Finance chiefs raise alarm on US Latin fallout
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Emerging Markets

Finance chiefs raise alarm on US Latin fallout

Debate rages on commodity prices, inflation

Finance chiefs gathered in Miami remain divided on the fallout of a likely US recession on Latin America, as prospects for global economic growth dim.

Citi senior vice chairman Bill Rhodes said in an interview with Emerging Markets yesterday: “We are about half way through the adjustment in the US economy. It has yet to run its course.”

Although the impact on Latin America has yet to be felt, the veteran Wall Street banker warned that the key variable is the severity of a US slowdown. “It will depend on how long, and how deep, a downturn you have in the US.”

His comments come as rich-world policy makers gear up for the G7 and IMF spring meetings on Friday and Saturday in Washington, eight months after the credit crunch first swept global markets.

Mexican finance minister Agustin Carstens, speaking at the Emerging Markets Latin America Lectures yesterday, was more sanguine. “I am confident we can withstand the impact of a US slowdown”, he said.

Charles Dallara, managing director of the Institute of International Finance, said that the US financial crisis has yet to unfold fully. “At this stage we are approaching the epicentre of the financial crisis. Even though it seems quite dark, I think we are approaching the last half of this.”

Although he noted the immediate impact on Latin America is likely to be mild, a prolonged weakening of the US economy “will have quite a substantial impact”, he said.

An easing in commodity prices this year and beyond could spur fresh dilemmas for central banks, especially in emerging economies, Dallara added. “Any central bank will face a real challenge of containing inflation while commodity prices are backing off a little bit. It’s going to be very complicated for Latin America.”

The IIF forecasts a 1% drop in regional growth this year, at 4.4%, easing to 4.1% in 2009. But this sum could drop further, “depending on the evolution of the US economy”.

Paulo Leme, managing director of emerging market economic research at Goldman Sachs, struck a more optimistic note, arguing that while the US crisis may “take away some of the froth”, the global economy is “not at beginning of a glacial period”.

He added: “Commodities are the strongest transmission channel, but the situation at the moment is comfortable.”

Former Deutsche Bank chief economist Liliana Rojas Suarez pointed out that a combination of dollar weakness and medium-term structural factors – including supply problems – will keep commodity prices high in the near future. “Investors take commodities as a safe haven when the dollar depreciates,” she said.

But she pointed to the risks resulting from US Federal Reserve governor Ben Bernanke’s sharp rate cuts and massive liquidity injections to the US financial system. “It will be very difficult to avoid inflation,” she said. “All this excess liquidity will have to be reabsorbed”, and the Fed will be forced to hike rates sharply.

“This will have a huge impact on Latin America,” she said. “Historically sharp rises in US interest rates have caused crises in Latin America.”

Other economists predict darker near term scenarios, including a double dip recession in the US. Guillermo Mondino, head of emerging market research at Lehman Brothers, told Emerging Markets that as the impulse from a forthcoming third quarter US fiscal package wanes going into next year, the American economy is likely to slow further.

“The impulse will only last during two quarters and then we go back into next year to slow down again,” he said. “[The package] will have a short term impact. It is not strong enough and targeted on the fundamental difficulties enough to operate a structural resolution of the issues.”

Latin America has “not yet suffered the shock,” Mondino added. He warned against taking a brief respite in the second half of the year as evidence that a global slowdown is over. “We may not be as well prepared as we should for a longer episode,” he said.

Dallara, however, dismissed the risk of a double-dip recession. “The serious issue is probably the extended weakness of the US economy with growth in the 1-2% range. That is the real risk,” he said.

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