Macroeconomic Perspectives for Latin America and the Caribbean, Presentation from LACEA, Santa Cruz, October 2015

1. Andrew Powell
Principal Advisor, Research Department
Inter‐American Development Bank
Macroeconomic Perspectives for Latin
America and the Caribbean
LACEA, Santa Cruz, Bolivia
October 15th ‐ 17th 2015
Strictly my personal views only

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purpose.

3. 1. Is this time different?
2. Perspectives – what’s going on?
3. Will we avoid a crisis?
4. What’s to be done?
Outline

4. • Steep fall in Commodity Prices
• Impending Rise in US Interest Rates
• Strong Dollar
• Weaker Fiscal Positions
• Higher Debt Ratios, Required Adjustment
• Déjà vu?
1. Is this time different?

5. Need Better Risk‐Management, Still!
Oxford Review of Economic
Policy (1989) 5 (4): 69‐87
• Better hedging needed:
• Commodity Prices
• Interest Rates
• Currencies
• Perhaps 1980’s Debt
Crisis would have been
averted or been less
severe…

6. The Fall in Commodity Prices:
Shock or Anticipated Change?
Oil
Source: IMF Primary Commodity Price Indices

7. March 2012 Latin American and Caribbean
Macroeconomic Report: Copper Prices
7
150
200
250
300
350
400
450
2010 2011 2012 2013 2014 2015 2016
c/lb (2011 values)
Baseline
Projection
Actual
We also had two more
negative scenarios ‐ it could
have been worse!
Adapted from The World of Forking Paths:
2012 Latin American and Caribbean
Macroeconomic Report, IDB March 2012

8. A Longer Term Perspective:
110 Years of Commodity Price Booms and Busts
• Source: Mariscal and Powell
(2014) ‐ we argued a fall in
commodity prices would
simply represent a return to
the previously established
equilibrium.
• Nb: equilibrium such that
commodity prices are
cointegrated with MUV’s ,
with a cointegrating vector =
1.0 (no trend) and a couple
of endogenously identified
breaks after major booms
• Powell (1991) suggested
supply innovations in booms.
1970’s bust…
Source: Mariscal and Powell (2014)

9. Interest Rates: The Fed Dots Indicate a
Steep Climb after “Lift‐Off”
Each dot is the view
of one member of
the FOMC
Median View
2015 0.25
2016 1.25
2017 2.5
2018 3.25
L. Run 3.5
But the market curve is less steep, will the market curve will get
steeper on lift‐off or will the dots change? Expect volatility!
Source: Federal Reserve Board, Economic Projections. Sep 2015

10. US Interest Rates: Policy Rates to Rise,
but what will the 10 Year Rate do?
US Ten Year Rate
Effective Fed
Funds Rate
In the 1990’s, big
change in the 10
year, in 2004,
nada!
St Louis Fed. FRED database.

11. The fiscal position of the region has weakened
In addition, observed primary fiscal balances have deteriorated
and are now at the levels of the global financial crisis.
1.6
‐0.9
0.3
0.0
‐0.1 ‐0.1
‐0.9 ‐1.1
‐5
‐4
‐3
‐2
‐1
0
1
2
3
4
2007 2008 2009 2010 2011 2012 2013 2014
% GDP
mean 25th percentile 75th percentile median
Structural Primary Balances, LAC
Source: 2015 Latin American and Caribbean Macroeconomic Report.

12. Most of the increase in spending has been on inflexible items
0.9% 1.8% 0.7% 0.3%
LAC
% GDP
Wages and salaries Subsidies and transfers Other current Investment
Change in LAC Primary Public Spending 2007‐14 by Category
3.7%
Total
Relatively inflexible, 2.7 %
0 1 2 3 4
Source: 2015 Latin American and Caribbean Macroeconomic Report

13. Debt Ratios and Required Adjustment
to Maintain Constant D/G

14. • Floating exchange rates
• More domestic, less external debt
• Strong reserve position
• Solid financial systems
On the other hand…

15. Floating Exchange Rates…

16. Sovereign Debt Mostly in Domestic Currency
and under Domestic Legislation
Source: Sandleris presentation in 42nd IDB “Chief Economists of Central Banks and Finance
Ministries Meeting, Lima, Peru. October 7th and 8th 2015.

17. Solid Financial Systems…
0
4
8
12
16
20
2006 2007 2008 2009 2010 2011 2012 2013 2014
Regulatory capital to risk‐weighted assets
(%)
Capital Ratios in LAC
Brazil Chile Colombia El Salvador Mexico Panama
Basel I and Basel II minimum capital recommendation
Source: IDB staff estimates and Financial Soundness Indicators (IMF)

18. 1. Is this time different?
2.Perspectives – what’s going on
3. Will we avoid a crisis?
4. What’s to be done?
Outline

19. • Two perspectives:
– “Secular Stagflation”
– vs. just a painful transition
2. What’s going on?

20. World Growth Prospects Falling…

21. Secular Stagflation in LAC: low growth, low’ish
productivity and loss of demographic boom
21
‐1.0
0.0
1.0
2.0
3.0
4.0
2001‐2010 2011‐2020
Growth of GDP per capita (%)
Change in Productivity Change in the Employment share
Change in the Capital Intensity Growth of GDP Per capita
Note: Productivity is measuredas Total Factor Productivity. The employment share is the ratio of employment to
population. The capital intensity is the ratio of capital stock to GDP.
Source: IDB staff estimates based on Penn World tables 8.0 and World Economic Outlook, IMF (2014)
1.4% higher TFP
growth required
to reach the per
capita growth
expected in
ASEAN countries
Baseline TFP
growth
Baseline
change in
factors
Source: 2015 Latin American and Caribbean Macoreconomic Report, IDB, Mar 2015
Need boost
in TFP or in
K to get
ASEAN
growth
rates
Loss of
demographic
boom from
2000’s more
than 1%

22. • Potential growth lower
• Depreciating exchange rates
• Greater Pass‐through
• Higher inflation..
At the same time…
“Secular Stagflation”

23. • Significant fall in Terms of Trade…
• Shift from Commodity and Non‐Tradeable to
Tradeable Non‐Commodity Sectors
• End of a major Credit Boom likely focused on
consumption, commodity and non tradeable
sectors (construction)
• Plus fiscal adjustment…
Or, a Painful “Dutch” + “Fiscal” Transition?

24. 1. Is this time different?
2. Perspectives – what’s going on
3.Will we avoid a crisis?
4. What’s to be done?
Outline

25. • Three risks:
– A. Brazil’s fiscal situation (and potential contagion)
– B. Corporate debt and the credit cycle
– C. Sudden Stop
3. Will We Avoid a Crisis?

26. Deteriorating Growth Prospects
for the Region and for Brazil
Brazil
Latin America ‐
Weighted
Average
Latin America ‐
Simple Average
‐3
‐2
‐1
0
1
2
3
4
Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15
Percentage

27. Deteriorating Fiscal Balances in Brazil
0
10
20
30
40
50
60
70
‐8
‐6
‐4
‐2
0
2
4
2010 2011 2012 2013 2014
Primary Balance Overall Balance General Gov. Gross Debt (right axis)
Source: Powell and Salazni (2015)

28. Miller‐Zhang (2013) Model of Fiscal Adjustment
Debt to GDP
Increasing
Reducing
spending
Increasing
spending
Debt to GDP
Decreasing
Starting position
here has primary
surplus but not
enough to keep debt
constant
Source: Mr Pangloss and Mr Keynes..

29. Parameterization of the Model
Model Parameters
Current tax revenues (% GDP)
Current primary expenditures (% GDP) g 25.0%
Long‐term real growth (%) gamma 2.0%
Current public debt level (% GDP) b 64.0%
Real interest rate (%) r 3.5%
Debt objective (% GDP) b* 40.0%
Primary expenditure objective (% GDP) g* 23.6%
Fiscal partial adjustment parameter alpha 75.0%

30. The “Tough” Adjustment Plan of Jan 2015
Multiplier = 0.3 Multiplier = 1.0 Multiplier = 1.5
Debt path
in blue
Plan as
announced
Takes 10 years to get
D/G to 60%
Needs tougher plan to
debt D/G down (blue)
Plan as
announced
unstable
Even tougher plan needed
to debt D/G down (blue)
2015 primary surplus target of 1.2%, implying a 1.8% adjustment in first year

31. “Less Tough” Plan Now Sent to Congress…
Multiplier = 0.3 Multiplier = 1.0 Multiplier = 1.0
Real Interest Rates of 5%
Debt now
rises
Debt settles
at high 60’s
Tougher adjustment plan
needed to get debt down
Debt rises before falls Even tougher adjustment
needed to get debt down
Such low
spending,
feasible?
2015 primary surplus target of 0.15% and 2016 target of 0.7%

32. Further Delay and then “Less Tough”…
Multiplier = 0.3 Multiplier = 1.0 Multiplier = 1.0
Real Interest Rates of 5%
Primary deficit for 2015 and 2016, adjustment in 2017 calibrated as “less tough”
Is such low
spending feasible?
Tougher adjustment
plan to get D/G down
D/G rises to 75%
D/G converges
to ≈70%

33. • Caveats of the analysis
– single multiplier on all spending
– potential growth assumed at 2% throughout
– inflation not modelled independently (only real int. rate)..
• Trade‐offs are already very serious…
• Sensitive to parameters, the key is to:
– Keep multipliers low
– Keep interest rates as low as possible
What do we learn?

34. Argentina the most affected
Contagion Risks: through the lens of a G‐VAR
0%
1%
2%
3%
4%
5%
6%
7%
Annual growth rates
LAC without Brazil WEO Baseline
LAC w/o Brazil ‐ History Brazil Y 1/2 sd shock
WEO LAC w/o Brazil Projections WEO LAC w/o Brazil (yealy av.)
October 2015 WEO Update
Country WEO *
Conditional to
Brazil shock
Difference
Average annual growth rate from 2015Q2 to 2018Q1 (12 quarters)
Argentina ‐0.1% ‐0.9% ‐0.8%
Mexico 2.8% 2.3% ‐0.5%
Peru 4.0% 3.5% ‐0.4%
Paraguay 3.7% 3.3% ‐0.4%
Colombia 2.9% 2.6% ‐0.4%
Chile 2.6% 2.3% ‐0.3%
Ecuador 0.2% 0.0% ‐0.2%
Nicaragua 4.1% 3.9% ‐0.2%
Costa Rica 4.0% 3.9% ‐0.1%
Jamaica 2.0% 1.9% ‐0.1%
El Salvador 2.5% 2.4% ‐0.1%
Bolivia 3.7% 3.6% ‐0.1%
* October 2015 WEO Update
‐1/2 Brazil Y sd shock

35. Source: 2014 Latin American and Caribbean Macroeconomic Report
B. Corporate Debt and the Credit Cycle..

36. LAC – 5 Bond Issuance
Source: 2014 Latin American and Caribbean Macroeconomic Report

37. Shift in EM Financing
Source: Turner (2014)

38. Source: 2014 Latin American and Caribbean Macroeconomic Report
And Consequent Switch to USD…

39. Source: Powell (Coord. 2014) Latin American and Caribbean Macroeconomic Report

40. Three Perspectives on Domestic Credit
Source: Latin Macro Watch
• Credit grew very strongly indeed in a number of countries in LAC
• It frequently makes sense to look at credit growth in nominal terms
• Boom at least partially funded by increased corporate deposits
• Will discuss potential risks later on…
% of GDP USD $bn USD $bn

41. Now Corporate Amortizations Rising, Issuance Falling
60
133
118
0
20
40
60
80
100
120
140
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
US$ billions
LAC Corporate Bond Issuance
International Debt Securities Domestic Debt Securities
Source: 2015 Latin American and Caribbean Report
38
59
64
0
10
20
30
40
50
60
70 Amortization Schedule
Foreign currency Local currency

42. Data: 757 LAC listed firms. In addition the share of firms that have
earnings below the level of short‐term debt obligations has risen.
And firms’ balance sheets have deteriorated
10%
15%
20%
25%
30%
35%
40%
2005‐2007 2013
Distribution of firms' debt to assets ratio
75 percentile
75 percentile
25 percentile
25 percentile
Median
Median
Source: 2015 Latin American and Caribbean Macroeconomic Report.

43. Source: LAC‐7. Thomson‐Reuters. Last data point Sep 14th. 2015 is annualized.
US$ bn
Corporate Bond Issuance Now Plummeted

44. Source: LAC 7. Thomson‐Reuters. Last data point is Sep 14th 2015. 2015 is annualized
US$ bn
In Local but Especially in Foreign Currency

45. • Currency Mismatches for Corporates
• Liquidity Risks for Banks
• Standard Credit‐Cycle Type Risks
• But LAC Financial Systems now large
• Potential Macro‐Impacts
• And Beware Second Round Effects
Credit‐Cycle Risks

46. C. Sudden Stop in Capital Flows
Excluding T&T and Ven that
had surpluses in 2014 and
also The Bahamas, Guyana
Panama, Barbados,
Belize, Suriname
Honduras, Jamaica
Nicaragua & Haiti that all
have higher CC deficits
% GDP Source: IMF, WEO Oct 2015

47. • Monetary policy: ease the transition
• Growth orientated reforms..
• Institutional reforms, PDP’s and the like
• Fiscal rebalancing
• “Infrastructure Plan” for LAC
3. What’s to be done?

48. INVERSION EN INFRAESTRUCTURA:
ARGENTINA, BRASIL Y MEXICO
% del PBI. 2008-2013
ARGENTINA BRASIL MEXICO
Pública Privada Total Pública Privada Total Pública Privada Total
2008 1.02 0.64 1.66 1.43 1.58 3.01 0.8 0.45 1.25
2009 1.44 0.44 1.88 1.75 1.92 3.67 1.4 0.47 1.87
2010 1.79 0.44 2.23 1.64 1.01 2.65 1.21 0.46 1.68
2011 1.34 0.57 1.91 1.42 1.33 2.75 1.25 0.63 1.88
2012 1.29 0.42 1.71 1.27 1.93 3.20 1.03 0.54 1.58
2013 1.24 0.51 1.75 1.34 1.41 2.75 1.05 0.73 1.78
PROMEDIO 1.86 3.00 1.67
Fuente: BID, CAF, CEPAL