Economic Growth Resumes in Latin America: Opportunities and Risks

Economic Growth Resumes in Latin America: Opportunities and Risks Guillermo Perry Chief Economist Latin America and the Caribbean Region The World Bank September 24

Outline Recent Trends and Projections Risks and Vulnerabilities External Vulnerabilities A Greater Resilience to External Shocks? Public Debt: LAC s Achilles Heal? Dealing with the Long Term Development Agenda

Recent Trends and Projections

Latin America had a good performance Percentage 3 2.5 during 199/98 Growth of Income per capita 2 1.5 1.5 World LAC LAC excl. crisis countries -.5-1 199-98 1999-2 23 24 25 Source: WDI.

But slowed down in 1999/22 (and some countries fell into crisis) Growth of Income per capita Percentage 3 2.5 2 1.5 1.5 World LAC LAC excl. crisis countries -.5-1 199-98 1999-2 23 24 25 Source : WDI.

LAC is now recovering Growth of Income per capita Percentage 3 2.5 2 1.5 1.5 World LAC LAC excl. crisis countries -.5-1 199-98 1999-2 23 24f 25f Source: WDI, GEP 24 and DECPG for projections.

The Recovery is Region-wide Indices SA (1998 =1) 3m ma 125 115 15 95 85 75 IPI Brazil Chile Colombia Mexico Peru 125 65 Jan-98 Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Indices (1997 = 1) 12 115 11 15 1 95 GDP Brazil Chile Colombia Mexico Peru 9 1997 I 1998 I 1999 I 2 I 21 I 22 I 23 I 24 I

...and Especially Strong in the Crises Countries Indices SA (1998 =1) 3m ma 11 IPI 9 7 Argenti na Uruguay Venezuel a 12 11 5 Jan-98 Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 GDP Indices (1997 = 1) 1 9 8 7 6 1997 I 1998 I 1999 I 2 I 21 I 22 I 23 I 24 I Argentina Uruguay Paraguay Venezuela Source: Central banks and National Statistics Institutes, and HAVER database.

Source: Forecasts are from Consensus Forecasts, August 16, 24. Growth Forecasts have Improved GDP Growth (in %) Average Forecast 199-97 1998-2 22 23 24f 25f ARGENTINA 5.6-3.1-1.9 8.8 7.1 3.7 BOLIVIA 4.3 2.4 2.8 2.5 3. 3.5 BRAZIL 2.2 1.7 1.9 -.2 3.9 3.5 CHILE 7.8 2.4 2.1 3.3 4.9 4.8 COLOMBIA 4..4 1.7 3.9 3.9 3.9 COSTA RICA 4.7 4.6 3. 5.6 4.7 4.2 DOMINICAN REPUBLIC 3.8 5.8 4.1 -.4 -.8 2.5 ECUADOR 3.2.9 3.4 2.8 4.9 3.6 MEXICO 3.1 3.2.9 1.3 4. 3.7 PANAMA 5.4 2.2.7 4.1 4.6 3.8 PARAGUAY 2.9. -2.3 1.9 2.4 3.1 PERU 4. 1.7 4.9 4.1 4.3 4.1 URUGUAY 3.9-2.7-1.8 2.8 6.6 4.2 VENEZUELA 3.8-1.8-8.9-9.4 9.5 3.8 LAC average 3.5 1.2-1.1 1.6 4.8 3.7 LAC w/o Arg., Par., Uru., and Ven. 2.4 1.7 1.1 4. 3.7 United States 4.1 2.4 3.1 4.5 3.8 Euro-zone 3.1.8.5 1.7 2. Asia Pacific 1.3 2.3 3.7 5.1 3.3

Slowdowns and recoveries have followed external factors LAC Exports have followed the cycle of OECD growth 14 12 1 8 6 4 2 4 3.5 3 2.5 2 1.5 1.5 LAC export growth OECD high income (right scale) 9 92 94 96 98 2 '2 '4 Source: WDI and DECPG.

* Manufacturing. Source: BEA for the USA and INEGI via Haver database. Slowdowns and recoveries have followed external factors Industrial production in Mexico has followed the cycle of the US 1 8 6 4 2-2 -4-6 -8 USA 2 21 22 23 24 Mexico* Industrial Production, 3 month average of annual percentage changes

Slowdowns and recoveries have followed external factors Terms of Trade have varied with commodity prices 16 14 12 1 8 6 Non-energy commodities Petroleum Agriculture Metals and Minerals 4 199 1992 1994 1996 1998 2 22 24 Source: DECPG.

Slowdowns and recoveries have followed external factors Financial flows have followed trends at international capital markets US$ billions 7 6 5 4 3 2 1 Gross private capital flows to LAC Private Public 199 1992 1994 1996 1998 2 22 Billions of US$ 1 8 6 4 2 Dec-3 Feb-4 Apr-4 Jun-4 Gross Financial Flows Public Bonds Private Bonds

Slowdowns and recoveries have followed external factors Spreads reflect general market trends Basis points 18 15 12 9 6 3 1/2/1997 1/2/1998 1/2/1999 1/2/2 1/2/21 1/2/22 1/2/23 1/2/24 25 2 15 1 5 Brazil EMBI Plus Peru Colombia Mexico Brazil

Source: GDF database, World Bank Growing Integration: Net Capital Flows and Economic Growth in LAC 8 7 8 6 5 6 Billions of US$ 4 3 2 1 4 2 Real GDP Growth 197-1 1974 1978 1982 1986 199 1994 1998 22-2 -2 Capital Flows Real GDP Growth

Capital Flows and Economic Growth in LAC RELATIVE GROWTH PER CAPITA: Moderate in the 6s, 7s and 9/98; negative during 8s and 99/3 Real GDP per capita growth, 196-23 196s 197s 198s 199s 199-98 1999-3 East Asia & Pacific 1.7 5.2 5.7 6.2 6.4 5.5 South Asia 1.8.8 3.4 3.4 3.2 3.5 Europe and Central Asia -2.6-3.1 4.2 Sub-Saharan Africa 2.3 1.3 -.7 -.7 -.8.6 Middle East & North Africa 4.4 4.5-1.3 1.2 1.4 1.7 Latin America and the Caribbean 2.3 3.5 -.2 1.2 1.5 -.5 OECD: High income 4.5 3. 2.3 1.7 1.6 1.6 OECD: Total 4.2 2.9 2.1 1.6 1.5 1.5 Low and Middle Income 2.3 2.9.9 1.2 1.2 2.4 World 3.5 2.3 1.3 1.1 1. 1.3 Source: World Bank.

Risks and Vulnerabilities

Interest rates increase Percentage Basis points 5. 14 45 1.8 1.3 4.5 4. 3.5 12 1 8 6 4 35 3 25 2.8 3. 9/11/22 3/11/23 9/11/23 3/11/24 9/11/24 Fed Funds Rate US 3-month bond US 1-year bond (right scale) 4 15 9/11/22 3/11/23 9/11/23 3/11/24 9/11/24 Latin EMBI Global US Junk Spread Source: Bloomberg.

Volatility in Exchange Rate Markets Nominal Exchange Rates and 12-month Forwards 13 1.3 125 12 1.2 115 11 15 1 9/11/22 3/11/23 9/11/23 3/11/24 9/11/24 Yen/US$ Yen/US$ Forward 1.1 1..9 9/11/22 3/11/23 9/11/23 3/11/24 9/11/24 Euro/US$ Euro/US$ Forward Source: Bloomberg.

Imbalances in US could cause sharp interest rate hikes and/or depreciation of the dollar U.S. Federal, state and local financial balances; current account balance, %GDP 3 2 1-1 Federal 3 2 1-1 -2-3 -4 State and Local -2-3 -4-5 Current Account -5-6 Q1-99 Q3-99 Q1- Q3- Q1-1 Q3-1 Q12 Q32 Q13 Q33 Q14-6 Source: FED and US Department of Commerce

LAC is now Better Prepared Floating exchange rates at competitive levels 199 = 1 14 Real Effective Exchange Rate in LAC 13 12 11 1 9 8 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 Source: IMF and own calculations. Observed data and 12-month moving average.

LAC is now Better Prepared Lower Current Account Deficits In percent of GDP -.5-1 -1.5-2 -2.5-3 -3.5-4 -4.5 1991 1993 1995 1997 1999 21 23 Source: IIF

LAC is now Better Prepared Short-Term Debt over Reserves Short term debt / Reserves excl. gold 4. 3.5 3. 2.5 2. 1.5 1..5 Latin America and East Asia End-June 9 End-June 97 End-March 4. Argentina Mexico Brazil Colombia LAC Peru Source: Bank for International Settlements. Short Term debt, up to and including one year. BIS International claims, which cover cross-border claims and local claims in foreign currency. Chile Korea Indonesia Thailand E. Asia

LAC is now Better Prepared Improvements in the Banking Sector NPL/Loans Provisions/NPL 2 % % 15 15 1 1 5 5 1998 1999 2 21 22 23 1998 1999 2 21 22 23 Chile Mexico Colombia Peru Chile Mexico Colombia Peru Source: Supervisory Agencies. Moody s and Fitch

LAC is now better prepared No signs of unsustainable credit booms 3 2 1-1 -2-3 199 1992 1994 1996 1998 2 22 LAC excl. Arg. & Ven. LAC Source: IMF

In percent of GDP 7 6 5 4 3 2 1 Public Debt: LAC s Achilles Heal? Lower Fiscal Deficits, but Higher Debt Levels... Public Debt/GDP 199 1992 1994 1996 1998 2 22 3 2 1-1 -2-3 -4-5 -6 In percent of GDP Fiscal Balances overall balance primary balance -7 199 1992 1994 1996 1998 2 22

Public Debt: LAC s Achilles Heal? Brazil: Debt Dynamics given a 2 basis point increase in US interest rates.63.62.61.6 2 pb de incremento en el FED funds rate (efecto unico) effecto combinado Escenario base.59.58.57.56.55.54 24 25 26 27 28 29 21

Public Debt: LAC s Achilles Heal? Mexico: Debt Dynamics given a 2 basis point increase in US interest rates.3.25 2 pb del incremento del FED funds rate effecto combinado escenario base.2.15.1.5 24 25 26 27 28 29 21

Public Debt: LAC s Achilles Heal? Public Debt: Moderate, but vulnerable given low tax revenues ECA EAP LAC SAS MENA Public Debt % GDP (Median, 23) 2 4 6 8 1 Source: FINCR. ECA MENA LAC EAP SAS Public Debt % Current Revenues (Median, 22) 1 2 3 4 5 6 7 Sources: WDI and FINCR. Note: Revenues for latest available year and public debt for 22. Russian Thailand Czech Chile Korea, Rep. Venezuela, RB Peru Mexico Malaysia Ecuador Poland Colombia Hungary Panama Indonesia Philippines Turkey Brazil India Pakistan Uruguay Argentina Public Debt % GDP (23) 5 1 15 Source: FINCR. Czech Chile Hungary Poland Korea Venezuela Russian Peru Malaysia Turkey Panama Brazil Mexico Uruguay Thailand Indonesia Ecuador Colombia Philippine Pakistan India Argentina Public Debt % Current Revenues (22) 2 4 6 8 1 12 Sources: WDI and FINCR. Note: Revenues for latest available year and public debt for 22.

Public Debt: LAC s Achilles Heal? Public Debt: Moderate, but vulnerable given a high proportion of dollar linked-debt 36 Argentina 1999 Q1 = 1 31 26 21 16 Real Exchange Rate Public Debt 11 6 1999 2 2 21 22 Uruguay 18 16 14 12 1 8 6 1998 1999 2 21 22 1999 Q1 = 1

Public Debt: LAC s Achilles Heal? External Debt: Moderate, but vulnerable given a low level of exports MENA External Debt % GDP (Median, 23) MENA External Debt % Exports (Median, 23) SSA ECA SAS SSA EAP EAP LAC SAS ECA LAC Source: 1 2 3 4 5 6 7 8 5 1 15 2 25 Source: IIF India Mexico Korea Costa Rica Thailand Czech Russian Fd. Venezuela Brazil Malaysia Peru Poland Colombia Pakistan Indonesia Chile Ecuador Turkey Panama Hungary Philippines Argentina Uruguay Source: IIF External Debt % GDP ( 23) 2 4 6 8 1 12 14 Malaysia Thailand Czech Republic Costa Rica Korea Mexico Hungary Venezuela Philippines Russian Fd. India Poland Chile Panama Indonesia Turkey Ecuador Colombia Pakistan Brazil Peru Argentina Uruguay Source: IIF External Debt % Exports (23) 1 2 3 4 5

Public Debt: LAC s Achilles Heal? Change in the Debt Composition towards Lower Currency Exposures: Mexico Bank Credit to the Private Sector in in Foreign Currency and & Public Foreign Debt Debt (Percent) (Percent) 45 9 4 8 7 35 6 3 Bank Credit in 5 25 foreign currency / total credit Foreign public 4 2 debt / total debt 3 1995-1 1996-1 1997-1 1998-1 1999-1 2-1 21-1 22-1 23-1 Bonds Issued by the Private Sector Stocks in Billions Pesos of Domestic market Dollars 23 External market 14 22 13 12 2 11 1 18 9 8 16 7 14 6 5 12 Jan-97 Jan-98 Jan-99 Jan- Jan-1 Jan-2 Source: Central Bank of Mexico Jan-3

Public Debt: LAC s Achilles Heal? Change in the Debt Composition towards Lower Currency Exposures: Mexico Debt Bonds Issued by by the Private Sector Stocks in Billions billions of pesos 18 16 14 12 1 8 6 4 2 Domestic market External market 97 I 98 I 99 I 2 I 21 I 22 I 23 I 24 I 22 21 2 19 18 17 16 15 14 13 12 billions of US$ Source: Central Bank of Mexico

Dealing with the Long Term Development Agenda

Growth and Reforms: How Disappointing? Reforms did pay, but we oversold them Impact of Different Factors on Growth: 198s vs 199s 7. 6.54 6. 5. 5.16 4. 3.48 3.83 3.99 3. 2.7 2. 1.42 1.93 1.27 1.. -.16-1. -.77-2. Argentina Bolivia Brazil Chile Colombia Costa Rica Ecuador El Salvador Mexico Peru Venezuela Convergence Reforms Cyclical External Source: Loayza, Fajnzylber and Calderon (22)

Long term growth: Innovation matters! LAC not among the superstars 5.% 4.5% Predicted & Observed R&D/GDP 4.% 3.5% 3.% 2.5% 2.% 1.5% 1.%.5%.% Israel Finland Korea China India Argentina Mexico 4 5 6 7 8 9 1 11 Log GDP per Capita Fuented : Lederman y Maloney (22) Costa Rica

Innovation requires active policies Technological change depends on the quality of the institutions and public policies (macro environment, labor flexibility, institutions and international economic integration -CAFTA, Doha-) Technological change is skill biased: it requires growing levels of education Technical change requires specific supports on: Intellectual property rights Competitive subsides University/Firms linkages Sectoral innovation clusters Capital Risk

Education matters: Skill biased technical change Growth in demand for education Tertiary VS. Secondary 1.6 Chile: Estimated Chile Relative Demand Alternative Implied Relative Demand Time Series - Tertiary and Secondary Education Chile - Males and Females 1.6 Mexico: Mexico Estimated Males and Females Relative Demand Alternative Implied Relative Demand Time Series - Tertiary and Secondary Education Mexico - Log Relative Demand for Workers with Postsecondary Education 1.1.6.1 -.4 1966 1968 197 1972 1974 1976 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 elas - 1 elas - 2 elas - 3 Log Relatrive Demand for Workers with Postsecondary Education 1.4 1.2 1.8.6.4.2 elas - 1 elas - 2 elas - 3 -.9 Year of Survey 1987 1988 1989 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 Year of Survey

Education matters: Large deficits in secondary enrollment. Net secondary enrolment rate, 1998 1 8 6 4 2 Nicaragu Jamaica Malaysia Trinidad Argentin Chile Guyana Peru Philippi Thailand Mexico Dominica China Ecuador Colombia IndonesiParaguay Costa Ri El Salva Belize Brazil Venezuel Sweden Korea Canada Finland New Zeal Australi United S Hong Kon 5 6 7 8 9 1 11 Log of per capita GDP, 1998

Education matters: Smaller deficits in tertiary enrollment. Gross tertiary enrolment rate, 1998 8 6 4 2 Korea Argentin Finland Australi United S New ZealSweden Canada Singapor Panama Chile Thailand Costa Ri Barbados Philippi PeruVenezuel Hong Kon Bolivia Bahamas Dominica Ecuador El Salva Colombia Mexico Nicaragu Honduras Brazil Guyana Indonesi Paraguay Malaysia Suriname Guatemal Jamaica China Trinidad Haiti Belize 5 6 7 8 9 1 11 Log of per capita GDP, 1998

Education matters: Large deficits in quality of education 65. Puntaje en Matemáticas, 1998 TIMSS 55 45 35 Moldova Slovak Hungary R Russian Malaysia Czech Re Bulgaria Latvia Romania Lithuani Thailand Macedoni Tunisia Turkey Iran Indonesi CHILE Philippi Morocco Singapor Korea Hong Kon Belgium Netherla Slovenia Canada Australi Finland England USA New Zeal Cyprus Italy Israel Japan South Af 6 7 8 9 1 11 Log PIB per cápita, 1998

Long-term growth: Institutions matter! An unfinished agenda Institutional Gaps and Income Gaps with USA.8 Explained Income Gaps.7.6.5.4.3.2.1 Voice and Accountability Political Stability Government Effectiveness Regulatory Quality Rule of Law Control of Corruption Institutional Gaps USA-Lac USA-Eastern Europe USA- Asia Tigers

Infrastructure matters: Deficits developed in the last decade (except Chile and Colombia) Total Investment (public and private)/gdp Fuente: Servén, Calderón (24)

1 Extreme inequality: An impediment for high growth? Gini coefficient: distribution of household per capita income, regions of the world, 199s 6 5 LAC Asia 4 Developed Eastern Europe 3 2 1 Source: Authors calculations based on UNU/WIDER-UNDP World Income; Inequality Database, Version 1., September 2.

Extreme inequality can limit growth Lost Investment opportunities Unequal access to credit Unequal access to education High levels of crime and violence Weak institutions (property rights) Weak response to external shocks

Rol of the State Small, inefficient and non redistributive States?.45 Total Taxes.4.35 Italy France.3 Spain.25 Nicaragua Uruguay Brazil.2.15.1 Dominican Republic Bolivia Colombia Guatemala Costa Rica Mexico Peru Chile Argentina United States.5. 4.5 5.5 6.5 7.5 8.5 9.5 1.5 ln GDP Per capita (constante 1995,$US) Average 199-2 11.5

The End