1 The Financial Crisis and its Impact on Latin America LASA Workshop on the Crisis and its Impact on Latin America October 6, 2010 Nora Lustig Samuel Z.

1

The Financial Crisis and its Impact on Latin America

LASA Workshop on the Crisis and its Impact on Latin

AmericaOctober 6, 2010

Nora LustigSamuel Z. Stone Professor of Latin

American EconomicsTulane University

2

3

1. What was the economic performance of the region before the financial crisis?

2. Where does Latin America stand today and where is it headed?

3. How will the crisis affect living standards?

4

1. Economic Growth in LA Before the Crisis was Robust: 5.3 % a yr. 2002-07(Source: CEPAL)

5

Economic Growth in LA Before the Crisis was Robust

6

2. What were the expectations and what happened?

Two Phases of Financial Crisis (Izquierdo and Talvi, 2008)

First Phase: mid-2007 until mid-2008

Second Phase: mid-2008 until ….

7

Phase 1 (cont.)

Conventional wisdom in early 2008: Latin America is in a much better position to withstand the external shock: prudent fiscal policy, sound banking system, low indebtedness and large amounts of international reserves.

Problem: Growth was highly linked to the boom in commodity prices and part of this boom was the result of the policies pursued to tackle with the financial crisis. In particular, with lower interest rates in the US.

8

Phase 2: From mid-2008 Onwards

Realization that: Financial system in advanced countries facing solvency issues

Advanced countries in deeper recession than anticipated

Emerging economies would face growth slow down. No decoupling

Post-Lehman collapse led to global credit market freeze

As a result:

Massive redemptions Flight to quality Demand for dollar/US Treasuries sky-rocket

=> commodity price, foreign currencies, foreign stock markets simultaneously fell

=>dollar appreciated

9

Phase 2: From mid-2008 onwards:

Biggest fears:Deep and protracted global recession

DeflationFor LAC: Adverse external shocks for commodity exporters but also for economies relying on exports to US, remittances, tourism and external capital flows

(Sources: IMF; Izquierdo and Talvi, Nov. 2008)

10

Boom and Bust of Commodity Prices

11

12

Latin America and the Caribbean: Transmission Channels

Financial: Exchange rate volatility, private sector debt and risky financial investments (Brazil, México)

Lower access to international credit markets

Capital outflows Real economy:

Lower exports, remittances and tourism Lower commodity prices: bad news for Mexico and South America; good news for CA and Caribbean, but insufficient to compensate for other negative factors

13

3. Where does Latin America stand today and where is it headed?

Growth for 2009 was negative but not as bad as some anticipated.

Countries most affected not necessarily those people were expecting Argentina and Venezuela have been holding their ground while…

…Mexico has been hit hard because of its close ties with US economy through exports and capital flows.

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 Central America(Real GDP, annual variation)

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009*

4.8%

-1.9%

Russian Russian CrisCrisisis

Beginning of Beginning of the the BoomBoom

Lehman’s Lehman’s BankruptcyBankruptcy

-1%

0%

1%

2%

3%

4%

5%

6%

7%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009*

Russian Russian CrisiCrisi

ss

Beginning of Beginning of the Boomthe Boom

4.4%

-0.6%

Real Impact of the Global Crisis:Economic Activity

CAC-7 is the simple average of Costa Rica, El Salvador, Guatemala, Honduras, Dominican Republic, Nicaragua and Panama.

* Estimate. Source: JPMorgan and WEO

(CAC-7)

Lehman’s Lehman’s BankruptcyBankruptcy

15

16

LAC Currencies: Appreciation Followed by Sharp Depreciation

17

US-Mexico correlation of business cycle in

manufacturing sector

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

Jun-93Jun-94Jun-95Jun-96Jun-97Jun-98Jun-99Jun-00Jun-01Jun-02Jun-03Jun-04Jun-05Jun-06Jun-07Jun-08

-15%

-10%

-5%

0%

5%

10%

15%

Correlation

Mexico

US

18

For the first time in decades, Latin American economies got hurt mainly due to adverse external shocks and not because of poor domestic macroeconomic policies.

Adverse external shocks are also an impediment to implement counter-cyclical fiscal policies.=> Adjustment costs can be significant

19

20

21

22

23

24

25

26

27

28

29

30

31

4. The Impact of the Crisis on Living Standards

Unemployment Real Wages Remittances Government monetary and in-

kind transfers Poverty (tbc) Inequality (tbc) Other social indicators (tbc)

32

33

34

Are Countries Ready to Mitigate the Impact on the Poor?

Which countries introduced counter-cyclical safety nets and what kind?

Did they cover the universe of the affected population?

Were transfers sufficiently large to compensate for the income losses?

35

Conditional Cash Transfers in LAC(Source: Inter-American Development

Bank, 2008)

Without program

Pilot Small scale

(<25% poor)

Medium & large scale (>25% poor)

Bahamas HaitiBarbados

NicaraguaBelize

SurinameGuyana

Guatemala Costa Rica El Salvador Dominican

Rep.

Honduras

    México

Uruguay   Paraguay JamaicaPanama

BoliviaTrinidad y TobagoVenezuela

ArgentinaPerú

BrasilColombia ChileEcuador

11 2 5 8

36

THANK YOU