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The Financial Crisis and its Impact on Latin America LASA Workshop on the Crisis and its Impact on Latin America October 6, 2010 Nora Lustig Samuel Z. Stone Professor of Latin American Economics Tulane University 1 2 1. What was the economic performance of the region before the financial crisis? 2. Where does Latin America stand today and where is it headed? 3. How will the crisis affect living standards? 3 1. Economic Growth in LA Before the Crisis was Robust: 5.3 % a yr. 2002-07 (Source: CEPAL) 4 Economic Growth in LA Before the Crisis was Robust 5 2. What were the expectations and what happened? Two Phases of Financial Crisis (Izquierdo and Talvi, 2008) First Phase: mid-2007 until mid-2008 Second Phase: mid-2008 until …. 6 Phase 1 (cont.) Conventional wisdom in early 2008: Latin America is in a much better position to withstand the external shock: prudent fiscal policy, sound banking system, low indebtedness and large amounts of international reserves. Problem: Growth was highly linked to the boom in commodity prices and part of this boom was the result of the policies pursued to tackle with the financial crisis. In particular, with lower interest 7 rates in the US. Phase 2: From mid-2008 Onwards Realization that: Financial system in advanced countries facing solvency issues Advanced countries in deeper recession than anticipated Emerging economies would face growth slow down. No decoupling Post-Lehman collapse led to global credit market freeze As a result: Massive redemptions Flight to quality Demand for dollar/US Treasuries sky-rocket => commodity price, foreign currencies, foreign stock markets simultaneously fell 8 =>dollar appreciated Phase 2: From mid-2008 onwards: Biggest fears: Deep and protracted global recession Deflation For LAC: Adverse external shocks for commodity exporters but also for economies relying on exports to US, remittances, tourism and external capital flows (Sources: IMF; Izquierdo and Talvi, Nov. 2008) 9 Boom and Bust of Commodity Prices 10 11 Latin America and the Caribbean: Transmission Channels Financial: Exchange rate volatility, private sector debt and risky financial investments (Brazil, México) Lower access to international credit markets Capital outflows Real economy: Lower exports, remittances and tourism Lower commodity prices: bad news for Mexico and South America; good news for CA and Caribbean, but insufficient to compensate for other negative factors 12 3. Where does Latin America stand today and where is it headed? Growth for 2009 was negative but not as bad as some anticipated. Countries most affected not necessarily those people were expecting Argentina and Venezuela have been holding their ground while… …Mexico has been hit hard because of its close ties with US economy through exports and capital flows. 13 Real Impact of the Global Crisis: Economic Activity (Real GDP, annual variation) Central America LAC-7 (CAC-7) Russian Crisis 8% Beginning of the Boom 7% Lehman’s Bankruptcy 7% Russian Crisis Beginning of the Boom 6% 6% 4.8% 5% 5% 4.4% 4% 4% 3% 3% 2% 2% 1% 0% 1% -1% 0% * Estimate. Source: JPMorgan and WEO LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. CAC-7 is the simple average of Costa Rica, El Salvador, Guatemala, Honduras, Dominican Republic, Nicaragua and 2008 2009* 2007 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 -1% 1991 2009* 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 -3% 2006 Lehman’s Bankruptcy -0.6% -1.9% 2005 -2% 15 LAC Currencies: Appreciation Followed by Sharp Depreciation 16 US-Mexico correlation of business cycle in manufacturing sector 120% 15% 100% Correlation 80% 10% Mexico 60% US 5% 40% 20% 0% 0% -5% Jun-08 Jun-07 Jun-06 Jun-05 Jun-04 Jun-03 Jun-02 Jun-01 Jun-00 Jun-99 Jun-98 Jun-97 Jun-96 Jun-95 -60% Jun-94 -40% Jun-93 -20% -10% -80% -15% 17 For the first time in decades, Latin American economies got hurt mainly due to adverse external shocks and not because of poor domestic macroeconomic policies. Adverse external shocks are also an impediment to implement countercyclical fiscal policies. => Adjustment costs can be significant 18 19 20 21 22 23 24 25 26 27 28 29 30 4. The Impact of the Crisis on Living Standards Unemployment Real Wages Remittances Government monetary and in-kind transfers Poverty (tbc) Inequality (tbc) Other social indicators (tbc) 31 32 33 Are Countries Ready to Mitigate the Impact on the Poor? Which countries introduced countercyclical safety nets and what kind? Did they cover the universe of the affected population? Were transfers sufficiently large to compensate for the income losses? 34 Conditional Cash Transfers in LAC (Source: Inter-American Development Bank, 2008) Without program Bahamas Haiti Barbados Nicaragua Belize Suriname Guyana Pilot Guatemala Small scale (<25% poor) Costa Rica El Salvador Dominican Rep. Medium & large scale (>25% poor) Honduras México Uruguay Paraguay Bolivia Trinidad y Tobago Venezuela 11 2 Jamaica Panama Argentina Perú Brasil Colombia Chile Ecuador 5 8 35 THANK YOU 36