11

Globalized, Resilient, Dynamic:The New Face of LAC

Dominican Republic

17-18 November 2010

Chief Economist OfficeLatin America and the CaribbeanThe World Bank

1. Breaking with the Past: Better-than-Expected Outcomes 2. Resilience: Benchmarking LAC Through the Cycle3. Driving Forces of Resilience and Performance4. Financial Re-Coupling, Real De-Coupling5. Policy Challenges and Tensions Ahead

LAC: Globalized, Resilient, Dynamic

2

1. Breaking with the Past: Better-than-Expected Outcomes 2. Resilience: Benchmarking LAC Through the Cycle3. Driving Forces of Resilience and Performance4. Financial Re-Coupling, Real De-Coupling5. Policy Challenges and Tensions Ahead

LAC: Globalized, Resilient, Dynamic

3

LAC: globalized yet resilient this time around

LAC is highly integrated to international financial markets LAC-7 much more so than others in the region

LAC has been crisis-prone Low growth and high volatility in the 1990s

Debate on the merits of financial globalization Stiglitz, Calvo, Hausmann, etc.

Amplification effects and perils of financial globalization if:• Currency mismatches

• Deficient regulatory frameworks

• Undeveloped markets for local currency-denominated debts

LAC’s performance in this crisis invites revisiting this debate

4

LAC: 2010 growth recovery is vastly exceeding expectations…

5Note: Since the November numbers for Consensus aren’t published yet for LAC and EAP countries, we used the October numbers for these countries. All the other projections are November numbers. Source: Consensus Forecasts (March 2009, October 2010, and November 2010).

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

South Africa

High Income

China Europe & Central

Asia

Latin America & Caribbean

India East Asian Tigers

Perc

enta

ge P

oint

sDifference in 2010 Growth Projections

Oct/Nov-10 vs. Mar-09, Weighted Averages

3.1%

7.1%

8.4%5.5%

4.0%10.1%

2.4%

Current growth rate projection for 2010

… especially among the most financially globalized LAC countries

6

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

Other South Am. Countries

Central Am. + Dom. Rep.

LAC-6 + URY

Perc

enta

ge P

oint

sDifference in 2010 Growth ProjectionsSep-10 vs. Mar-09, Weighted Averages

-1.3%

6.3%

3.2%

Current growth rate projection for 2010

Note: Since the November numbers for Consensus aren’t published yet for LAC and EAP countries, we used the October numbers for these countries. All the other projections are November numbers. Source: Consensus Forecasts (March 2009, October 2010, and November 2010).

LAC: poverty and unemployment responses to the 2009 downturn were much milder than initially anticipated

Poverty One year ago: 10 million people were expected to enter moderate

poverty in 2009 (estimates based on historical coefficients)

Now: 2.1 million people actually joined the ranks of the poor in 2009 (actual data, at $4 a day)

Unemployment One year ago: 3.5 million people were predicted to join the

unemployed in 2009

Now: the number of unemployed is estimated to have increased by only about 2 million in 2009

7

Defining and measuring resilience

Definition – resilience is the ability to: Withstand the initial external shock

Engineer a fast and strong recovery

Conduct counter-cyclical policies in bad and good times

Measurement – indirectly, through an outcome variable (GDP) that actually reflects a combination of factors … Size of the shock

Degree of exposure to the shock

Extent of resilience per se (“relative” resilience)

… which we sort out through econometric techniques and using appropriate comparators

8

Exposure to the shock: degree of financial globalization

9Note: Financial openness is the amount of inflows and outflows of capital as a percentage of GDP. In this graph, Central America excludes Panama (an outlier due to its condition as offshore financial center). Source: IMF’s BOP

0

2

4

6

8

10

12

14

16

18

20

Other South Am. Countries

Central Am. + Dom. Rep.

Caribbean LAC-6 + URY

Perc

enta

ge of

GD

PFinancial Openess (Flows)

Simple Averages

Exposure to the shock: degree of trade openness

10Note: Trade openness is the sum of exports and imports as a percentage of GDP. Source: IMF’s WDI

0

20

40

60

80

100

120

LAC-6 + URY Other South Am. Countries

Central Am. + Dom. Rep.

Caribbean

Perc

enta

ge o

f GD

PTrade OpennessSimple Average

1. Breaking with the Past: Better-than-Expected Outcomes 2. Resilience: Benchmarking LAC Through the Cycle3. Driving Forces of Resilience and Performance4. Financial Re-Coupling, Real De-Coupling5. Policy Challenges and Tensions Ahead

LAC: Globalized, Resilient, Dynamic

11

Resilience: benchmarking LAC through the cycle

Resilience in the downturn: synchronized growth deceleration LAC was not immune, but its growth collapse was comparable to that of the

East Asian Tigers and significantly smaller than that of ECA Larger growth collapses in financially globalized LAC countries (LAC-7, Caribbean)

Resilience in the upturn: faster and stronger growth recovery LAC’s recessionary phase was shorter compared to previous crisis episodes

and to the MIC average Brazil led the LAC pack: industrial production started to recover in 3 months!

Strong recovery: like other non-ECA MICs, LAC’s GDP in 2010 will be above its 2008 level (ECA: 1.7% below; HICs: 0.2% below) LAC’s GDP will be closer to its potential level that that of the East Asian Tigers, reflecting

LAC’s lower trend growth rate

Brazil, Peru, Argentina, Uruguay, Panama, and Dominican Republic lead the LAC pack

12

2009 growth collapse: LAC no worse than the East Asian Tigers

13Notes: Growth collapses are defined as growth in 2009 minus growth in 2007. Source: IMF's WEO (October 2010)

-18%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

Ant &

Barb

Gren

ada

Vene

zuela

Parag

uay

Mex

icoPa

nama

Costa

Rica

Trin

& T

obHo

ndur

asPe

ruEl

Salv

ador

Arge

ntin

aLA

CBr

azil

Chile

Guate

mala

Colo

mbia

Dom

Rep

Urug

uay

Nica

ragua

Jama

icaGu

yana

Domi

nica

Surin

ame

Ecua

dor

Beliz

eBo

livia

Perce

ntag

e Poi

nts

GDP Growth CollapsesAcross LAC Countries

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

ECA South Africa

HIC East Asian Tigers

LAC China India

Perc

enta

ge Po

ints

GDP Growth CollapsesAcross Regions

-9.0%

-8.5%

-8.0%

-7.5%

-7.0%

-6.5%

-6.0%

-5.5%

-5.0%

Caribbean Central Am. + Dom. Rep.

LAC-6 + URY Other South Am. Countries

Perc

enta

ge Po

ints

GDP Growth CollapsesWithin LAC Regions

Size and duration of downturn: LAC better than its past and ahead of the MIC average

14Notes: In the figures, period T stands for the Peak year in GDP business cycles. The sample of LAC countries includes: Argentina, Brazil, Chile, Colombia, Costa Rica, Ecuador, Mexico, Peru, and Venezuela. Sources: Calderón and Servén (2010), EIU, Haver Analytics, LAC Central Banks and Statistical Offices.

-4.5

-3.5

-2.5

-1.5

-0.5

0.5

T-8

T-6

T-4

T-2 T

T+2

T+4

T+6

T+8

Gro

wth

Rat

e (%

)

Latin America & the Caribbean

Historic cycleCurrent cycle

-4.5

-3.5

-2.5

-1.5

-0.5

0.5

T-8

T-6

T-4

T-2 T

T+2

T+4

T+6

T+8

Gro

wth

Rat

e (%

)

Middle Income Countries

Historic cycleCurrent cycle

-4.5

-3.5

-2.5

-1.5

-0.5

0.5

T-8

T-6

T-4

T-2 T

T+2

T+4

T+6

T+8

Gro

wth

Rat

e (%

)

High Income Countries

Historic cycleCurrent cycle

Cyclical Growth Dynamics in a Comparative Setting

Heterogeneity across LAC countries:Length of recession based on IP indexes

15Sources: World Bank’s Global Economic Monitor (Oct 2010).

0

2

4

6

8

10

12

14

16

18

Brazil Argentina Peru Uruguay MexicoVenezuela Chile Colombia

Num

ber o

f mon

ths

Speed of RecoveryMonths between peak and trough in IP Indexes

Resilience: benchmarking LAC through the cycle

Resilience in the downturn: synchronized growth deceleration LAC was not immune, but its growth collapse was comparable to that of the

East Asian Tigers and significantly smaller than that of ECA Larger growth collapses in financially globalized LAC countries (LAC-7, Caribbean)

Resilience in the upturn: faster and stronger growth recovery LAC’s recessionary phase was shorter compared to previous crisis episodes

and to the MIC average Brazil led the LAC pack: industrial production started to recover in 3 months!

Strong recovery: like other non-ECA MICs, LAC’s GDP in 2010 will be above its 2008 level (ECA: 1.7% below; HICs: 0.2% below) LAC’s GDP will be closer to its potential level that that of the East Asian Tigers, reflecting

LAC’s lower trend growth rate

Brazil, Peru, Argentina, Uruguay, Panama, and Dominican Republic lead the LAC pack

16

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Ant

. & B

arb.

Vene

zuel

aJa

mai

caG

rena

daEl

Sal

vado

rTr

in. &

Tob

.D

omin

ica

Bel

ize

Gua

tem

ala

Ecua

dor

Hon

dura

sN

icar

agua

Guy

ana

Cos

ta R

ica

Bol

ivia

Surin

ame

Dom

. Rep

.C

olom

bia

Mex

ico

Pana

ma

Chi

leLA

CPa

ragu

ayU

rugu

ayB

razi

lPe

ruA

rgen

tina

Perc

ent

GDP Growth Forecasts for 2010 and 2011Across LAC Countries

2010 2011

Strength of the recovery:LAC trailing the East Asian Tigers in growth rates

17

0.0

2.0

4.0

6.0

8.0

10.0

12.0

HIC South Africa

ECA LAC East Asian Tigers

India China

Perc

ent

GDP Growth Forecasts for 2010 and 2011Across Regions

2010 2011

-6%

-4%

-2%

0%

2%

4%

6%

8%

LAC-6 + URY Other South Am. Countries

Central Am. + Dom. Rep.

Caribbean

2009 Real GDP Growth and Forecasts for 2010-11Annual GDP Real Growth Rate, Weighted Averages

2009 2010 2011

Note: Since the November numbers for Consensus aren’t published yet for LAC and EAP countries, we used the October numbers for these countries. All the other projections are November numbers. Source: Consensus Forecasts (March 2009, October 2010, and November 2010).

-30%

-20%

-10%

0%

10%

20%

Trin

. & T

ob.

Ant

. & B

arb.

Vene

zuel

aBe

lize

Gre

nada

Hon

dura

sM

exic

oJa

mai

caCo

sta R

ica

El S

alva

dor

Colo

mbi

aN

icar

agua

Chile

Gua

tem

ala

Ecua

dor

Dom

. Rep

.Su

rinam

ePa

ragu

ayPa

nam

aBr

azil

Dom

inic

aPe

ruBo

livia

Guy

ana

Arg

entin

aU

rugu

ay

Perc

ent

Expected GDP Levels Relative to Trend GDPLAC Countries

2010 2011

Strength of the recovery:LAC recovering potential output faster than the Tigers

18Notes: Trend GDP, used in Panels B and C, is defined as the GDP that each country would have attained if it had grown between 2008 and 2010 at the same pace as in between 2000 and 2007. Sources: Didier, Hevia, and Schmukler (2010).

-5%

0%

5%

10%

15%

20%

25%

30%

35%

ECA HIC South Africa

LAC East Asian Tigers

India China

Perc

ent

Expected GDP Levels in 2010 and 2011 Relative to GDP in 2008

2010 2011

-20%

-15%

-10%

-5%

0%

5%

ECA HIC South Africa

East Asian Tigers

LAC China India

Perc

ent

Expected GDP Levels Relative to Trend GDP

2010 2011

Resilience: benchmarking LAC through the cycle (2)

Shielding the poor The poverty response to the 2009 downturn was milder than in past

downturns and smaller than the response to the 2000-2007 upturn Poverty increased mainly in Mexico and some Central American Countries; it actually

continued to decline (at a lower rate) in Brazil, Peru, Uruguay

If poverty reduction is as elastic to growth as it was during the 2000-2007 expansion, 7 million Latinos will climb out of moderate poverty in 2010

Unexpectedly strong labor market performance During 2009, the LAC unemployment rate increased much less than in ECA

and slightly more than in the East Asian Tigers ...

... the increase in unemployment given the decline in GDP was much milder than in previous crises

... the trend towards labor market formalization was not reversed …

… and all this despite constant or increasing real average wages

19

Shielding the poor: milder increase in poverty compared to the past and heterogeneous effects within the region

Source: The World Bank, 2010. “Did Latin America learn to shield its poor from economic shocks?” Washington, DC: The World Bank, Latin America and the Caribbean Poverty Sector (LCSPP)

-8

-6

-4

-2

0

2

4

Andean Region Central America & Mexico

Cono Sur ExtendedPe

rcen

tage

Poin

ts

Change in Moderate Poverty(US$ 4 a day)

2004 - 2005 2005 - 2006 2006 - 20072007 - 2008 2008 - 2009 2009 - 2010*

-4

-3

-2

-1

0

1

2

3

4

1993

-199

4

1994

-199

5

1995

-199

6

1996

-199

7

1997

-199

8

1998

-199

9

1999

-200

0

2000

-200

1

2001

-200

2

2002

-200

3

2003

-200

4

2004

-200

5

2005

-200

6

2006

-200

7

2007

-200

8

2008

-200

9

2009

-201

0*

Perc

enta

ge Po

ints

Change in Moderate Poverty(US$ 4 a day)

20

Resilience: benchmarking LAC through the cycle (2)

Shielding the poor The poverty response to the 2009 downturn was milder than in past

downturns and smaller than the response to the 2000-2007 upturn Poverty increased mainly in Mexico and some Central American Countries; it actually

continued to decline (at a lower rate) in Brazil, Peru, Uruguay

If poverty reduction is as elastic to growth as it was during the 2000-2007 expansion, 7 million Latinos will climb out of moderate poverty in 2010

Unexpectedly strong labor market performance During 2009, the LAC unemployment rate increased much less than in ECA

and slightly more than in the East Asian Tigers ...

... the increase in unemployment given the decline in GDP was much milder than in previous crises

... the trend towards labor market formalization was not reversed …

… and all this despite constant or increasing real average wages

21

Labor market performance: unemployment less responsive to the downturn than previously, except in Colombia

22

0.0

0.5

1.0

1.5

2.0

2.5

Argentina Brazil Chile Colombia Mexico

Semi-Elasticity of Unemployment With Respect to GDP Growth

Previous recession

Current Recession

Note: Previous recession periods are: Argentina (1998.Q4 – 2002.Q2); Brazil (1997.Q4 – 1998.Q2); Chile (1998.Q3 – 1999.Q4); Colombia (1998.Q3 – 1999.Q4); and Mexico (1995.Q1 – 1996.Q1). Current recession periods are: Argentina (2008.Q3 – 2009.Q2); Brazil (2008.Q4 – 2009.Q2); Chile (2008.Q3 – 2009.Q3); Colombia (2008.Q3 –2009.Q2); and Mexico (2008.Q2 – 2009.Q2). Source: LCRCE Staff calculations based on National Statistical Institutes data.

1. Breaking with the Past: Better Outcomes than History Would Suggest2. Resilience: Benchmarking LAC Through the Cycle3. Driving Forces of Resilience and Performance4. Financial Re-Coupling, Real De-Coupling5. Policy Challenges and Tensions Ahead

LAC: Globalized, Resilient, Dynamic

23

The driving forces: policy-driven

Silent revolution in macro-financial policy frameworks In a break with history, this enabled counter-cyclical policies, particularly in

monetary policy and to a lesser extent in fiscal policy

Amplifiers turned cushions: currency, banking system, fiscal process

No financial crises at home this time around

Safer international integration Financial: the region became a net creditor in debt and a net debtor in

equity

Trade: increased trade and other economic linkages with China

24

LAC breaking with history: countercyclical macro policy

25Notes: Panel C reports the average quarterly variation (in percentage points of GDP) of the cyclically-adjusted primary balance of LAC-6 countries during the global downturn associated to the 2008 - 2009 financial crisis and during previous crisis. Negative (positive) values indicate an expansion (contraction) in discretionary fiscal policy. Sources: IMF’s “Fiscal Monitor: Navigating the Fiscal Challenges Ahead” (May 2010), ECLAC, and Bloomberg for Panels A and B; and LCRCE staff calculations based on Haver Analytics, Datastream in Panel C.

-9%

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

Costa

Rica

Arge

ntin

a

Para

guay

Guate

mala

Mex

ico

Trin

. & T

ob.

Urug

uay

Hond

uras

Barb

ados

Braz

il

Peru

Dom

. Rep

.

Colo

mbi

a

Jam

aica

Chile

Perc

entag

e Poi

nts

Monetary PolicyChanges in Monetary Policy Rates

0%

2%

4%

6%

8%

10%

12%

14%

16%

Jul-0

7

Sep-

07

Nov

-07

Jan-

08

Mar

-08

May

-08

Jul-0

8

Sep-

08

Nov

-08

Jan-

09

Mar

-09

May

-09

Jul-0

9

Sep-

09

Nov

-09

Jan-

10

Mar

-10

May

-10

Jul-1

0

Sep-

10

Monetary Policy RatesInflation-Targeting LAC Countries, in %

US Peru

Colombia

Chile

Brazil

Mexico

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Argentina Brazil Chile Colombia Mexico Peru Dom. Rep.

Variation in the cyclically-adjusted primary surplus(in percentage points of GDP)

In previous crises

During current global crisis

LAC and the East Asian Tigers: Flexible exchange rates cushioned the shock this time…

26Notes: This figure depicts the behavior of the nominal exchange rate around crises episodes of external origin to the region in question. Sources: Didier, Hevia, and Schmukler (2010).

80

90

100

110

120

130

Sep-94 Oct-94 Nov-94 Dec-94 Jan-95 Feb-95 Mar-95

Inde

x Jul

-97 =

100

East Asia & Pacific Previous Crisis

China Indonesia Korea, Rep. MalaysiaPhilippines Singapore Thailand

80

90

100

110

120

130

Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Inde

x Jul

-97 =

100

East Asia & Pacific Current Crisis

China Indonesia Korea, Rep. MalaysiaPhilippines Singapore Thailand

80

90

100

110

120

130

Apr-97 May-97 Jun-97 Jul-97 Aug-97 Sep-97 Oct-97

Inde

x Jul

-97 =

100

Latin America & Caribbean Previous Crisis

Argentina Brazil Chile ColombiaMexico Peru Venezuela Dom. Rep.

80

90

100

110

120

130

Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Inde

x Jul

-97 =

100

Latin America & Caribbean Current Crisis

Argentina Brazil Chile ColombiaMexico Peru Venezuela Dom. Rep.

… not least because reduced currency mismatches helped dispel the “fear of floating” in most of LAC

0%

10%

20%

30%

40%

50%

60%

70%

80%

Corporate Banks

Corporate and Banks' Dedollarization in LAC

Source: Gozzi et al. (2009), IFS

Issues in Foreign Currency / Total Issues Foreign Liabilities / Broad Money

1990-1993

2006-2009

2001-20032006-2008

Note: GDP-weighted averages of the periods noted.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1998 2008 1998 2008 2002 2008

Mexico Colombia Brazil

Share of the Domestic and Foreign Public Debt in Total DebtSelected LAC Countries

Domestic Foreign

27Sources: Gozzi et al (2009), Reinhart, Rogoff and Savastano (2003), IFS.

LAC breaking with history: no systemic damage at home

28

Financial Crises Around the World

The driving forces: policy-driven

Silent revolution in macro-financial policy frameworks In a break with history, this enabled counter-cyclical policies, particularly in

monetary policy and to a lesser extent in fiscal policy

Amplifiers turned cushions: currency, banking system, fiscal process

No financial crises at home this time around

Safer international integration Financial: the region became a net creditor in debt and a net debtor in

equity

Trade: increased trade and other economic linkages with China

29

LAC has migrated towards a safer form of integration into international financial markets

30Note: The net debt position (vis-à-vis ROW) is the sum of debt assets and reserves minus debt liabilities. In turn, the net equity position (vis-à-vis ROW) is the sum of net FDI assets and net portfolio equity assets. The sample ranges from 1990 to 2008. Source: Lane and Milesi-Ferretti (2007).

-40%

-30%

-20%

-10%

0%

10%

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Perce

nt of

GDP

A Safer Integration in LAC Finance

Net Debt Position vis-à-vis Rest of the WorldNet Equity Position vis-à-vis Rest of the World

Net C

redito

rNe

t Deb

tor

The China connection: LAC countries has been sharply intensifying trade and FDI links to Asia

31Source: IMF’s Direction of Trade Statistics (DOTS).

0%

10%

20%

30%

40%

50%

60%

70%

80%

Surin

ame

Barb

ados

Jam

aica

Nica

ragu

aTr

in. &

Tob

.H

ondu

ras

Gua

tem

alaM

exico

Baha

mas

Guy

ana

Ecua

dor

Colo

mbi

aBe

lize

Dom

. Rep

.Bo

livia

Para

guay

Ecua

dor

Hai

tiPa

nam

aVe

nezu

elaU

rugu

ayA

rgen

tina

Braz

ilCo

sta R

icaD

omin

icaPe

ruCh

ile

Perc

ent

LAC Exports to Selected Regions as % of total exports, 2008 data

EAP Euro Zone US

The driving forces: exogenous factors

Rebound in commodity prices Commodity prices started rebounding in Jan 09 and are at their 2007 level

Asymmetric effects on the region (South America vs. Central America)

Pronounced move towards risk appetite in financial markets The comeback of risk appetite has contributed to strong capital inflows to

LAC, and intensified the strength of the recovery

Capital inflows to the region in 2010 are already higher than those observed in 2007

32

Commodity prices rebounded quickly to 2007 levels

33Source: Bloomberg.

30

50

70

90

110

130

150

50

100

150

200

250

300

350

Jan-

05

May

-05

Sep -

05

Jan-

06

May

- 06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Oil

WT

I, Cu

rren

t US$

Whe

at, C

oppe

r and

Soy

bean

, 01-

Jan-

05=1

00Commodity Prices

Oil WTI in Current US$, Wheat, Copper and Soybean: Index 01-Jan-05=100

Oil (rhs)

Copper

Wheat

Soybean

The driving forces: exogenous factors

Rebound in commodity prices Commodity prices started rebounding in Jan 09 and are at their 2007 level

Asymmetric effects on the region (South America vs. Central America)

Pronounced move towards risk appetite in financial markets The comeback of risk appetite has contributed to strong capital inflows to

LAC, and intensified the strength of the recovery

Capital inflows to the region in 2010 are already higher than those observed in 2007.

34

35Note: for Panel A, data goes until Sep-10. Sources: CPB and Bloomberg

A swing from risk aversion to risk appetite is boosting capital flows to EMs

0

10

20

30

40

50

60

70

80

90

100

Jan-

02Ju

n-02

Nov

-02

Apr

-03

Sep-

03Fe

b-04

Jul-0

4D

ec-0

4M

ay-0

5O

ct-0

5M

ar-0

6A

ug-0

6Ja

n-07

Jun-

07N

ov-0

7A

pr-0

8Se

p-08

Feb-

09Ju

l-09

Dec

-09

May

-10

Oct

-10

VIXCBOE Volatility Index

Lehman

Citi's Memo Greece

-2

-1

0

1

2

3

4

5

6

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Jul-1

0

Financial Conditions Indexes

United States Financial Stress

St Louis Federal Reserve Bank Financial Stress Index

Lehman

Citi's Memo Greece

Capital flows to LAC have surged in 2010 to levels significantly higher than those observed in 2007

36Source: Dealogic and World Bank, DEC Prospects Group

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2007 Q1 2007 Q3 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q1 2010 Q3

Gross International Capital Flows to Latin America

Equity Bond Bank

1. Breaking with the Past: Better Outcomes than History Would Suggest2. Resilience: Benchmarking LAC Through the Cycle3. Driving Forces of Resilience and Performance4. Financial Re-Coupling, Real De-Coupling5. Policy Challenges and Tensions Ahead

LAC: Globalized, Resilient, Dynamic

37

Re-coupling, de-coupling

Real de-coupling from HICs and increased coupling with China Over time, economic activity in EMs has become less sensitive to economic

activity in HICs, and more sensitive to economic activity in China

Financial re-coupling While EM policy fundamentals boost economic resilience, they are not the

main drivers of financial asset performance

EM asset returns have become more sensitive to common factors than to differences in EM fundamentals

The co-movement of asset returns across the world has increased over time, reducing the gains of international portfolio diversification

38

Real de-coupling: growth in EMs has become more sensitive to China and less sensitive to the G-7

LAC-7 CRB ChinaIndependent Variables: (1) (2) (3) (4) (5) (6) (7) (8)

0.432*** 1.636*** 0.988*** 1.936*** 0.960 0.052 0.327* 0.169(0.000) (0.000) (0.000) (0.000) (0.253) (0.592) (0.081) (0.435)0.146** -1.299*** -0.763*** -1.54*** 0.492** 0.487**(0.043) (0.000) (0.000) (0.000) (0.033) (0.039)

0.850*** 0.557*** 0.847*** 2.826*** 0.121* 0.050(0.000) (0.000) (0.000) (0.000) (0.067) (0.511)

0.420*** 0.174*** 0.535*** -0.153*** -0.223***(0.000) (0.006) (0.000) (0.005) (0.002)

0.091*** 0.060* 0.000 0.028*(0.000) (0.058) (0.000) (0.069)

0.013*** -0.023** 0.000 0.002(0.005) (0.012) (0.000) (0.611)

0.028*** -0.086*** -0.040*** -0.101*** -0.269*** 0.097***(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Observations 1357 1357 1357 264 63 64 264 264R-squared 0.12 0.26 0.30 0.26 0.27 0.00 0.42 0.43

0.578*** 0.347*** 0.226*** 0.397*** 0.818*** 0.657***(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

1.270*** 0.731*** 1.382*** -0.054 -0.172(0.000) (0.000) (0.000) (0.579) (0.123)

α

G-7 + G-7, Late

China + China, Late

G-7

G-7, Late

China

China, Late

CRB

WTI

Emerging Markets Non-Euro Advanced EconomiesPanel Estimations Panel Estimations

39Notes: The late period goes from 2000 to 2009. Median sample estimations report the median values from country-by-country regressions. G-7 growth was computed as the average of individual growth rates weighed by the dollar GDP in the previous year. Non-Euro Advanced Economies include Australia, New Zealand, Norway, and Sweden. For panel regressions, ***,** and * denotes significance at a 1%, 5% and 10% respectively. P-values are reported in parentheses. Sources: IMF's IFS.

The co-movement of growth between LAC countries and China has been clearly trending upward…

40Source: National Authorities. Note: Solid colors reflect correlation values significant at a 10% confidence interval.

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1980 1984 1988 1992 1996 2000 2004 2008

Output Co-Movement Between LAC and China20 years rolling correlation of the Real GDP Growth

Brazil Chile ColombiaMexico Peru ArgentinaPanama Dom. Rep.

Re-coupling, de-coupling

Real de-coupling from HICs and increased coupling with China Over time, economic activity in EMs has become less sensitive to economic

activity in HICs, and more sensitive to economic activity in China

Financial re-coupling While EM policy fundamentals boost economic resilience, they are not the

main drivers of financial asset performance

EM asset returns have become more sensitive to common factors than to differences in EM fundamentals

The co-movement of asset returns across the world has increased over time, reducing the gains of international portfolio diversification

41

The variance of EM asset return is increasingly explained by common factors

42Notes: A principal component is estimated for returns on equities, on foreign exchange spot contracts, and on CDS sovereign spreads. Then, country-specific returns for each asset class are regressed on its associated PC1 in order to get an R-squared. The average R-squared is being reported for countries within each region. See Levy Yeyati (2010) for more details. Sources: Bloomberg.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Equity Foreign Exchange CDS Spreads

Perc

ent

Emerging Market Asset Returns and Common Factors Average R-Squared from Country Regressions

Early Period (2000-2005)Late Period (Jan-05 to Jul-08)Crisis (Aug-08 to Apr-09)

1. Breaking with the Past: Better Outcomes than History Would Suggest2. Resilience: Benchmarking LAC Through the Cycle3. Driving Forces of Resilience and Performance4. Financial Re-Coupling, Real De-Coupling5. Policy Challenges and Tensions Ahead

LAC: Globalized, Resilient, Dynamic

43

Policy challenges and tensions ahead

No time for complacency Downside risks stemming from HICs, and Europe in particular, remain

Continued resiliency not guaranteed and must be cultivated

Over-burdened monetary policy Fiscal stance is pro-cyclical throughout most of the region

Need to rebalance the monetary-fiscal policy mix

Need for macro-prudential policies to avoid financial excesses in LAC

Global coordination failure complicates things for LAC Asymmetry in output gaps/inflation pressures & risk appetite fuel capital flows to EMs

As EMs collectively resist currency appreciation, interest rates in HICs have to be lower than otherwise, further boosting capital flows to EMs

Can the recovery involve higher trend growth and not just cyclical rebound? LAC’s non-inflationary growth rate is lower than in the East Asian countries

A premium must be placed on the productivity agenda

44

Capital inflows surge and global rebalancing

45

HIC-EM asymmetry:output gap & inflation pressures

Interest rate differentials / risk appetite comeback

“Frothy” capital inflow surge to EMs

EM resistance to appreciation (to dollar depreciation)

Lower than otherwise interest rates in HICs QE2

• Global coordination failure• Could be broken if the Chinese currency appreciates significantly• LAC: responding to a global distortion or adding to the global distortion?

Global imbalances

Currency appreciation pressures are already felt and bound to intensify…

46Note: The Exchange Market Pressure Index is the weighted average of year-on-year percentage changes in: (a) the nominal exchange rate of the local currency vis-à-vis the US dollar (such that an increase represents an appreciation of the LAC currency), and (b) the level of international reserves. The weights are given by the inverse of the annual standard deviation of the changes in the nominal exchange rate and the standard deviation of the changes in reserves. An increase in the Exchange Market Pressure index signals appreciation pressures and/or accumulation of reserves. Source: LCRCE Staff calculations based on IMF’s IFS.

-4

-3

-2

-1

0

1

2

3

4

5

Jan-

00

Aug

-00

Mar

-01

Oct

-01

May

-02

Dec

-02

Jul-0

3

Feb-

04

Sep-

04

Apr

-05

Nov

-05

Jun-

06

Jan-

07

Aug

-07

Mar

-08

Oct

-08

May

-09

Dec

-09

Chile

Appreciation pressuresReserve AccumulationExchange Market Pressure

-4

-3

-2

-1

0

1

2

3

4

5

6

7

Jan-

00

Aug

-00

Mar

-01

Oct

-01

May

-02

Dec

-02

Jul-0

3

Feb-

04

Sep-

04

Apr

-05

Nov

-05

Jun-

06

Jan-

07

Aug

-07

Mar

-08

Oct

-08

May

-09

Dec

-09

Colombia

Appreciation pressures

Reserve Accumulation

Exchange Market Pressure

-5

-3

-1

1

3

5

7

Jan-

00

Aug

-00

Mar

-01

Oct

-01

May

-02

Dec

-02

Jul-0

3

Feb-

04

Sep-

04

Apr

-05

Nov

-05

Jun-

06

Jan-

07

Aug

-07

Mar

-08

Oct

-08

May

-09

Dec

-09

Brazil

Appreciation pressuresReserve AccumulationExchange Market Pressure

-8

-6

-4

-2

0

2

4

6

8

10

12

Jan-

00

Aug

-00

Mar

-01

Oct

-01

May

-02

Dec

-02

Jul-0

3

Feb-

04

Sep-

04

Apr

-05

Nov

-05

Jun-

06

Jan-

07

Aug

-07

Mar

-08

Oct

-08

May

-09

Dec

-09

Dominican Republic

Appreciation pressures

Reserve Accumulation

Exchange Market Pressure

-4

-3

-2

-1

0

1

2

3

4

Jan-

00

Aug

-00

Mar

-01

Oct

-01

May

-02

Dec

-02

Jul-0

3

Feb-

04

Sep-

04

Apr

-05

Nov

-05

Jun-

06

Jan-

07

Aug

-07

Mar

-08

Oct

-08

May

-09

Dec

-09

Mexico

Appreciation pressures

Reserve Accumulation

Exchange Market Pressure

-3

-2

-1

0

1

2

3

4

5

Jan-

00

Aug

-00

Mar

-01

Oct

-01

May

-02

Dec

-02

Jul-0

3

Feb-

04

Sep-

04

Apr

-05

Nov

-05

Jun-

06

Jan-

07

Aug

-07

Mar

-08

Oct

-08

May

-09

Dec

-09

Peru

Appreciation pressuresReserve AccumulationExchange Market Pressure

Over-burdened monetary policy

Monetary policy focused on pre-empting inflation is also dealing with capital inflows surge and natural resource windfalls Withdrawal of fiscal and credit stimulus is taking longer than expected

Short-fall of countercyclical policy in good times – fostered by:• Easing of financial conditions – mood swing

• Substantial margin to borrow

• Demonstration effect from rich-country fiscal and monetary largesse

Towards a sounded macro-financial policy mix Emphasis on cyclically-adjusted fiscal targets

• Public saving even more important in countries with commodity bonanza

Need for a macro-prudential agenda to avert financial excesses• But a significant degree of exchange rate flexibility is needed to ensure

prudential policy independence

47

48

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