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Emerging Markets

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Latin economists sound alarm on debt, banking outlook

The Latin American economy risks a dramatic deterioration in its fundamentals – including fiscal, banking and liquidity indicators – if policymakers fail to take urgent action, leading economists have warned.

They cautioned against the belief that the global economy will recover steam early next year.

A growing number of experts argue that although the region enters the global crisis in a strong fiscal position, a more protracted world slowdown could result in a “gradual, persistent and large” fiscal deterioration.

That could radically alter public debt dynamics and lead to large capital losses in the banking sector.

Ernesto Talvi, director of the Uruguay-based Centre for the Study of Economic and Social Affairs (Ceres), said that under an “L-shaped” growth scenario, the region will experience negative growth in 2009 and 2010 and the average growth could be “close to zero” for the next five years.

“The dynamics of output, and the impact on revenues, will have knock on effects on the dynamics of interest rates, public debt, exchange rates and so on,” he told Emerging Markets.

“Revenues could falter and interest payments would then rise sharply. All this could occur even if we assume that global growth contracts at consensus rates, but that the recovery takes longer to occur.”

Talvi added that the mindset of the region’s policymakers “is one where we went from a belief in decoupling to another perspective, but one that is still complacent and based on the view that the region is still in a relatively strong position. This view is dangerous.”

He added: “Unless you’re prepared to believe religiously that we will have a mild contraction, followed early next year by a recovery, you have to take a more cautious view with respect to policy. Liquidity issues must be a central part of any framework evaluating the region’s risks and policy trade-offs.”

Claudio Loser, former director of the IMF’s Western Hemisphere department, said he fears a sharper fall in global output could wreak havoc on Latin America’s financial sector. “You may have to have contingency plans that cover the [financial] system on the order of 20% of GDP,” he said. “I’m a bit nervous about this – it could be in the range of $200 billion.”

Former IDB chief economist Guillermo Calvo argued that sustainable structural fiscal positions must be upheld “despite the political temptation to indulge in counter-cyclical policies.” Otherwise a public financing crunch could emerge from a prolonged downturn, he said.

Talvi noted that the “best countercyclical policy we can afford is to reduce the probability of a catastrophe or a run on the system.”

Rather than costly pump priming, the region – together with multilateral lenders – should “focus on refinancing the stock of debt that comes due – and to refinance it on the long term, not the short term as the IMF is proposing today.”

He calculates that the region’s borrowing requirements – including public debt amortizations and fiscal deficit financing – total $637 billion over the next two years, with $325 billion alone this year.

Such views contrast with a resurgent market optimism that a severe global recession could be avoided following US policy initiatives last week. Last night US Treasury Secretary Tim Geithner acknowledged to an audience in Medellin that “the recovery around the world depends on a recovery in the US”.

Guillermo Mondino, head of Latin America research at Barclays Capital, said: “Growth is going to come back rapidly towards the end of next year. Once we start turning around, we are probably going to have a healthy year in 2010.”

And Joyce Chang, global head of emerging markets at JP Morgan, said that this is neither a “monetary crisis” nor a “sovereign debt crisis”, but a “a real economy crisis ... in a synchronized world downturn”.

Philip Suttle, global head of economic research at the IIF, said: “There are already some tentative signs of improvement both in terms of the financial markets as well as the economic data flow.”

But other analysts draw a darker picture. Gray Newman, chief Latin American economist at Morgan Stanley, said: “The severity of the downturn is likely to tell you a great deal about the duration of the downturn.”

He predicts that Latin America’s economy will contract by 4% this year, against the IIF’s forecast of –1.3%. “We expect the product of the deleveraging of markets, households and firms to provide little chance for a meaningful recovery in 2009 or for most of 2010.”

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