Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB,...

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB, 2009 (A. Izquierdo & E. Talvi, coordinators)

EMDB Meeting on Debt IssuesEMDB Meeting on Debt IssuesJuly 8, 2009July 8, 2009

Alejandro IzquierdoAlejandro IzquierdoInter-American Development BankInter-American Development Bank


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

Initial ResilienceInitial Resilience

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 and Policy Proposals: Policy Trade-offs and Policy Proposals:

A Liquidity ApproachA 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::


* 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

EU-15*

Japan

Industrial Countries

External Factors: Industrial Countries Growth

Peak Trough

-3,4%

May-08 Forecast

Current Forecast

96

97

98

99

100

101

102

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

TroughPeak

-8,4%

Current Forecast

May-08 Forecast

90

92

94

96

98

100

102

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

94

95

96

97

98

99

100

101

102

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

-4,8%

Peak TroughMay-08 Forecast

Current Forecast

Peak Trough

-4,3%

Current Forecast

May-08 Forecast

95

96

97

98

99

100

101

102

103

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


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%


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 Spreads

The End of the Panglossian Period: International Financial Conditions

(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

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.

External Factors: International Financial Conditions


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

External Factors: International Financial Conditions


However, Latin America’s fundamentals were strong However, Latin America’s fundamentals were strong enough to withstand (at least initially) the worsening enough to withstand (at least initially) the worsening of global conditions…of global 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


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.

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


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.

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


……and, thus, the region was better equipped to and, thus, the region was better equipped to pursue countercyclical monetary and fiscal pursue countercyclical monetary and fiscal policiespolicies to mitigate the impact of adverse external to mitigate the impact of adverse external shocksshocks


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

However, Latin America’s fundamentals were strong However, Latin America’s fundamentals were strong enough to withstand (at least initially) the worsening enough to withstand (at least initially) the worsening of global conditions…of global conditions…


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


Predominant views: The recession in 2009 will be Predominant views: The recession in 2009 will be relatively deep but short livedrelatively deep but short lived, the region will return , the region will return to positive growth in 2010…to positive growth in 2010…


……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

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…


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 %

-1.9 %

91-97 Growth Average : 4.6%

98-02 Growth Average : 0.7%

03-06 Growth Average: 5.6%

Forecasts*

2.7 %


……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

Predominant views: The recession in 2009 will be Predominant views: The recession in 2009 will be relatively deep but short lived, the region will return relatively deep but short lived, the region will return to positive growth in 2010…to positive growth in 2010…


……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

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…


Phase 3

Latin EMBI

EMBI+

100

200

300

400

500

600

700

800

900

1000

Ene

-07

Abr

-07

Jul-0

7

Oct

-07

Ene

-08

Abr

-08

Jul-0

8

Oct

-08

Ene

-09

Abr

-09

Variaction in bps

Latin EMBI

EMBI+

67

71

Phase 1 Phase 2

469

448

-193

-205

Phase 3

SpreadsSpreads(EMBI+, Latin EMBI Spread in basis points)

Phase 1 Phase 2

External Factors

Commodity Prices International Financial Conditions

World Growth

Phase 3

40

60

80

100

120

140

160

180

200

Ene

-07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Ene

-08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Ene

-09

Mar

-09

May

-09

76

28

22

-71%

26%

Commodity PricesCommodity Prices(S&P GSCI Commodity Index, 03-Jan-07 = 100)

Phase 1 Phase 2Phase 3

25

30

35

40

45

50

55

60

65

Ene

-07

Mar

-07

May

-07

Jul-0

7

Sep

-07

Nov

-07

Ene

-08

Mar

-08

May

-08

Jul-0

8

Sep

-08

Nov

-08

Ene

-09

Mar

-09

Germany

Japan

USA

Manufacturing PMI*Manufacturing PMI*(difussion Index, Over 50= expansion)(difussion Index, Over 50= expansion)

Phase 1 Phase 2

* Purchasing Managers Index* Purchasing Managers Index

Impact of Distension of the Financial Crisis in the US on Key External Factors for LAC


Catastrophic scenarios seem to have been Catastrophic scenarios seem to have been ruled out as distension continues, making ruled out as distension continues, making scenarios covered in our report more scenarios covered in our report more relevant.relevant.

But: Will recovery be quick (as initially But: Will recovery be quick (as initially predicted by markets) or will it be more predicted by markets) or will it be more protracted (as experience on financial protracted (as experience on financial crisis would tellcrisis would tell)?)?








OUTLINE


ROADMAPROADMAP

To assess the predominant view on the region in the To assess the predominant view 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 under alternative hypotheses on how the dynamics under alternative hypotheses on how the global recovery unfoldsglobal 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


Tequila Crisis

Asian / Russian Crises

Dot-Com Crisis

Beginning of the Boom

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”, IADB and CERES Working Paper., Romero, R. and Talvi, E. (2008): “Booms and Busts in Latin America: The Role of External Factors”, IADB and CERES Working Paper

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)


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.

*Recovery to pre-crisis levels of output

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: Are Debt Dynamics Sustainable?

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%




Liquidity IndicatorsLiquidity Indicators


t

0 1 2 3 4

Rt

B t+1ST

R’t

B t+1ST

Fiscal Fiscal EffectEffect

Effective Level of Effective Level of Reserves EffectReserves Effect

Precarization Precarization EffectEffect

ILR DynamicsILR Dynamics

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)

Liquidity Indicators: A Simple Analytical Framework


ConclusionsConclusions

The likelihood of a liquidity crisis as The likelihood of a liquidity crisis as determined by ILRs determined by ILRs will depend on will depend on external factors (i.e. duration of the global external factors (i.e. duration of the global crisis) and idiosyncratic factors (i.e. crisis) and idiosyncratic factors (i.e. determinants of ILRs dynamics)determinants of 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. Therefore, problems may threshold is hit. Therefore, problems may not be evident until it is too latenot be evident until it is too late

Threshold

0 1 2 3 4

t

Rt

B t+1ST

ILR DynamicsILR Dynamics

Country 1Country 1

Country 2Country 2

Liquidity CrisisLiquidity Crisis

Liquidity Indicators: A Simple Analytical Framework


0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

2009 2010 2011 2012 2013

Normal InternationalFinancial Conditions

Sudden Stop

L -

V -

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

2009 2010 2011 2012 2013

Normal InternationalFinancial Conditions

Sudden Stop

Shaped Scenario

V - Shaped Scenario

Liquidity Indicators Under Two Hypotheses on the Global Economy

ILR Dynamics: Precarization and Fiscal EffectsILR Dynamics: Precarization and Fiscal Effects(LAC-7)(LAC-7)


80%

90%

100%

110%

120%

130%

140%

150%

160%

170%

180%

2009 2010 2011 2012 2013

ILR1

ILR2

80%

90%

100%

110%

120%

130%

140%

150%

160%

170%

180%

2009 2010 2011 2012 2013

ILR1

ILR2

ILR1

ILR2

90%

100%

110%

120%

130%

140%

150%

160%

170%

180%

190%

2009 2010 2011 2012 2013

ILR1

ILR2

90%

110%

120%

130%

140%

150%

160%

170%

180%

190%

2009 2010 2011 2012 2013

ILR Dynamics Under L-Shaped ScenarioILR Dynamics Under L-Shaped Scenario(LAC-7)(LAC-7)

ILR Dynamics Under V-Shaped ScenarioILR Dynamics Under V-Shaped Scenario(LAC-7)(LAC-7)

ILR 1t = Reservest / Public Debt Amortizationst+1

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

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

Liquidity Indicators Under Two Hypotheses on the Global Economy

Key to consider:Key to consider:

ILR Dynamics are ILR Dynamics are beforebefore IMF flexible IMF flexible credit linecredit line


Under a V-shaped global recoveryUnder a V-shaped global recovery, the dynamics of key macro , the dynamics of key macro fundamentals suggest that fundamentals suggest that the predominant views on the region the predominant views on the region are largely correctare largely correct

CONCLUSIONSCONCLUSIONS

MACRO DYNAMICS IN LATIN AMERICA UNDER TWO HYPOTHESES ON THE GLOBAL ECONOMY

Under the L-shaped scenario, Under the L-shaped scenario, the region could experiencethe region could experience negative growth in 2009 and 2010 and average growth will be negative growth in 2009 and 2010 and average growth will be close to zero in the next five yearsclose to zero in the next five years

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

IIt is crucial to anticipate gathering problems early ont is crucial to anticipate gathering problems early on to act in a to act in a timely fashion,timely fashion, and to design a set of policies that prevent esign a set of policies that prevent countries from entering into financially fragile territorycountries from entering into financially fragile territory








OUTLINE


Confronting the Global Crisis in Latin America: Policy Trade Offs

Mitigate Recessionary

PressuresTrade - Off Weaken Liquidity

Position

EXPANSIONARY FISCAL POLICY

ILR with expansionary

policy

GDP with expansionary policy and no liquidity crisis

Threshold

GDP with no policy

0 1 2 3 4

ILR

t

ILR with no policy

GDP

t-1 0 1 2 3

Threshold

GDP with expansionary policy and liquidity crisis


POLICY PRINCIPLES: MAIN GOALS

Anticipate gathering problems early onAnticipate gathering problems early on to act in a to act in a timely fashion timely fashion

Design a set of policies that prevent countries from Design a set of policies that prevent countries from entering into financially fragile territoryentering into financially fragile territory that might that might expose them to a liquidity crisis and a major expose them to a liquidity crisis and a major economic collapseeconomic collapse


(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

POLICY PRINCIPLES: CONSTRAINTS


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 (and borrowers)-of-last play a key role as a lenders (and borrowers)-of-last resortresort, akin to the role that credible governments, such , akin to the role that credible governments, such as the US government, play domesticallyas the US government, play domestically

The question then is The question then is not whether multilaterals should not whether multilaterals should play a key role in the current crisis, but which is the most play a key role in the current crisis, but which is the most effective way to channel their interventioneffective way to channel their intervention and at what and at what financial costfinancial cost

POLICY PROPOSALS

THE ROLE OF MULTILATERALSTHE ROLE OF MULTILATERALS


1.1. Strengthen the role of multilateral institutionsStrengthen the role of multilateral institutions. Multilateral support . Multilateral support will be vital under precarious access to credit markets.will be vital under precarious access to credit markets.

2.2. Move away from short-term financingMove away from short-term financing. Multilaterals should avoid . Multilaterals should avoid short-term emergency financing and only consider medium to short-term emergency financing and only consider medium to long-term financing in order to partially “complete” markets in long-term financing in order to partially “complete” markets in terms of maturities.terms of maturities.

3.3. Redefine the emphasis of multilateral supportRedefine the emphasis of multilateral support. Multilaterals . Multilaterals should not only provide medium to long-term financing for fiscal should not only provide medium to long-term financing for fiscal stimulus –when fiscal sustainability is not at stake– but more stimulus –when fiscal sustainability is not at stake– but more importantly, they should provide liquidity for refinancing of importantly, they should provide liquidity for refinancing of maturing debt obligations.maturing debt obligations.

4.4. Ensure that countries work towards sustainable fiscal policy Ensure that countries work towards sustainable fiscal policy while strengthening social protectionwhile strengthening social protection. Multilateral support should . Multilateral support should be complemented with incentive-compatible conditionality, to be complemented with incentive-compatible conditionality, to ensure fiscal sustainability and strengthen social protection. ensure fiscal sustainability and strengthen social protection.

POLICY PRINCIPLES


EMDB Meeting on Debt IssuesEMDB Meeting on Debt IssuesJuly 8, 2009July 8, 2009

Alejandro Izquierdo,Alejandro Izquierdo,Inter-American Development BankInter-American Development Bank

FULL REPORT AVAILABLE AT:

http://www.iadb.org/res/pub_desc.cfm?pub_id=B-635

Policy Trade-offs for Unprecedented Times: Confronting the Global Crisis in Latin America, IADB,...

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