Split forecasts reveal scale of LatAm policy bind
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Emerging Markets

Split forecasts reveal scale of LatAm policy bind

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The policy dilemma confronting Latin America’s economic stewards was thrown into sharp relief this weekend amid warnings that global uncertainty would continue to cloud the outlook for the region

The policy gridlock facing Latin economies was thrown into sharp relief this weekend amid warnings from leading experts that widespread and persistent global uncertainty would continue to cloud the outlook for the region.

Latin American economies could equally enjoy fairly robust growth in excess of that seen in rich countries, or alternatively be plunged into “a mild recession” this year, the IDB said yesterday in its flagship economic report.

Looming risks for the region include a worsening European debt crisis and a Chinese growth slump, the report said. “The world is one of forking paths and it is impossible to know which alternative will become reality,” the report said, though it pointed out the region nevertheless “has good reason to be optimistic.”

The sharply divergent scenarios will add to concerns voiced by experts in Montevideo that the balance of risks facing the region has left traditional policymaking in a bind.

Barry Eichengreen, a professor at the University of California, Berkeley, told Emerging Markets this weekend that uncertainty over whether the region was facing a benign outlook, slower growth and more capital flows or the prospect of a severe external shock made it “especially hard to formulate policies.”

But despite the challenges facing policymakers, they have more tools at their disposal than before, said IDB chief economist Santiago Levy. “We have a much stronger arsenal of instruments than we had in the past,” he said. “There is more space in monetary and fiscal policy. So we hope that the incidence of protectionism will be much lower or non-existent.”

But Phil Suttle, deputy managing director of the Institute of International Finance, which represents most of the world’s largest banking groups, warned that governments were not fully facing up the issue.

“Our biggest concern now is on the policy side – and that’s policy complacency,” he told Emerging Markets.

The bank’s baseline scenario forecasts a decline in regional growth from 5.4% on average over the last two years to 4%. In the worst case scenario in Europe and in China, the region would be plunged in a “relatively mild recession”, according to the IDB.

The report also considers the potentially destabilizing effects of capital inflows. “About 50% of inflow surges in emerging economies end in either a banking crisis or a recession,” it says.

Levy added: “The composition of capital inflows has changed. Portfolio investments are more volatile. I do not mean to say there are such risks at the moment, but it could be a source of vulnerability going forward.”

The IDB report highlighted the threat from a renewed European crisis. “If Europe suffers a recession through 2012 and a crisis in 2013, the effects on Latin America and the Caribbean would be both deeper and more persistent,” it said.

“A shock of comparable magnitude to Lehman but originating in Europe, plus an autonomous negative shock to growth in China, would provoke a relatively mild recession for Latin America and the Caribbean.”

But Levy said there reason to be optimistic: income has increased twice as much as public debt, international reserves continue to grow and are at a higher level than in 2008, and they are also higher than the level of public debt.

In an interview with Emerging Markets, Ricardo Lagos, who was the president of Chile for most of the last decade, said that the global financial crisis had hit after six years of “tremendous growth” in Latin America.

“But that growth came about not so much because of what we did, but rather – simply – because of the engine of growth in China and other Asia economies. Prospects remain good so long as the Chinese engine keeps working,” he said.

“Even though we are in much better shape, the outlook depends on us – and on whether we understand that most of today’s revenues have to be invested in long term projects and not channelled to current fiscal expenditure.”

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