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The region posts solid gains

Latin America and the Caribbean will achieve a growth rate of 5 percent in 1997, substantially surpassing last year's 3.6 percent, according to the latest IDB estimates. The region's economic growth in 1997 will tie the 1994 level, which was the highest since before the debt crisis of the 1980s.The growth forecasted for 1997 means that average per capita income will rise by 3 percent.

Argentina, Chile, Mexico, Peru and some of the smaller economies will post growth rates near or better than 6 percent. Brazil's economy will grow only 4 percent this year, but even this will contribute to an overall improvement over last year's growth levels.

On another bright note, inflation in Latin America during 1997 may drop to an average of 12 percent (weighted by the population of each country), or a median rate of 9.5 percent--the lowest level in several decades. In 1996 the weighted average inflation was 18.5 percent, and in 1995 it was 27.7 percent, not to mention average rates above 100 percent in previous years.

Has Latin America turned the corner? Perhaps, but the region is still burdened by chronic weaknesses in some key areas, and this year's performance should be greeted with caution, not euphoria.

In fact, there are signs that this year's 5 percent growth rate may not be sustainable. According to estimates in the 1997 edition of the IDB report Economic and Social Progress in Latin America, the region's potential for sustainable growth is probably closer to 4 percent, assuming that current economic policies and institutional frameworks remain unchanged. This said, it must be recognized that Latin America has come a long way. The potential for sustainable growth today is much greater than a decade ago. The IDB has estimated that structural and macroeconomic reforms carried out by the region's governments in the past 10 years have added two percentage points to the region's long-term, sustainable economic growth. These reforms have also contributed substantially to alleviating macroeconomic problems that resulted from past price instability and fiscal turmoil.

Latin America's fiscal situation has improved considerably. In fact, most Latin American countries have fiscal deficits below 3 percent of GDP, thus meeting the conditions for fiscal discipline set by the European Union's Maastricht Treaty. Not only are fiscal deficits in Latin America smaller than those of developed countries when they are measured as a percentage of the gross domestic product, but also when they are measured with respect to tax revenue, which obviously is much more modest in Latin America than in the industrialized world.

Finally, it is remarkable that Latin America has achieved fiscal discipline even as it advances rapidly toward democratization and decentralization in areas such as the provision of social services and fiscal and tax administration. It could be assumed that these changes would put serious pressures on the public treasury, but that has not prevented a major fiscal consolidation, as mentioned above.

REFORMS AND BOOMS...Given these favorable developments, why is there a need for caution? As explained in the report, stabilization and reforms completed by many countries in recent years have produced spending and credit booms in excess of what local economies could absorb, in spite of the better framework for growth created by these very same reforms.

The high rate of growth for the region in 1997 could be partly influenced by this temporary overabundance of spending and credit. Such financial booms lead to financial, external and fiscal vulnerabilities. Banks become overextended and take on excessive risk. External debt increases at an unsustainable rate, while the real exchange rate appreciates and exports lose competitiveness. With abundant external financing and tax resources, governments tend to increase spending. However, those means of financing may prove to be temporary, and the deficits unsustainable, forcing painful corrections.

Another reason for caution is decentralization, which still could become a factor in the destabilization of public finance. In a number of countries, systems of fiscal transfers to the regions tend to reinforce procyclical public spending and facilitate excessive indebtedness of state and local governments.

TOWARDS LONG-TERM GROWTH...According to the report, Latin America faces three great challenges: consolidating macroeconomic stability, completing structural reforms, and substantially elevating the level of education of its work force. By doing so Latin America can sustain a 6 percent growth rate that would significantly reduce poverty and inequity.

It is generally accepted that success in consolidating macroeconomic stability depends on maintaining prudent monetary and fiscal policies. But this is easier said than done in countries where financial systems are weak or poorly regulated, or when fiscal institutions do not allow room for maneuver during critical periods. Indeed, while prudent monetary and fiscal policies may appear less urgent to countries that are in the midst of a fiscal boom, this is when they are most needed.

Latin American fiscal institutions, despite their success in reducing deficits, even in the face of growing democracy, are not immune from weaknesses. The region's fiscal institutions should be designed in order to prevent public spending from increasing during booms and during elections, as is now conspicuously the case.

Fiscal institutions must also be reformed by putting in place transparent budget controls that cannot be manipulated by governments, and which must be scrutinized by independent referees who do not take part in spending decisions. But consolidating macroeconomic stability is not enough. The region's structural reform process is also incomplete. Countries have not advanced at the same pace, and some are far behind. The IDB estimates that if the reforms now being carried out are completed in the areas of trade and financial liberalization, improved tax collection and reduced state participation in areas better performed by the private sector, sustainable annual economic growth in the region could reach 5.5 percent.

EDUCATION HOLDS THE KEY...Despite the importance of structural reforms, the main obstacle to economic growth in the medium term is deficient educational systems.

According to the report, educational reforms will not come easily, but they will yield substantial benefits. If in the next 10 years the average level of schooling in Latin America is increased from the present five years to 6.8 years, sustainable growth could be raised by at least one percentage point, according to estimates derived from several studies. If improvements in the quality and extent of schooling are combined with the completion of structural reforms, the region's sustainable economic growth rate could increase to 6.5 percent per year.

Education is the key, not only in accelerating economic growth, but also in alleviating poverty and inequality in Latin America, which now has the most unequal distribution of wealth in the world.

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