Toward the end of the 2008 global economic crisis, the consensus was that developed economies would recover just as quickly as they did in past recessions. It was also expected that emerging market economies would continue acting as the world growth locomotive for a relatively long time. Until mid-2011, this perspective appeared to be in the process of materializing. By now, however, this scenario differs significantly from reality.
As a result, the consensus among international analysts has, therefore, become increasingly pessimistic. In the case of developed economies, the slow recovery has even led some experts to suggest the possibility of entering into a secular stagnation process. In Latin America, the economic slowdown has reverted growth rates towards potential rates similar to historical averages following a strong expansionary period. Between 2009 and 2013, the region benefited from the aggressive response to the 2008 crisis by advanced economies’ central banks (particularly the Fed) and the strong countercyclical policy in China. Nowadays, part of Latin America’s slowdown is clearly cyclical. After the boom in commodity prices, there was a strong increase in investments related to these industries, which is now coming to an end.
These developments are of special interest to the Latin American Shadow Financial Regulatory Committee (CLAAF for its Spanish name), a group of leading experts on Latin American economics that I (Liliana) chair. In the latest CLAAF statement, the committee identified two additional risk factors that have not been appropriately internalized by the current consensus. The first is that asset liquidity might fall significantly when the Fed increases interest rates, a move the market has started to anticipate. This fall in asset liquidity might drastically reduce emerging markets’ external funding. The second is that there are indications that a slowdown in China’s economic growth will be deeper than what is forecasted by the current international consensus. The committee also identified an additional risk factor resulting from a larger fall in commodity prices than anticipated by consensus estimates.
Committee members find that Latin America is less able now to face to risks than it was in 2008. There are a number of reasons:
- Excessive public and private expenditure and insufficient savings ratios led to a deterioration of current account balances even before the recent decline in commodities prices.
- Public-sector deficits increased significantly in several countries, including those where countercyclical fiscal policies adopted in 2009 were not reverted during the subsequent recovery.
- Domestic costs of production increased faster than productivity, reducing competitiveness in non-commodity tradable industries.
- Indebtedness levels of firms and families are relatively high in several countries.
- Efforts for increasing productivity in the region have clearly been insufficient.
The risks from the global scenario described above have a clearly systemic dimension. In this context, CLAAF believes that it is desirable to strengthen the international financial architecture to improve its capability to respond to a sudden deterioration in global financial markets. In particular, the committee recommends the following:
- The creation of an Emerging Markets Fund (EMF) with the capacity to intervene in sovereign debt markets for the purpose of reducing volatility. Such a fund may intervene in debt markets in case of systemic financial turmoil and under predetermined rules.
- To complement the role of current multilateral organizations, particularly the IMF, through the creation of regional institutions. In this regard, the Committee favors the creation of a Latin American Liquidity Fund mainly aiming at (1) providing liquidity to the public sector and (2) providing credit that can mitigate the possible volatility in trade credit lines. The committee estimated that such institutions should need a capitalization of US$ 50 billion and a lending capacity of US$ 100 billion, equivalent to the net liquidity needs by the region during the 2008–09 crisis (this recommendation has been previously stated by the committee in its Statement No. 27).
- That countries in the region run new stress tests in order to update possible financial needs for the public and private sectors that might arise if the Fed increases interest rates suddenly.
- To keep appropriate exchange rate flexibility and avoiding “fear to float” behaviors. The countries that are most able to reduce currency mismatches in balance sheets and dollarization will be better positioned to face the challenges of a greater financial volatility and lower economic growth.
CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.