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All That Glitters May Not Be Gold: Debating Key Issues May 8th, 2008 Prepared for Presentation at the XXVII Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC. This Presentation is based on the IADB Research Department report “All That Glitters May Not Be Gold: Assessing Latin America’s Recent Macroeconomic Performance”, coordinated by Alejandro Izquierdo and Ernesto Talvi OBJECTIVES To present a regional macroeconomic perspective Synchronization of Economic Fluctuations in Latin America (Real GDP, average annual growth) 15% Tequila Crisis Russian Crisis Beginning of Current Boom 10% 5% 0% Argentina Brazil -5% Chile Colombia Cumulative R2 -10% Mexico 1st PC 0.42 Peru 2nd PC 0.64 Venezuela PC= Principal Component Dic-06 Dic-05 Dic-04 Dic-03 Dic-02 Dic-01 Dic-00 Dic-99 Dic-98 Dic-97 Dic-96 Dic-95 Dic-94 Dic-93 Dic-92 Dic-91 -15% OBJECTIVES To present a regional macroeconomic perspective To evaluate macroeconomic performance and fundamentals internalizing the impact of external factors External Conditions for Latin America World Production Commodity Prices (World-7 GDP Index, Annual Variation, Weighted by PPP adjusted GDP*) External Financial Conditions (Index of Oil and Non-Oil Commodities, Oct-02=100) 5.5% (EMBI spread, basis points) 364 365 1000 984 900 315 5.0% 800 265 4.8% Average 91-97 700 4.5% Oil 600 215 548 200 Non-Oil 4.0% EMBI+ 500 165 400 299 300 3.5% Average 91-97 115 200 *World-7 includes G-3 (EU-15, Japan and USA) and EM-4 (China, India, Korea and Russia) Oct-07 May-07 Jul-06 Dic-06 Feb-06 Sep-05 Abr-05 Nov-04 Jun-04 Ene-04 Ago-03 Mar-03 Oct-02 Oct-07 Abr-07 Oct-06 Abr-06 Oct-05 Abr-05 Oct-04 Abr-04 Oct-03 Abr-03 100 Oct-02 Jul-07 Mar-07 Nov-06 Jul-06 Mar-06 Jul-05 Nov-05 Mar-05 Nov-04 Jul-04 Mar-04 Nov-03 65 Jul-03 Mar-03 3.0% 264 Non-Latin EMBI Average 91-97 Mar-08 Average 91-97 OBJECTIVES To present a regional macroeconomic perspective To evaluate macroeconomic performance and fundamentals internalizing the impact of external factors To stimulate a constructive policy debate Growth Performance Growth Performance in Latin America ‘This Time Is Different’ Observed GDP Growth Forecast for GDP: 2003 – 2006* (LAC-7, GDP Annual Growth) (LAC-7, Values in logs) Russian Crisis 90s Boom 7% ‘All That Glitters May Not Be Gold’ Current Boom 4.85 90% confidence interval 03-07 Average: 5.8% 6% 5% 91-97 Average: 4.6% 4% 4.80 4.75 74-06 Average: 3.2% 3% Predicted GDP with Observed External Factors 4.70 2% 4.65 1% GDP at long run average growth Observed GDP 0% 4.60 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. *Izquierdo, Romero and Talvi (2007) Jul-06 Mar-06 Nov-05 Jul-05 Mar-05 Nov-04 Jul-04 Mar-04 Nov-03 Jul-03 Mar-03 Nov-02 Jul-02 4.55 Mar-02 2007 2005 2003 2001 1999 1997 1995 1993 -2% 1991 -1% Growth Performance in Latin America ‘This Time Is Different’ Observed GDP Growth Growth in EMs: A Comparative Perspective (LAC-7, GDP Annual Growth) (Real GDP, 2003-2007 annual growth) Russian Crisis 90s Boom 7% ‘All That Glitters May Not Be Gold’ World: 5.0% Current Boom 03-07 Average: 5.8% 6% 5% 91-97 Average: 4.6% 4% Emerging Asia Ex USSR 74-06 Average: 3.2% 3% 2% Middle East Emerging Europe 1% 0% Africa 2007 2005 2003 2001 1999 1997 1995 1993 -2% 1991 -1% Latin America 2% 3% 4% 5% 6% 7% 8% 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. 9% Investment in Latin America ‘This Time Is Different’ ‘All That Glitters May Not Be Gold’ Investment to GDP Ratio Investment: 90’s vs. 00’s Expansion (Private investment, constant prices, in %) 90s Boom 0,18 Russian Crisis (Private investment, LAC-7, Year 0 = 100) Current Boom 17.0% 0,17 16.5% 175 Current Expansion 165 0,16 155 0,15 145 90s Expansion 135 0,14 125 0,13 115 0,12 105 0,11 2006 2004 2002 2000 1998 1996 1994 1992 1990 95 0 1 2 3 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. * Deflated by capital price indexes. The current expansion year 0 is 2002 and the 90s expansion year 0 is 1990. 4 Productivity in Latin America ‘This Time Is Different’ Total Factor Productivity Productivity: 90’s vs. 00’s Expansion (1990=100 and annual variation in %) (Total Factor Productivity, LAC-7, Year 0 = 100*) Russian Crisis Current Boom 4% Total Factor Productivity Index 113 122 111 118 109 2% 114 1% 90-06 Average Growth: 1.0% 110 0% 105 106 -2% 102 101 -3% 98 -1% 90s Expansion 107 103 Current Expansion 2006 2004 2002 2000 1998 1996 1994 1992 Annual Variation 1990 Productivity Growth 3% 126 Productivity Index 90’s Boom 5% ‘All That Glitters May Not Be Gold’ 99 0 1 2 3 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. *The current expansion year 0 is 2002 and the 90s expansion year 0 is 1990. 4 Productivity in Latin America ‘This Time Is Different’ ‘All That Glitters May Not Be Gold’ Total Factor Productivity Productivity Growth by Region (1990=100 and annual variation in %) (Total Factor Productivity, 1990-2006; annual rate) 90’s Boom 5% Russian Crisis Current Boom 4% 3.0% 122 118 2% 114 1% 90-06 Average Growth: 1.0% 110 0% 3.0% 2.5% Productivity Index Total Factor Productivity Index 3% 2.0% 1.8% 1.5% 1.0% 106 1.0% -2% 102 0.5% -3% 98 0.0% -1% 1.0% 2006 2004 2002 2000 1998 1996 1994 1992 Annual Variation 1990 Productivity Growth 3.5% 126 Emerging Asia Emerging Regions* Advanced Economies 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. * Excluding LAC and China LAC-7 QUESTIONS FOR DISCUSSION: GROWTH PERFORMANCE From a growth perspective, does your country fit the regional pattern? Why yes or why not? From your country’s perspective, do you consider that external factors play an important role in explaining current growth performance? Our evidence suggest that even if the favorable external environment persists, the effect on growth will probably dissipate. Do you think that external conditions have a level or growth effect on economic activity? Has the trend growth rate in your country increased above its historical average? If so, can the dynamics of investment and productivity during the current expansion support higher trend growth rates in your country? Fiscal Policy Observed and Structural Fiscal Balances* (Structural balances computed by applying the “Chilean Fiscal Rule” to other LAC-7 countries) 3% Latin America Chile (LAC-7, % of GDP) (% of GDP) Russian Crisis 10% Beginning of Current Boom 2% Russian Crisis Beginning of Current Boom 8% ‘This Time Is Different’ 1% 1.0% Observed (Observed) 6% 0% 4% -1% Structural 2% -2% 0% -3% ‘All That Glitters May Not Be Gold’ -4% (Structural) -2% -4.1% 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. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *Izquierdo, Ottonello and Talvi (forthcoming). 2005 2003 2001 1999 1997 1995 1993 2005 2003 2001 1999 1997 1995 1993 1991 1991 -4% -5% Fiscal Balances by Country (Dec-06, in % of GDP) Structural Fiscal Balance Observed Fiscal Balance Traditional HP Filter* “Chilean” Fiscal Rule** 1,8% 0,6% -2,2% Brazil -3,0% -3,3% -4,9% Colombia -0,5% -1,2% -0,1% Mexico 0,1% -0,5% -4,5% Peru 2,1% 0,6% -1,8% -0,2% -2,0% -16,0% LAC-6 0,0% -1,0% -4,9% Chile 7,7% 6,1% 1,0% LAC-7 1,1% 0,0% -4,1% Argentina Venezuela LAC-6 is the simple average of Argentina, Brazil, Colombia, Mexico, Peru and Venezuela. 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. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *HP = Hodrick Prescott; lambda = 1600 (quarterly data). **Izquierdo, Ottonello and Talvi (forthcoming). Fiscal Revenues and Expenditures* (Adjusted revenues computed by applying the “Chilean Fiscal Rule” to other LAC-7 countries) Latin America Chile (LAC-7, Fiscal Revenues, Mar-91 = 100) (Fiscal Revenues, Mar-91 = 100) 335 Russian Crisis 335 Beginning of Current Boom Beginning of Current Boom Russian Crisis Fiscal Revenues 285 285 235 235 Fiscal Revenues Fiscal Expenditures Adjusted Revenues 185 Adjusted Revenues 185 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. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *Izquierdo, Ottonello and Talvi (forthcoming). 2005 2003 2001 1999 1997 1995 1993 2005 2003 2001 1999 1997 85 1995 85 1993 135 1991 135 1991 Fiscal Expenditures Revenue Bonanza and Government Expenditure in Latin America Fiscal Revenues and Expenditures* (LAC-7, Fiscal Revenues, Mar-91 = 100; Adjusted Revenues following the “Chilean Fiscal Rule”) 335 Russian Crisis Increase in Public Expenditures (in % of increase in fiscal revenues, 2003-2006) Beginning of Current Boom Venezuela Fiscal Revenues 285 Brazil Mexico 235 Fiscal Expenditures Colombia Adjusted Revenues 185 Peru Argentina 135 LAC-7: 77% Chile 2005 2003 2001 1999 1997 1995 1993 1991 85 0% 20% 40% 60% 80% 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. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *Izquierdo, Ottonello and Talvi (forthcoming). 100% Revenue Bonanza and Government Expenditure in Latin America Fiscal Revenues and Expenditures* Public Investment Expenditure (LAC-7, Fiscal Revenues, Mar-91 = 100; Adjusted Revenues following the “Chilean Fiscal Rule”) 335 Russian Crisis Beginning of Current Boom (LAC-7, in % of Primary Expenditure) 18% Fiscal Revenues 17.2% 17% 285 16% 235 15% Fiscal Expenditures 14.0% Adjusted Revenues 185 14% 13.1% 13% 12% 135 11% 2005 2003 2001 1999 1997 1995 1993 1991 85 10% 1998 2002 2007 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. *Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *Izquierdo, Ottonello and Talvi (forthcoming). Observed and Structural Public Debt* (LAC-7, in % of GDP) Russian Crisis 90s Boom Current Boom 55% 52% 50% ‘This Time Is Different’ 50% (Observed Debt) 47% ‘All That Glitters May Not Be Gold’ 45% 44% (Structural Debt) 40% 37% 35% 33% 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 30% 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. *Izquierdo, Ottonello and Talvi (forthcoming). QUESTIONS FOR DISCUSSION: FISCAL POLICY (I) From a fiscal policy perspective, does your country fit the regional pattern? Why yes or why not? Do you consider the structural fiscal balance a relevant concept for evaluating the stance of fiscal policy? If so, is a ‘Chilean-Style’ smoothing (i.e. saving the boom to a large extent) relevant for your own country? Do you think having explicit structural fiscal balance targets à la Chile could be useful for your country? If so, what are the difficulties in implementing such a rule? QUESTIONS FOR DISCUSSION: FISCAL POLICY (II) Should structural fiscal balance targets be established taking into account the target levels of structural public debt? How should these target levels be determined? Is the 20% of GDP rule of thumb a valid one for your country? Assuming that we are in the presence of a permanent improvement in the external environment, which is the optimal way of assigning the increase in fiscal revenues in your country: increase current expenditure, increase capital expenditure, debt reduction or reduction in tax rates? Public Debt Management Debt Composition in Latin America ‘This Time Is Different’ ‘All That Glitters May Not Be Gold’ Mutation in Debt Riskiness: Two Revealing Examples Debt Riskiness (LAC-7, Risky Debt in % of Total Domestic Debt*) (Risky Debt in % of Total Domestic Debt**) 80 100% 90% 90% 75 80% 70 67% 70% 60% 65 50% 40% 60 28% 30% 20% 55 10% 2005 2003 2001 1999 1997 1995 1993 1991 50 5% 0% Dec-93 Nov-94 Mexico Aug-97 Dec-98 Brazil 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. *Risky debt includes foreign-currency debt, short-term debt and variable interest rate debt. LAC-7 excludes Peru. **For Mexico, risky debt is computed by taking the ratio of Tesobonos (denominated in US dollars) to total domestic public debt. The latter includes Cetes, Bondes Ajusta Bonos and Tesobonos. For Brazil, risky debt is constructed by taking the ratio of the sum of domestic public debt indexed to the Selic plus exchange-rate-indexed debt over total domestic public debt. QUESTIONS FOR DISCUSSION: PUBLIC DEBT MANAGEMENT Form a public debt management perspective, does your country fit the regional pattern? Why yes or why not? How much of the change in debt composition is structural and how much due to favorable international conditions? From a risk perspective, do you believe that changes in debt composition are a reasonable substitute for the reduction in debt levels? If so, how should debt composition targets be determined? External Position Capital Flows to Latin America* ‘This Time Is Different’ ‘All That Glitters May Not Be Gold’ Net Capital Flows Capital Inflows and Outflows (LAC-7, Billions of US Dollars) (LAC-7, Billions of US Dollars) 100 140 Russian Crisis Russian Crisis Inflows 120 80 100 60 80 40 60 Outflows 40 20 20 0 0 LAC-7 is the sum 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. * Calvo and Talvi (2007). 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1991 -20 -20 International Reserves in Latin America ‘This Time Is Different’ ‘All That Glitters May Not Be Gold’ International Reserves International Reserves to M2 Ratios (LAC-7, in %) (LAC-7, Billions of US Dollars*) 0.55 Russian Crisis 415 Beginning of Current Boom Russian Crisis 404 365 0.50 LAC-7 315 Dec.02-Dec.07 Variation: 175% Jan.91-Jun.98 Variation: 271% 265 0.45 44% 215 40% 0.40 174 165 115 0.35 Jun.98-Dec.02 Variation: -15% 65 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. *LAC-7 is is computed as the sum 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. Dic-06 Dic-05 Dic-04 Dic-03 Dic-02 Dic-01 Dic-00 Dic-99 Dic-98 Dic-97 Dic-96 Dic-95 Dic-94 Dic-93 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1991 1992 0.30 15 International Reserves in Latin America ‘This Time Is Different’ ‘All That Glitters May Not Be Gold’ International Reserves International Reserves to M2 Ratios (LAC-7, in %) (LAC-7, Billions of US Dollars*) Russian Crisis 415 404 25 Russian Crisis Beginning of Current Boom 365 22.1 EA-5 315 Dec.02-Dec.07 Variation: 175% Jan.91-Jun.98 Variation: 271% 265 20 17.0 16.9 215 174 165 15 Jun.98-Dec.02 Variation: -15% 65 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. *LAC-7 is is computed as the sum 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. EA-5 is the simple average of Indonesia, Korea, Malaysia, Philippines and Thailand. Dic-06 Dic-05 Dic-04 Dic-03 Dic-02 Dic-01 Dic-00 Dic-99 Dic-98 Dic-97 Dic-96 Dic-95 Dic-94 Dic-93 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 10 1992 1991 15 LAC-7 13.0 115 QUESTIONS FOR DISCUSSION: EXTERNAL POSITION (I) From a capital account perspective, does your country fit the regional pattern? Why yes or why not? Do you think that a sectoral perspective of the capital account offers a relevant angle for vulnerability analysis? Is there information available at the country level to make a sectoral analysis of the capital account? QUESTIONS FOR DISCUSSION: EXTERNAL POSITION (II) Which are the effective ways of financial insurance in the absence of international risk sharing arrangements? Should reserves be acquired with genuine resources, i.e. fiscal surpluses that take into account an optimal pattern of reserve accumulation? Do international reserves obtained by issuing monetary liabilities (including sterilization bonds) really constitute an effective insurance, available in times of sudden stops? Is reserves-to-M2 ratio a relevant indicator in a context of flexible exchange rates? Latin America and the US Subprime Crisis Latin America’s Reaction to US Subprime Crisis Bond Prices by Region (US High Yield and Latin EMBI Bond Price Equivalent, 23-Jul-07 = 100) 104 102 100 Latin America 98 96 94 Variation* 92 US High Yield Latin America 90 Bond Price (in %) Spread (in bps) -10.8% 0% 305 105 US High Yield Feb-08 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Jul-07 88 Aug-07 *23 Jul-19 Feb Emerging Markets’ Reaction to US Subprime Crisis Bond Prices by Region (US High Yield, Latin EMBI, Asia EMBI and Europe EMBI, Bond Price Equivalent, 23-Jul-07 = 100) Emerging Europe 104 Asia 102 100 Latin America 98 96 94 Variation* 92 US High Yield Latin America Asia Emerging Europe 90 Bond Price (in %) Spread (in bps) -10.8% 0% 1.3% 2.8% 305 105 90 81 US High Yield Feb-08 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Jul-07 Aug-07 *23 Jul-19 Feb 88 Emerging Markets’ Reaction to US Subprime Crisis Bond Prices in Emerging Countries and Fundamentals (US High Yield and EMBI Bond Price Equivalent, 23-Jul-07 = 100) 108 Credit Ratings* AAA AA AA- Investment Grade 105 A+ A Strong Fundamentals* Investment Grade A- 102 BBB+ BBB Weak Fundamentals* Speculative Grade 99 BBVariation** Variation** 93 US High High Yield Yield US Weak Fundamentals Speculative Grade Strong Fundamentals Investment Grade Bond Price Price Bond (in %) %) (in Spread Spread (in bps) bps) (in -10.8% -1.3% -0.3% -0.2% 3.2% 298 140 127 B+ B B- US High Yield CCC+ 108 76 CCC **23 Jul-19 Jul-19 Feb Feb **23 CCC- Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 87 Jul-07 BB+ BB 96 90 BBB- CC SD * A country with strong fundamentals is defined as a country that displays both a current account and a fiscal surplus and a country with weak fundamentals is a country that displays both a current account and a fiscal deficit. * Standard & Poor’s Credit Ratings prior to US subprime crisis. Speculative Grade Emerging Markets’ Reaction to US Subprime Crisis and the Fed 105 5.5 Investment Grade 103 Fed Funds Rate 99 Speculative Grade 4.5 97 4 95 US High Yield 3.5 93 91 3 89 Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 2.5 Aug-07 87 FED Funds target rate, in % 5 101 Jul-07 US High Yield and EMBI Bond Price Equivalent (23-Jul-07 = 100) Bond Prices in Emerging Countries and the Fed Funds Rate QUESTIONS FOR DISCUSSION: THE US SUBPRIME CRISIS AND LATIN AMERICA What is your interpretation of the apparently limited reaction of Latin America to the US Subprime Crisis? Could the US Subprime Crisis create an ‘Indian Summer’ in the region? If so, what should be the policy response? Should monetary and fiscal policy be tightened? Should we expect a Volcker-jump in interest rates once the financial crisis in the US subsides? If so, what should our countries be doing to protect themselves from that eventuality? All That Glitters May Not Be Gold: Debating Key Issues May 8th, 2008 Prepared for Presentation at the XXVII Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC. This Presentation is based on the IADB Research Department report “All That Glitters May Not Be Gold: Assessing Latin America’s Recent Macroeconomic Performance”, coordinated by Alejandro Izquierdo and Ernesto Talvi