Attempting to generalize about the economic picture in Latin America can often seem like trying to flatten out a balloon. When one country is booming, another falls into a crisis or correction.Take Argentina and Mexico. Both now boast strong economies, with growth rates driven by rapid export and investment growth, besting last year's regional average of 3.6 percent. Memories of capital flight and recession following the devaluation of the Mexican peso in 1994 have dimmed.
But as these two countries forge ahead, mighty Brazil, which accounts for half the South American land mass and population, is lagging. Its strong currency and large external deficits raise fears that Brazil could be headed for another round of monetary instability. And then there's the special case of Venezuela, where the cost of living rose 100 percent in 1996, compared with the regional average of 11 percent.
Can any sense be made out of this potpourri of performances?
The uneven growth and inflation rates become more understandable if we recognize that countries go through clear cycles of reform, expansion, correction, and post-correction, as described in the 1997 edition of the IDB report Economic and Social Progress in Latin America. Country by country, the cycles differ in intensity but the patterns remain similar.
If managed correctly, cycles need not be a cause for alarm, says the report. They are natural, evolutionary processes that accompany major stabilization and reform efforts. The problems arise when the cycles and their root causes are ignored.
Good macroeconomic policies reduce the severity of the cycles. But if the wrong policies are put in place, and if needed reforms are delayed, it can be a very bumpy ride indeed.
LAYING THE GROUNDWORK...
At first glance, some countries appear to be losing ground when in fact they are preparing the foundation for major improvements.
Venezuela's very high inflation in 1996 was caused by an economic stabilization and reform package that included a sharp devaluation and elimination of domestic price and exchange controls. This year, Venezuela's inflation, which started out at 100 percent, should settle down to 30 40 percent.
The country's reform program, called Agenda Venezuela, is founded on three fundamental changes: labor reform, pension reform, and privatization.
The IDB report points to Venezuela as a case study of how failing to carefully manage the ripple effects of a major reform can bring about the need for yet another stabilization program. The country's adjustment program, which began in 1989, ended in 1994 with recession, bank crises, and re-imposition of exchange controls. The ensuing period of economic instability could have been avoided if the country had managed the preceding, reform-induced "boom" more cautiously.
CHILE: THE CYCLE SLAYER...
Chile stands out as a country that has conquered the cycles. It began its reforms more than 20 years ago, and its growth rate, which last year reached 7 percent, is the highest in Latin America. In 1996, inflation fell, real wages rose 4.5 percent, and the country's savings rate now stands at 30 percent.
Today, Chile is much less vulnerable to economic shocks, such as when the price of copper, the country's chief export, fell last year. The economy shrugged off the reversal and continued its pace-setting growth.
TWO MATURE REFORMERS...
Bolivia and Uruguay are also at a relatively advanced stage in the reform cycle, and both are growing at rates of 4 percent annually.
Bolivia's recently completed privatization and pension reform programs, and the eventual completion of the natural gas pipeline to Brazil, will help boost the country's rate of growth and its efforts to reduce the gap in per capita income with wealthier neighbors.
Uruguay's challenge is to follow through on its present program of de-indexation, pension reform and government downsizing. Despite its relative stability, Uruguay's inflation was more than double the regional average in 1996, a problem that is gradually being corrected.
THE CHALLENGE OF BRAZIL...
Brazil faces yet a different set of challenges. The country is now in its third year of a reform process that succeeded in reducing inflation from 5,000 percent in 1994 to 11 percent in 1996. Today, Brazil is seeing a sharp upswing in domestic spending, with the result that the current account deficit increased from balance in 1993 to 3.3 percent of GDP in 1997¯typical signals of the expansion phase in the cycle identified by the IDB report.
Brazil's underlying vulnerability in the correction cycle was illustrated by the quick-trigger sell-off response of the Brazilian stock market to the "monsoon effect" caused by the monetary troubles in Thailand. In contrast, Argentina, Chile, and Mexico felt the Asian financial crisis to a much lesser degree.
Brazil has reduced fears of a banking crisis by tightening credit, which in turn is cooling off the economy, a move that reduces the danger of a sharp cyclical swing further down the road. The main challenge for Brazilian policymakers is to address the fiscal imbalance that has accompanied stabilization.
Prospects for Brazil's reform effort remain bright. With reserves of around $60 billion and a massive privatization program gaining momentum, the country is well positioned to complete its reform process while keeping up a growth rate as good as or better than Latin America's average.
BUMPY ROAD IN THE ANDES...
The economies of Colombia and Ecuador are showing many of the characteristics associated with the stress and correction phases of the adjustment process. The governments of both countries have already applied policies to reduce inflation and have carried out significant structural reforms.
As residents of both countries increased their holdings of domestic currency, spending increased and a bank lending boom resulted. Investment grew rapidly, especially in Colombia, where new oil fields attracted capital.
But in 1996, the bank lending boom slowed, real interest rates rose dramatically, and investment demand slumped. Ecuadorian and Colombian authorities had to correct fiscal imbalances just as private demand was weakening, a double blow to economic growth.
The challenge to Ecuadorian and Colombian policymakers, says the IDB, is to manage the correction to minimize the likelihood of a major economic downturn.
CORRECTION IN PERU...
As in the case of Brazil, Peru is contending with previous overspending and a troublesome current account deficit, now at 6 percent of GDP.
The correction is likely to be short-lived, and the Peruvian economy is showing little sign of stress. Money demand continues to rise and capital flows remain high. But there is concern that Peru may undergo an inflated boom in bank lending, thus becoming vulnerable to a correction so severe it could destabilize the financial system and derail otherwise impressive economic accomplishments. The country's growth is expected to hit 4.5 percent in 1997, earning it a place with Argentina, Bolivia, Mexico and Uruguay as a solid achiever in the reform process.
CYCLES IN THE CARIBBEAN...
Jamaica is another example of the reform, boom, and correction cycle. When inflation in that country reached 80 percent in 1991, the government began a stabilization program that cut price rises in half the subsequent year. Inflation now stands at 15 percent.
As in Colombia and Ecuador, a rise in the demand for Jamaican bank deposits helped finance a domestic lending boom, which in turn supported an expansion of domestic spending that brought the current account deficit to nearly 8 percent of GDP in 1996.
Jamaica is now undergoing a correction, marked by high real interests rates, problems in the financial system, and recession.
TAMING THE CYCLES...
The IDB report draws two principle conclusions from the region's experiences with the cycle of post-reform expansion, deceleration, correction, and post-correction.
First, countries at an early expansion stage following reform and stabilization should take preemptive action to ensure that the recovery does not cause financial stress. A nation's fiscal position should be strong enough in the expansion to ensure that large deficits will not emerge when the boom ends, thus avoiding the need for a disruptive fiscal contraction.
Secondly, a country's banking system should be kept under a watchful eye during the process of reform, recovery and expansion. If weaknesses should appear, the state should intervene early to prevent a major crisis.
If corrections are made early and decisively, disruptive crises can be avoided, and the "cyclical" dynamics that often follow the reform process will become less important, enabling governments to concentrate on improving prospects for long-term stable growth.