News Releases

Mar 31, 2009

Crisis harming Latin America and Caribbean long-term growth prospects

Multilaterals need to shift policy towards long-term lending to support countries, IDB study says

The global financial crisis will have important negative economic effects in Latin America and the Caribbean even if rich nations start to recover in 2010, according to a study by the Research Department of the Inter-American Development Bank (IDB).

The annual average output growth in the region’s seven biggest economies—Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela—could slow to 1.9 percent in the 2009–2013 period if developed nations begin their economic recovery in the second half of the year.  However, growth could slow to an annual average of only 0.1 percent in the next five years if recovery in the United States and Europe takes longer than expected. The seven nations grew 5.8 percent between 2003 and 2007.

The results of the study—"Policy Tradeoffs for Unprecedented Times: Confronting the Global Crisis in Latin America"—were presented at a session with the Board of Governors of the IDB. Representatives of the Bank’s 48 member countries are meeting in Medellin March 29–31 to discuss the impact of the global financial crisis and ways the IDB can increase its support to the region.

A prolonged economic slowdown in rich nations combined with reduced capital flows could deteriorate the fiscal, liquidity and banking system situation of some countries in the region. As a result, governments need to be aware of policy trade-offs.  In some cases, measures to foster growth in the short-term could end up increasing the risk of fiscal disarray and liquidity problems in the medium-term.

“Latin America and the Caribbean are much more prepared to face the impacts of the financial crisis because of their lower levels of debt, debt dollarization, smaller budget deficits and high level of international reserves.’’ said Santiago Levy, Vice-President of Sectors and Knowledge at the IDB. “But they will still suffer the effects.  Depending on how rapidly growth in the rest of the world picks-up, the collateral damage of the crisis could be felt years to come and policies need to be devised to protect the most vulnerable in society while ensuring macroeconomic sustainability.”

The crisis could prompt the seven biggest economies in the region to post budget deficits in coming years from a combined surplus of 1.6 percent of the gross domestic product in 2007. The shortfall may increase to 2.6 percent of the gross domestic product next year, under the scenario that developing countries will begin a recovery at the end of 2009. The deficit may rise to 5 percent of their GDP in 2011 if rich nations take longer to recover, and no measures are taken to counter inertial tendencies.

Indebtedness is also expected to increase by 2013 from a low of 27 percent of GDP in 2008. The total debt-to-GDP ratio of the seven countries may rise to 34 percent if recovery begins this year. It may rise to 49 percent if recovery in developed nations takes longer to materialize.

Proposal for Multilateral Support

The region’s seven biggest economies need to finance $400 billion of maturing public debt in the next two years and may potentially need another $200 billion to finance their growing budget deficit. Argentina, Brazil. Chile. Colombia, Mexico, Peru and Venezuela represent 91 percent of the output of Latin America and the Caribbean.

Multilateral support will be “vital” for the region, particularly if access to credit market remains constrained for several years.  To avoid a precarious financial situation, multilaterals need to step in and play for these countries the same role governments with better access to credit do to channel funds domestically.

“The question is not whether the multilaterals should play a key role in the current crisis, but which is the most effective way to channel their intervention,” the study said.

The study recommends the multilateral system should help countries achieve sustainable fiscal positions gradually while protecting social programs and enhancing productivity. In addition, multilateral institutions should shift their policies towards long-term financing from short-term emergency lending.

Policy coordination is a key element for multilateral support to be effective. When it is needed, the International Monetary Fund could help countries ensure a consistent macro-economic framework to prevent a deterioration of the country’s fiscal and debt situation and a liquidity crisis. Meanwhile, multilateral development institutions such as the IDB should help design policies so countries reap the best social benefits while insuring policies are not an obstacle to future productivity growth.

Social and Labor Policies for Difficult Times

Based on previous crises, formal employment is expected to decline more in small and medium firms, which represent two-thirds of employment and as much as 40 percent of the region’s GDP, the study said.

In addition, if left unattended, the crisis could have detrimental effects on education and health as it may prompt households and governments to cut spending on services.  Data from 59 developing countries show that periods of crisis, particularly large ones, produced substantial increases in infant mortality. That is why the study emphasizes the critical importance of effective social programs.

“The challenge is to develop a social safety net that promote productivity while protecting welfare,’’ Levy said.

Also available in: Español