinators

Prepared for Presentation at the XXIX Meeting of the Latin American Network of Prepared for Presentation at the XXIX Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC, April 22Central Banks and Finance Ministries, IADB, Washington DC, April 22ndnd, 2009., 2009.

I.I. Latin America and the Global Crisis: Latin America and the Global Crisis:

Predominant ViewsPredominant Views

II.II. Macro Dynamics in Latin America Under Macro Dynamics in Latin America Under

Two Hypotheses on the Global EconomyTwo Hypotheses on the Global Economy

III.III. Policy Trade-offs for Unprecedented Policy Trade-offs for Unprecedented

Times: A Liquidity ApproachTimes: A Liquidity Approach

OUTLINE

LATIN AMERICA AND THE GLOBAL CRISIS: PREDOMINANT VIEWS

As a result of the global crisis As a result of the global crisis Latin America Latin America suffered a drastic deterioration in the external suffered a drastic deterioration in the external environmentenvironment::

Source: JPMorgan

United StatesMay-08

Mar-09

08 Q3 08 Q4 09 Q1 09 Q32008 2009 09 Q2

External Factors: Industrial Countries Growth (GDP; yoy and qoq saar)

1.5%1.0%

2.0%3.0% 2.5%

-0.5%

-6.2%

-5.0%

-2.0%

1.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

1.5%2.1%

1.1%

-2.5%-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

100.1

Average US Post - WWII Recession*

98.5

98.9

99.3

99.7

t t+1 t+2 t+3

Peak

-1.6%

Trough

(GDP, real terms)

*Own calculations based on NBER dating.

Current US Recession(GDP, real terms)

PeakTrough

-3.5%96

97

98

99

100

101

102

08.II 08.III 08.IV 09.I 09.II 09.III

May-08 Forecast

Current Forecast

* EU-15 includes Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovenia and Spain.

Source: JPMorgan

(GDP, real terms)

United States

Peak Trough

-3.5%

96

97

98

99

100

101

102

08.II 08.III 08.IV 09.I 09.II 09.III

May-08 Forecast

Current Forecast

EU-15*

Japan

90

92

94

96

98

100

102

08.I 08.II 08.III 08.IV 09.I 09.II 09.III 09.IV

Peak Trough

May-08 Forecast

Current Forecast

-9.7%

95

96

97

98

99

100

101

102

103

08.I 08.II 08.III 08.IV 09.I 09.II 09.III

Current Forecast

Peak Trough

May-08 Forecast

96

97

98

99

100

101

102

08.II 08.III 08.IV 09.I 09.II 09.III 09.IV

-3.9%

May-08 Forecast

Current Forecast

Peak Trough

-4.3%

Industrial Countries

External Factors: Industrial Countries Growth

50

150

250

350

450

550

650

750

2001

2002

2003

2004

2005

2006

2007

2008

70

90

110

130

150

170

190

2001

2002

2003

2004

2005

2006

2007

2008

70

100

130

160

190

220

250

280

310

340

2001

2002

2003

2004

2005

2006

2007

2008

External Factors: Commodity Prices

Source: IMF

OilOil(1991-1997 Average = 100)(1991-1997 Average = 100)

FoodFood(1991-1997 Average = 100)(1991-1997 Average = 100)

MetalsMetals(1991-1997 Average = 100)(1991-1997 Average = 100)

US Financial Crisis 725

228

373

-68%

91-97 Average

177

123

-30%

US Financial Crisis

123

91-97 Average

US Financial Crisis

313

158

-46%

91-97 Average

Variation Dec.01 – Jul.08:

+616%Variation

Dec.01 – Jun.08: +133%

Variation Dec.01 – Mar.08:

+282%

LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP.

(LAC-7, Jun-97=100)

External Factors: Terms of Trade

Russian Crisis US Financial CrisisBeginning of the

Boom

Variation Dec.01-Jun.08:

82%

85

95

105

115

125

135

145

155

165

175

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

Variation Jul.08-Dec.08:

-26%

Annualized Variation

1990-2006

Dec.01 – Jun-08

2.0%

9.5%

0

100

200

300

400

500

600

700

800

900

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Mar

-09

Corporate Bond SpreadsCorporate Bond SpreadsCorporate Bond PricesCorporate Bond Prices

External Factors: International Financial Conditions

(Latin CEMBI; Bond Price Equivalent*, 01-Jan-07 = 100) (Latin CEMBI; 01-Jan-07 = 100)

Total

Variation in bps

CEMBI 87

Jan.07-May.08

Jun.08-Mar.09

516 603

Jan-07

221

06-Mar-09

824

CEMBI

% Variation

-0.1

Jan.07-May.08

Jun.08-Mar.09

-.22.3

Total

-.22.4

65

70

75

80

85

90

95

100

105

Jan-

07

Apr

-07

Jul-0

7

Oct

-07

Jan-

08

Apr

-08

Jul-0

8

Oct

-08

Jan-

09

*Assumes a coupon of 11% and a 10Y maturity.

Corporate Bonds: MaturityCorporate Bonds: Maturity(LAC-7, issuances with maturity less than 1 year, % of

total issuance)

40.5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Mar

-07

Jun-

07

Sep

-07

Dec

-07

Mar

-08

Jun-

08

Sep

-08

Dec

-08

Mar

-09

LAC-7 is the simple sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP.

Corporate Bonds: IssuanceCorporate Bonds: Issuance(LAC-7, billions of USD)

0

5

10

15

20

25

Ma

r-0

7

Jun-

07

Sep

-07

Dec

-07

Ma

r-0

8

Jun-

08

Sep

-08

Dec

-08

Ma

r-0

9

21.2

2.5


Sovereign Bond SpreadsSovereign Bond Spreads(EMBI+ and Latin EMBI; Spreads, Basis Points)

Latin EMBI

EMBI+

(EMBI+, Latin EMBI and US AA Corporates; Bond Price Equivalent*, 01-Jan-07 = 100)

Latin EMBIEMBI+

US AA

Sovereign Bond PricesSovereign Bond Prices

Total

Latin EMBI

EMBI+

AA

% Variation

-1.0

.-0.6

0.5

Jan.07-May.08

Jun.08-Mar.09

-18.4

-18.0

-6.4

-19.2

-18.4

-5.9

Total

Variation in bps

Latin EMBI

EMBI+

67

71

Phase 1 Phase 2

401

448

468

519

Jan-07

186

170

06-Mar-09

654

689

65

70

75

80

85

90

95

100

105

Jan-

07

Ma

r-0

7

Ma

y-0

7

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Ma

r-0

8

Ma

y-0

8

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Ma

r-0

9

0

100

200

300

400

500

600

700

800

900

1000

Jan-

07

Ma

r-0

7

Ma

y-0

7

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Ma

r-0

8

Ma

y-0

8

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Ma

r-0

9

*Assumes a coupon of 11% and a 10Y maturity.


SovereignSovereign Bonds: Maturity Bonds: Maturity(LAC-7, issuances with maturity less than 1 year, % of

total issuance)

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

Mar

-07

Jun-

07

Sep

-07

Dec

-07

Mar

-08

Jun-

08

Sep

-08

Dec

-08

Mar

-09

63.3%

28.6%

LAC-7 is the simple sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP.

SovereignSovereign Bonds: IssuanceBonds: Issuance(LAC-7, billions of USD)

56.6

97.8

40

50

60

70

80

90

100

Ma

r-0

7

Jun-

07

Sep

-07

Dec

-07

Ma

r-0

8

Jun-

08

Sep

-08

Dec

-08

Ma

r-0

9


However, However, Latin America has very strong Latin America has very strong fundamentalsfundamentals to withstand the worsening of global to withstand the worsening of global conditions…conditions…


As a result of the global crisis As a result of the global crisis Latin America Latin America suffered a drastic deterioration in the external suffered a drastic deterioration in the external environmentenvironment


Fiscal Balance in Latin America(LAC-7; Overall Balance, % of GDP)

Public Debt in Latin America(LAC-7; Public Debt, % of GDP)

30%

32%

34%

36%

38%

40%

42%

44%

46%

48%

50%

52%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Russian Crisis Beginning of

2000s Boom US

Financial Crisis

50%

33%

52%

35%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

1.5%

Russian CrisisBeginning of 2000s Boom

Latin America:

Fiscal Balance and Public Debt

US Financial Crisis

Latin America: Banking Indicators


Source: Bankscope

Non Performing Loans in Latin AmericaNon Performing Loans in Latin America(LAC-7, % of Total Loans)(LAC-7, % of Total Loans)

9.5

6.2

4.4

3.73.3

2.5

0

1

2

3

4

5

6

7

8

9

10

2002 2003 2004 2005 2006 2007

Loan Loss Provisions in Latin AmericaLoan Loss Provisions in Latin America(LAC-7, Loan Loss Provisions to Non Performing Loans)(LAC-7, Loan Loss Provisions to Non Performing Loans)

1.2

1.4

1.7

2.12.2

2.4

0.5

1.0

1.5

2.0

2.5

2002 2003 2004 2005 2006 2007

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

International Reserves in Latin AmericaInternational Reserves in Latin America(LAC-7, (LAC-7, in billions of USDin billions of USD))

0

50

100

150

200

250

300

350

400

450

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Russian Crisis

Beginning of the Boom

US Financial Crisis

174

275

447

Latin America: International Liquidity Indicators

LAC-7 is the simple sum (*average) of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP.

Liquidity Indicators in Latin AmericaLiquidity Indicators in Latin America(LAC-7*, International Reserves to External Public Debt Amortizations in the

next twelve months plus Central Bank Short Term Liabilities)

Russian Crisis


US Financial Crisis

1.0

1.8

147

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

Latin America: Financial Dollarization

Credit Dollarization in Latin America(LAC-7; Bank Credit in Foreign Currency , % of Total Credit)

Beginning of

2000s Boom

23%

50%

LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. These countries represent 91% of Latin America’s GDP. For bank credit figures, LAC-7 excludes Brazil, Colombia and Venezuela.For bank credit figures, LAC-7 excludes Brazil, Colombia and Venezuela.

Public Debt Dollarization in Latin America(LAC-7; Foreign Currency Debt, % of Total Debt)

30%

35%

40%

45%

50%

55%

60%

65%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

65%

35%

Beginning of 2000s Boom

LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. These countries represent 91% of Latin America’s GDP. * * Sturzenegger and Talvi (2008): Sturzenegger and Talvi (2008): “Unveiling Monetary Policy in Latin America”“Unveiling Monetary Policy in Latin America”**Excludes Venezuela**Excludes Venezuela***Includes Australia, Canada, New Zealand, South Africa and United Kingdom***Includes Australia, Canada, New Zealand, South Africa and United Kingdom

Latin America: Exchange Rate Flexibility

‘Fear of Floating’ Coefficient in Latin America*(LAC-7**)

1.34

0.28

0.10

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Pre Asian/RussianCrisis

Current Industrial Countries***

Central Bank’s Reaction Function

where: Rt denotes the Central Bank policy interest rate

πt denotes the inflation rate

yt denotes output

st denotes the nominal effective exchange rate

pR captures the partial adjustment of the interest rate to target

ψ1 ,ψ2 , and ψ3 captures the monetary authorities reaction to inflation, output and

exchange rate fluctuations respectively

RttttRt-Rt εΔsψyψπψ)ρ(RρR

3211 1

Fear of Floating Coefficient

……and thus better equipped to pursue and thus better equipped to pursue countercyclical monetary and fiscal policiescountercyclical monetary and fiscal policies to to mitigate the impact of adverse external shocksmitigate the impact of adverse external shocks


As a result of the global crisis As a result of the global crisis Latin America Latin America suffered a drastic deterioration in the external suffered a drastic deterioration in the external environmentenvironment


Latin America: Monetary and Fiscal Policy Response

Monetary Policy

Inte

rest

Ra

te

Interest Rate

Exchange Rate

Exc

ha

ng

e R

ate

8.5%

8.7%

8.9%

9.1%

9.3%

9.5%

9.7%

9.9%

Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09

98

102

106

110

114

118

122

126

(LAC-7*, Interbank interest rate and Nominal Exchange Rate, in % and Sep-15-08=100)

Fiscal Stimulus Announcements in Latin America

(% of GDP)

Source: Credit Suisse

Argentina

Brazil

Chile

Mexico

Peru

5.1

0.3

1.0

0.5

0.0

0.2

0.1

1.1

1.0

1.4

1.1

3.3

0.7

0.0

1.1

6.4

3.6

2.8

1.5

2.5

ON - BUDGET OFF – BUDGET

TOTALRevenue-side Expenditure-side


*Excludes Argentina and Venezuela


*Excludes Argentina and Venezuela

Monetary and Fiscal Policy Response: Russian Crisis vs. Current Crisis

20%

22%

24%

26%

28%

30%

32%

34%

36%

38%

40%

Jul-98 Aug-98 Sep-98

98

100

102

104

106

108

110

112

114

116

118

Interest Rate

Exchange Rate

Inte

rest

Ra

te

Exc

ha

ng

e R

ate

Monetary Policy(LAC-7*, Interbank Interest Rate and Nominal

Exchange Rate, in % and Jul-98=100)

Fiscal Policy(LAC-7, Structural Fiscal Balance, % of GDP)

-3.2%

-1.2%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

Dec

-96

Ma

r-9

7

Jun-

97

Sep

-97

Dec

-97

Ma

r-9

8

Jun-

98

Sep

-98

Dec

-98

Ma

r-9

9

Jun-

99

Sep

-99

Russian Crisis

As a result, the recession in 2009 will be relatively As a result, the recession in 2009 will be relatively deep but short liveddeep but short lived, the region will return to , the region will return to positive growth in 2010…positive growth in 2010…




Market Forecasts: Economic Performance

LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP.*Source: JPMorgan

(LAC-7; real GDP, annual variation)

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Russian Crisis Beginning of the Current Boom

US Financial Crisis

Current Forecast

Apr-08 Forecast

Average 71-06: 3.4%

4.9 %

-0.9 %

3.0 %

91-97 Growth Average : 4.6%

98-02 Growth Average : 0.7%

03-06 Growth Average: 5.6%

Forecasts*

……and and liquidity crises and economic collapses, so liquidity crises and economic collapses, so prevalent in the past, will be largely avoidedprevalent in the past, will be largely avoided

As a result, the recession in 2009 will be relatively As a result, the recession in 2009 will be relatively deep but short liveddeep but short lived, the region will return to , the region will return to positive growth in 2010…positive growth in 2010…




I.I. Latin America and the Global Crisis: Latin America and the Global Crisis:

Predominant ViewsPredominant Views

II.II. Macro Dynamics in Latin America Under Macro Dynamics in Latin America Under

Two Hypotheses on the Global EconomyTwo Hypotheses on the Global Economy

III.III. Policy Trade-offs for Unprecedented Policy Trade-offs for Unprecedented

Times: A Liquidity ApproachTimes: A Liquidity Approach

OUTLINE

ROADMAPROADMAP

To assess the predominant views on the region in the To assess the predominant views on the region in the face of the global crisis, we proceed as follows:face of the global crisis, we proceed as follows:

i.i. Go beyond a snapshot of the region and see the Go beyond a snapshot of the region and see the motion picture right to the endmotion picture right to the end, t, tracing the macro racing the macro dynamics of a key set of variables under alternative dynamics of a key set of variables under alternative hypotheses on how the global recovery unfoldshypotheses on how the global recovery unfolds

ii.ii. Develop a simple framework emphasizing liquidity Develop a simple framework emphasizing liquidity issuesissues as a key element in evaluating the region’s as a key element in evaluating the region’s risks and policy trade-offsrisks and policy trade-offs

Hypotheses on the Global EconomyHypotheses on the Global Economy

L-Shaped L-Shaped ScenarioScenario

100

200

300

400

500

600

700

2006 2007 2008 2009 2010 2011 2012 2013

Sovereign Bond SpreadSovereign Bond Spread

Source: JPMorgan for Bond Spreads

Pre- Asian Crisis LevelsPre- Asian Crisis Levels

(EMBI +, bps)(EMBI +, bps)

V-Shaped V-Shaped ScenarioScenario

Trough Jun-07

Peak Jun-09

T-to-P 512

Recovery* Sep-10

V-Shaped

*Recovery to Pre-Asian crisis levels


75

85

95

105

115

125

135

2006 2007 2008 2009 2010 2011 2012 2013

Global Commodity Price IndexGlobal Commodity Price Index

Source: IMF and Bloomberg*

Pre-Crisis LevelsPre-Crisis Levels

(2006 = 100)(2006 = 100)


*Recovery to Dec-06 levels

Peak Jun-08

Trough Jun-09

P-to-T -47.3%

Recovery* Sep-10

V-ShapedMar-08

Jun-09

-4.3%

Dec-13

L-Shaped

EXTERNAL FACTORS

Commodity Prices

International Financial Conditions

Industrial Countries Growth

Two Hypotheses on the Global Economy

G7 is the PPP-weighted average of the Canada, France, Germany, Italy, Japan, United States, UK

G7 Industrial ProductionG7 Industrial Production(2006 = 100)(2006 = 100)


Pre-Crisis LevelsPre-Crisis Levels

97

99

101

103

105

107

109

2006 2007 2008 2009 2010 2011 2012 2013

V-Shaped

Peak Mar-08

Trough Jun-09

P-to-T -4.3%

Recovery* Sep-10

*Recovery to pre-crisis levels of output

Source: Own calculations based on WEO and JPMorgan*, Oct-08.


Jun-08

Jun-09

-47.3%

Dec-13

L-Shaped

Jun-07

Jun-09

512 .

Dec-13

L-Shaped

Economic PerformanceEconomic Performance

Tequila Crisis

Asian / Russian Crises

Dot-Com Crisis


External Factors

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Actual

Fitted

**Izquierdo, Izquierdo, AA., Romero, R. and Talvi, E. (2008): “Booms and Busts in Latin America: The Role of External Factors”, Working Paper 631, IADB Research Department., Romero, R. and Talvi, E. (2008): “Booms and Busts in Latin America: The Role of External Factors”, Working Paper 631, IADB Research Department

Growth in Industrial Countries

International Financial Conditions

Commodity Prices

LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.

These countries represent 91% of Latin America’s GDP.

Economic Fluctuations in Latin America: The Role of External Factors*

(LAC-7; real GDP, annual growth rate)

Economic Activity Under Two Hypotheses on the Global Economy

GDP GrowthGDP Growth(LAC-7, annual growth rate)(LAC-7, annual growth rate)

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

2006 2007 2008 2009 2010 2011 2012 2013

1991-2007 Avg.: 3.3%

2003-2007 Avg.: 5.8%



V-Shaped 2009-13 Avg.: 1.9%

L-Shaped L-Shaped 2009-13 Avg.: 0.1%2009-13 Avg.: 0.1%



95

100

105

110

115

120

125

2006 2007 2008 2009 2010 2011 2012 2013

Economic ActivityEconomic Activity(LAC-7 GDP, 2006 = 100)(LAC-7 GDP, 2006 = 100)

Pre-Crisis Levels



V-Shaped L-Shaped

Peak Dec-08 Dec-08

Trough Sep-09 Dec-10

P-to-T -3.9% -5.1%

Recovery* Mar-11 Dec-13


ECONOMIC ACTIVITY UNDER TWO HYPOTHESES ON THE GLOBAL ECONOMY

Moreover, Moreover, in the L-shaped scenario the region could in the L-shaped scenario the region could experience negative growth in 2009 and 2010 and experience negative growth in 2009 and 2010 and average growth will be close to zero in the next five average growth will be close to zero in the next five yearsyears, indicating that Latin America should prepare , indicating that Latin America should prepare for tougher economic conditions in the years to comefor tougher economic conditions in the years to come

CONCLUSIONSCONCLUSIONS

Under both hypotheses, output performance for the Under both hypotheses, output performance for the next five years will be mediocre at bestnext five years will be mediocre at best and and substantially below the 6 percent average growth substantially below the 6 percent average growth rates of the previous boom (2003-2007)rates of the previous boom (2003-2007)

Fiscal PositionFiscal Position

Fiscal Position Under Two Hypotheses on the Global Economy



1.8%

2.3%

2.8%

3.3%

3.8%

4.3%

2006 2007 2008 2009 2010 2011 2012 2013

Interest PaymentsInterest Payments(LAC-7, % of GDP)(LAC-7, % of GDP)



2.3%

4.1%

2.6%

V-Shaped L-Shaped

Trough 2008 2008

Peak 2012 2013

Δ T-to-P 0.4% 1.8%

Recovery* n.a. n.a.

Fiscal RevenuesFiscal Revenues(LAC-7, 2008 = 100)(LAC-7, 2008 = 100)

2006 2007 2008 2009 2010 2011 2012 2013

87

92

96

101

105



100

105

95

93

86

V-Shaped L-Shaped

Peak 2008 2008

Trough 2010 2011

P-to-T -7.2% -13.5%

Recovery* 2012 n.a.


Primary ExpenditurePrimary Expenditure(LAC-7, 2008 = 100)(LAC-7, 2008 = 100)

80

85

90

95

100

105

2006 2007 2008 2009 2010 2011 2012 2013

Fiscal Position Under Two Hypotheses on the Global Economy

Fiscal BalanceFiscal Balance(LAC-7, % of GDP)(LAC-7, % of GDP)

-6%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

2006 2007 2008 2009 2010 2011 2012 2013



1.6%

-2.6%

-5.0%

0.3%

-3.7%

Public DebtPublic Debt(LAC-7, % of GDP)(LAC-7, % of GDP)

23%

28%

33%

38%

43%

48%

53%

2006 2007 2008 2009 2010 2011 2012 2013



34%

27%

49%



FISCAL POSITION UNDER TWO HYPOTHESES ON THE GLOBAL ECONOMY

Although the region starts from a strong fiscal positionAlthough the region starts from a strong fiscal position, , under the L-shaped scenario the combination of under the L-shaped scenario the combination of declining economic activity, collapsing commodity prices declining economic activity, collapsing commodity prices and rising financial costs, leads to a and rising financial costs, leads to a gradual, persistent gradual, persistent and potentially severe deterioration in the overall fiscal and potentially severe deterioration in the overall fiscal positionposition (even under very conservative assumptions on (even under very conservative assumptions on primary expenditures)primary expenditures)

Fiscal deterioration results in an exponential dynamics of Fiscal deterioration results in an exponential dynamics of public debtpublic debt

CONCLUSIONS CONCLUSIONS

Banking IndicatorsBanking Indicators

Banking Indicators Under Two Hypotheses on the Global Economy

Non Performing LoansNon Performing Loans(LAC-7, in % of Total Loans)(LAC-7, in % of Total Loans)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

2006 2007 2008 2009 2010 2011 2012 2013



8.8%

4.3%

2.1%



Loan Loss ProvisionsLoan Loss Provisions(LAC-7, Loan Loss Provisions to Non Performing Loans)(LAC-7, Loan Loss Provisions to Non Performing Loans)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2006 2007 2008 2009 2010 2011 2012 2013



0.4

1.1

2.4

V-Shaped L-Shaped

In % 5.9%32.1%

Bank Capital Losses

BANKING INDICATORS UNDER TWO HYPOTHESES ON THE GLOBAL ECONOMY

Although initial conditions of banks in the region are Although initial conditions of banks in the region are sound, sound, the decline in economic activity in the L-shaped the decline in economic activity in the L-shaped scenario could lead to a gradual and relatively large scenario could lead to a gradual and relatively large deterioration in bank’s loan portfoliosdeterioration in bank’s loan portfolios resulting in equally resulting in equally large capital losseslarge capital losses


Liquidity IndicatorsLiquidity Indicators

Liquidity Indicators: A Simple Analytical Framework

Liquidity Indicators Liquidity Indicators

DefinitionDefinition

RRtt

B B t+1t+1STST

ILR ILR tt ==

wherewhere

ILRILRtt = International Liquidity Ratio in t = International Liquidity Ratio in t

RRtt = International Reserves in t = International Reserves in t

BBSTSTt+1t+1

= Public Debt Amortizations in t+1= Public Debt Amortizations in t+1

B tST

t

Debt Amortization ProfileDebt Amortization Profile

1 2 3 4 5

6


1 2 3 4 5

B tST

t

ILR DynamicsILR Dynamics

Rt

B t+1ST

t

0 1 2 3 4

ILR with no Financial Precarization


1 2 3 4 5

B tST

t t

0 1 2 3 4

Rt

B t+1ST


Precarization Precarization EffectEffect



ILR with no Financial Precarization

ILR with Financial Precarization


1 2 3 4 5

B tST

t t

0 1 2 3 4

Rt

B t+1ST


Fiscal Fiscal EffectEffect



Fiscal EffectFiscal Effect



t

0 1 2 3 4

Rt

B t+1ST

Effective Level of Reserves Effective Level of Reserves (R’)(R’)

R’t

B t+1ST


Effective Level of Effective Level of Reserves EffectReserves Effect


Degree of intervention in the FX marketDegree of intervention in the FX market

Degree of liquidity assistance to the Degree of liquidity assistance to the corporate and banking sectorcorporate and banking sector

Willingness to use reserves for public debt Willingness to use reserves for public debt repaymentsrepayments



t

0 1 2 3 4

Rt

B t+1ST

R’t

B t+1ST


Effective Level of Effective Level of Reserves EffectReserves Effect



Determinants of ILR DynamicsDeterminants of ILR Dynamics

Initial level of public debtInitial level of public debt

‘‘Effective’ level of international reservesEffective’ level of international reserves

Time profile of debt amortizationsTime profile of debt amortizations

Dynamics of fiscal deficit and public debt Dynamics of fiscal deficit and public debt (which will depend on the initial fiscal (which will depend on the initial fiscal deficit and the policy response)deficit and the policy response)


ConclusionsConclusions

The likelihood of a liquidity crisis as The likelihood of a liquidity crisis as determined by ILRs determined by ILRs will depend on the will depend on the interaction between external factors (i.e. interaction between external factors (i.e. duration of the global crisis) and duration of the global crisis) and idiosyncratic factors (i.e. determinants of idiosyncratic factors (i.e. determinants of ILRs dynamics)ILRs dynamics)

Not every country may hit a critical threshold Not every country may hit a critical threshold in the relevant period of the global crisis and in the relevant period of the global crisis and for those that do, they will not do so at the for those that do, they will not do so at the same time. Liquidity crises, if they occur, will same time. Liquidity crises, if they occur, will be sequential rather than simultaneousbe sequential rather than simultaneous

Liquidity problems may evolve gradually Liquidity problems may evolve gradually but materialize suddenly when a critical but materialize suddenly when a critical threshold is hit. threshold is hit.

Threshold

0 1 2 3 4

t

Rt

B t+1ST


Country 1Country 1

Country 2Country 2

Liquidity CrisisLiquidity Crisis


Liquidity Indicators Under Two Hypotheses on the Global Economy



ILR 2t = Reservest / (Public Debt Amortizationst+1 + Short Term Private External Debt Amortizations)

ILR DynamicsILR Dynamics(LAC-7, ILR(LAC-7, ILR22))

V-Shaped Scenario

L-Shaped Scenario

80%

90%

100%

110%

120%

130%

140%

2008 2009 2010 2011 2012

Normal International Financial Conditions

LIQUIDITY INDICATORS UNDER TWO HYPOTHESES ON THE GLOBAL ECONOMY

Under the L-shaped scenario, Under the L-shaped scenario, liquidity ratios could liquidity ratios could gradually evolve towards critical thresholdsgradually evolve towards critical thresholds increasing increasing the likelihood of a liquidity crisis and a severe output the likelihood of a liquidity crisis and a severe output contractioncontraction


CLOSING REMARKS (I)

Under a V-shaped global recoveryUnder a V-shaped global recovery, the dynamics of key , the dynamics of key macro fundamentals, i.e., fiscal, banking and liquidity macro fundamentals, i.e., fiscal, banking and liquidity indicators, suggest that indicators, suggest that the predominant views on the the predominant views on the region are largely correctregion are largely correct

Thus, the recessionary impact of the global crisis will be Thus, the recessionary impact of the global crisis will be inevitable, but inevitable, but liquidity crises and economic collapses will liquidity crises and economic collapses will be largely preventedbe largely prevented

However, a moderate perturbation from the V-shaped However, a moderate perturbation from the V-shaped scenario completely changes the region’s outlookscenario completely changes the region’s outlook

CLOSING REMARKS (II)

It is against this backdrop, of a potentially more fragile It is against this backdrop, of a potentially more fragile scenario evolving through time, that scenario evolving through time, that proposals to pursue proposals to pursue active countercyclical fiscal policies must be evaluated with active countercyclical fiscal policies must be evaluated with carecare

Under an L-shaped scenario, there is a Under an L-shaped scenario, there is a large and persistent large and persistent deterioration in key macro fundamentalsdeterioration in key macro fundamentals, i.e., fiscal, , i.e., fiscal, banking and liquidity indicatorsbanking and liquidity indicators

A key feature of this scenario is that A key feature of this scenario is that the deterioration in the deterioration in fundamentals is gradual and therefore problems may not fundamentals is gradual and therefore problems may not become evident until it is too latebecome evident until it is too late

CLOSING REMARKS (III)

The challenge is thus to The challenge is thus to anticipate gathering problems anticipate gathering problems early on early on to act in a timely fashion, and to to act in a timely fashion, and to design a set of design a set of policies that prevent countries from entering into financially policies that prevent countries from entering into financially fragile territoryfragile territory that might expose them to a liquidity crisis that might expose them to a liquidity crisis and a major economic collapse and a major economic collapse

Precarious access to credit markets for many emerging Precarious access to credit markets for many emerging market governments market governments calls for multilaterals to step in and calls for multilaterals to step in and play a key role as a lenders-of-last resortplay a key role as a lenders-of-last resort, akin to the role , akin to the role that credible governments, such as the US government, that credible governments, such as the US government, play domesticallyplay domestically

(Latin EMBI and Latin CEMBI, Yield in %)

Sovereign and Corporate Bonds in USSovereign and Corporate Bonds in US(US 10y T-Bonds and US BBB Corporate, Yield in %)

Latin EMBI

Latin CEMBI

6

7

8

9

10

11

12

13

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Mar

-09

Source: Bloomberg

US 10Y

BBB

US

10

Y

BB

B

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Jan-

09

Mar

-09

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

Sovereign and Corporate Bonds in LACSovereign and Corporate Bonds in LAC

PRECARIOUS CREDIT MARKETS: US VS EMs

Total Borrowing Requirements

Full Support

Public Debt Amortizations

402

Fiscal Deficit Financing 236

Geithner’s Proposal* 39

638

Passive Fiscal Deficit 198

LAC-7 is the sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.


*Assuming full impact of the Keynesian multiplier on output and fiscal revenues.

External 52

Domestic 350

Partial Support

Fiscal Deficit Financing Only

228

236

39

464

198

34

194

0

236

39

236

198

0

0

No Multilateral Support

Full Financing of Fiscal Deficit and No Financing of

Debt Amortizations

Normal International Financial Conditions

Full Financing of Fiscal Deficit and Partial Financing of Debt

Amortizations

75%

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

2008 2009 2010 2011 2012

ILR Dynamics Under Alternative Strategies(LAC-7, L-Shaped Scenario, ILR(LAC-7, L-Shaped Scenario, ILR22))

ILR 2t = Reservest / (Public Debt Amortizationst+1 + Short Term Private External Debt Amortizations)

Strategy

Support by Multilaterals: Alternative Strategies(LAC-7, billions of dollars, 2009-2010)

RECENT INICIATIVES: POINTING IN THE RIGHT DIRECTION

• Increase in resources of the IMF (US$ 500 bn)Increase in resources of the IMF (US$ 500 bn)

Increase in the lending capacity of multilaterals with Increase in the lending capacity of multilaterals with a focus on liquidity and crisis preventiona focus on liquidity and crisis prevention

• New SDR allocation (US$ 250 bn)New SDR allocation (US$ 250 bn)

• Provision of trade financing (US$ 250 bn)Provision of trade financing (US$ 250 bn)

• IMF new FCL and HAPAIMF new FCL and HAPA

New (and more flexible) array of financial instrumentsNew (and more flexible) array of financial instruments

• Recapitalization of MDBsRecapitalization of MDBs

Recognition of the complementary role of the IMF Recognition of the complementary role of the IMF and MDBsand MDBs

Ernesto Talvi, CERESErnesto Talvi, CERESAlejandro Izquierdo, IADBAlejandro Izquierdo, IADBCoordinatorsCoordinators

Prepared for Presentation at the XXIX Meeting of the Latin American Network of Prepared for Presentation at the XXIX Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC, April 22Central Banks and Finance Ministries, IADB, Washington DC, April 22ndnd, 2009., 2009.

Ernesto Talvi, CERES Alejandro Izquierdo, IADB Coordinators Prepared for Presentation at the XXIX...

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