The IMF Western hemisphere director Nicolas Eyzaguirre warned yesterday of the impact of a sudden reversal of capital flows in Latin America.
He urged caution despite the current good performance and fundamentals of the regional economy, which the Fund says will grow at a faster pace in the next four years than the historic average.
The IMF’s forecast of accelerated growth comes at a time of growing uncertainty in the global economy and possible monetary tightening in the European Union and the US.
“Don’t get used to living with too high a level of external financing, and especially with a high level of external financing of a short-term nature, because that is a recipe for trouble,” Eyzaguirre said yesterday in an interview with Emerging Markets. “A sudden reversal of capital flows could precipitate a crisis from one day to another.”
Eyzaguirre said conditions that explain the fast growth are likely to remain there for a while – both external and internal conditions.
“There has been fundamental progress in the region which will make it possible for the Latin American economies to achieve a higher level of external financing on a permanent basis.
“In terms of the risks, the faster you run, the more precipitous the shock can be if something goes wrong. Probably you need to be even more countercyclical and even more cautious when it comes to building buffers to be able to resist a possible shock,” Eyzaguirre said.
Former IDB chief economist Guillermo Calvo said that “liquidity can disappear not only for fundamental reasons, but for liquidity reasons. For example, if the US rate takes a hike. And we have seen that in the past.”
Eyzaguirre stressed that a potential reversal of capital flows may be even more damaging than inflation, which has already reached double digit levels in various countries.
“What we should be worried about the most is the amount and the size of capital flows. Inflation is a very pervasive and worrisome phenomenon, but inflation does not move dramatically from one day to another. ... It is not something that can derail the growth process in itself. But capital flows can,” he said.
Eyzaguirre said that economically policies in the region “are less procyclical than they used to be – both in the fiscal and the monetary domain, as well as in the financial sector supervision,” he said.
Nevertheless, “if the intensity of capital flows continues as it has been and the bias towards more volatile sources remains, that should unleash a policy response to mitigate the potential effects.”
The threats of bubbles may resurface. “Some of the flows that we are seeing are healthy flows, they are going in the direction of rebalancing the world economy in terms of capital flows, and Latin America in particular has a strong basis to absorb those flows”, Calvo said. “My concern is that there could be an element of bubble and this element could disappear very quickly if interest rates go up.”