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China has had a stellar growth performance over the past two decades, growing at record rates of around 10 percent. But high growth has come along with a series on imbalances, notably overinvestment in the real estate sector and huge increase in domestic credit, all of which has caused China’s growth projections to moderate.

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Any substantial reversal of China’s growth will definitely have an  impact on Latin American countries. But how would China affect the region, and how serious could it be? This was the topic of discussion during our most recent CLAAF meeting, held last weekend at CGD’s headquarters.

As explained in the latest CLAAF statement, there are four main channels through which a Chinese growth slowdown could affect Latin America:

  1. Lower Chinese growth would drive commodities prices downwards, via lower demand. This is the biggest and most evident channel of transmission, and its importance in each country will depend on which commodities suffer the most, the extent to which such commodities are exported by the country, as well as on its degree of trade openness.
  1. Lower growth prospects for China have the potential to worsen the risk assessment of Latin American countries, but also of emerging markets as an asset class. In particular, the possibility of contagion among emerging markets, as seen during past crisis episodes, is a latent risk.
  1. Chinese direct investment in the region has increased significantly over the past years, especially in agriculture, energy, and mining. The effect of a Chinese slowdown on Latin America via this channel is uncertain: if lowering domestic investment leads to an increase in China’s current account balance, FDI to Latin America could even increase. But if Chinese investment declines in a more generalized way, affecting both domestic and foreign investment, FDI could decline too, adding recessionary pressures to the regional and the global economy.
  1. An incipient channel through which serious risks could be building up is the (increasing) presence of Chinese banks in the region’s financial markets. While the benefits are unquestionable – since it has the potential to increase the availability of funding for key productive sectors in the region – a more systematic expansion of Chinese banking exposes the region to China’s own financial fragilities.

Given these channels of transmission, China’s economic performance entails several potential risks to Latin America. While it is hard to estimate whether these will materialize, and how serious could be its impact on the region, it is imperative for Latin America to be prepared to face these risks.

CLAAF recommends that policymakers follow a two-stage approach to assess how countries would be expected to perform if any of these risks materializes. The first stage consists on performing stress tests that take into account all of the problems that a Chinese slowdown could suppose for Latin American economies. The second stage consists on performing such tests in a coordinated way, with the support of global and regional International Financial Institutions, in particular the International Monetary Fund. Implementing strong fiscal and monetary policies, naturally, is crucial to shield the economy from eventual shocks—with adequate liquidity cushions being a clear priority.

The Committee highlighted the importance of counting on a lender of last resort to guarantee stability in times of financial stress. In this sense, the IMF is the organization par excellence with the capabilities, while not the capacity, to become a global lender of last resort. To be capable of effectively assisting countries in difficulty, the IMF needs to be recapitalized. At the regional level, institutions like the Fondo Latinoamericano de Reservas (FLAR) can suitably complement the IMF’s role in guaranteeing ongoing liquidity for Latin American economies.

This and previous CLAAF statements are available in English and in Spanish. You can also click here to watch CLAAF members’ public presentation of the statement, followed by an interesting discussion on the topic.