Actividad. Política Cambiaria y Monetaria. Inflación.
Miercoles 9 de octubre de 2013
Latin America’s Deceleration and the Exchange Rate Buffer
Fuente:
World Bank
Autor:
Augusto de la Torre, Eduardo Levy Yeyati and Samuel Pienknagura
Executive Summary
Economic and financial news in the past six months confirm that the external tailwinds that propelled economic activity in Latin America and the Caribbean (LAC) over the past decade continue to recede. The softening of Chinese growth and its implications for the terms of trade of natural resource-abundant LAC, and the seemingly inevitable normalization of monetary policy in the U.S. have moved to the center of attention for policy makers in the region. The external setting for LAC is significantly complicated by the convergence of “the great deceleration”—affecting emerging economies across the board—, the pronounced steepening of the U.S. yield curve, and the nervous overreactions of financial markets to changing perceptions on the timing and implications of the tapering of quantitative easing (QE) in the U.S. Some consolation does come from the fact that the U.S. economic recovery appears on firmer footing (although besieged by high policy uncertainty associated with vitriolic political impasses) and that the European Union seems to have hit economic bottom. Overall, however, the global environment is no longer friendly to emerging markets in general and LAC in particular.
The growth deceleration in the region is indeed part of a synchronized (in timing and magnitude) slowdown across emerging economies (EMs)—including the middle-income countries in Eastern Europe, East Asia, and LAC, as well as China—whereby growth rates have declined by about 3 percentage points from their 2010 peaks to the present. In the case of LAC, the growth rate has fallen from about 6 percent in 2010 to around 3 percent in 2012 and to an estimated 2.5 percent in 2013. While the EM synchronization clearly indicates that a weakening of common (global) drivers of growth is at work, it is also the case that the variance in growth performance has been on the rise—as common factors lose strength, country specific factors play a bigger role. LAC is no exception in this regard. Growth forecasts for 2013 vary widely across countries in the region. They go from rates at or below 1 percent for Jamaica and Venezuela, to Asian-style growth rates of 5.5 and 8 percent for the two best performers in the region in the past decade, Peru and Panama, respectively. Reassuringly, a good number of mid-sized LAC countries (such as Chile, Colombia, Costa Rica, Ecuador, Guatemala, and Uruguay) are beating the regional average, with growth rates in the 3-4 percent range. Regrettably, the region’s giants, Brazil and Mexico, are growing below the LAC average, with Mexico’s growth falling below 2 percent despite the ongoing wave of reforms that is fueling investor optimism.
The great deceleration and intensification of volatility in capital flows and asset prices—including local bond yields and currencies—have sparked a wave of pessimism over the region’s future. Expressions such as “submerging economies” and “the party is over” have become common in analysts’ and investors’ parlance and, while mainly applied to the BRICS (Brazil, Russia, India, China, and South Africa), have contaminated perceptions about LAC. This marks a major turnaround in sentiment which not too long ago had nothing but praises for the region’s decade of stellar economic and social progress. Skeptics now argue that such progress was largely a mirage—i.e., that the region metabolized the terms of trade gains and capital inflows bonanza into a consumption-driven, credit-fueled (ultimately unsustainable) expansion that concealed (and fed) underlying macro-financial weaknesses—and a missed development opportunity of dramatic proportions—i.e., that the region failed to seize the favorable external conditions to build the foundations for productivity growth. In its stronger version, this pessimistic view predicts that the ongoing deterioration of the external environment will expose the region’s fragile dependence on speculative foreign finance and, as a result, the downturn will end up in tears, that is, in the type of macroeconomic and financial havoc that the region tended to experience in the 1990s following sudden stops and reversals in capital flows.
Is this gloomy prognosis justified? This report assesses this crucial question and comes out with a relatively optimistic yet nuanced view. For starters, it argues that the region’s last decade of social and economic progress is far from an illusion. To this end, it suffices to set right a few crucial facts about the region’s last decade of growth with equity. First, while growth was indeed driven by domestic demand (and not by external demand as in Asia), it was not—contrary to popular belief—a mere consumption story. A vigorous expansion in investment was a crucial part of the story, to the point that the average rate of investment in the region now compares favorably to that in the East Asian middle- income countries (MICs). (The efficiency of such investment, to be sure, is a different issue that cannot be taken cavalierly and requires more research.) Second, LAC’s current account deficits have been largely financed by foreign direct investment (FDI) rather than by short-term portfolio inflows, as is often believed. (Again, the quality of FDI and whether LAC is adequately capturing its positive spillovers is a different issue where concerns may be warranted.) Third, while brisk consumer credit expansion has naturally raised some policy concerns, overall credit growth was moderate in LAC by comparison with other MIC regions, was closely monitored by strict regulatory authorities and, hence, does not pose significant systemic risk worries (except perhaps in financially fragile Caribbean countries). Fourth, the social progress registered in the region over the last decade—whereby some 70 million Latin Americans left poverty and some 50 million joined the middle class—was real enough, and while it may stall and lead to frustrated expectations in a low-growth scenario, it is unlikely to be reversed in the short-run.
Most importantly, and this is the main focus of this report, there has been a fundamental improvement in the region’s “macro-financial immune system” which should, in a veritable break with history, enable several of the larger countries in the region—particularly those with monetary policy frameworks based on inflation targeting and exchange rate flexibility—to rely on currency depreciations to absorb adverse external shocks and stimulate local economic activity, thereby cushioning the downturn as external tail winds recede. Moreover, given global uncertainties and jittery financial markets, a case can be made that such depreciations will likely have to be accompanied by hands-on interventions by central banks in the foreign exchange market so as to limit excessive currency volatility.
Two fundamental changes explain why inflation-targeting LAC countries can now embrace currency depreciations without fear in times of cyclical downturns. The first is the de-dollarization of financial contracts, which has substantially reduced the adverse (solvency) effects of currency depreciations on the balance sheets of debtors (households, firms, government). The second is the substantial decline in the so called “exchange rate pass through”, a decline that reflects a more credible monetary policy that is better able to coordinate expectations in a forward looking manner— i.e., around the inflation target preannounced by the central bank—thereby breaking the old tendency for prices and wages to be set in a backward looking manner—i.e., indexed to past inflation and devaluation.
By leaving the fear of depreciation behind, inflation-targeting LAC countries stand now ready, arguably for the first time in their monetary history, to savor the text-book benefits of a currency depreciation during a downturn. These benefits could not be fully had during the 2008-2009 crisis because of its globally systemic nature (there was nowhere to export the recession to despite the sharp currency corrections) but may be had now that foreign demand for LAC exports (from China and the U.S.) is growing—not as vigorously as in pre-crisis years, but growing after all. First, flexible exchange rates make possible an independent and countercyclical monetary policy, whereby central banks can lower the interest rate to stimulate domestic economic activity in the context of falling external demand. Second, the depreciation of the currency in a downturn can help keep the external current account under control and, at the same time, boost domestic output and employment, not just by encouraging exports but also the production of goods and services for the local market. (Whether the elasticity of supply in the region is strong enough for these positive effects to significantly materialize is, of course, yet to be seen and some room for doubt is warranted.) Third, a depreciation of the currency can, by quickly adjusting the relative values of foreign and domestic assets, mitigate capital outflows, including by promoting “bargain hunting” inflows.
Naysayers may retort by pointing to the fact the inflation-targeting central banks in LAC intervene heavily in foreign exchange markets, which presumably raises doubts as to whether currencies are truly flexible. This report presents evidence showing that the intervention motives are justifiable. For starters, central banks in LAC accumulate reserves for self-insurance purposes. In addition, and this is the focus of this report, such interventions can no longer be characterized as efforts to defend the indefensible—where central banks lose big time and are forced to buy dear the dollars that they foolishly sold cheap in a futile effort to sustain an unviable peg. The evidence rather shows that inflation-targeting central bankers now intervene not to fight against fundamentals but mainly to mitigate excess volatility—they buy dollars (accumulate international reserves) when the exchange rate is overvalued relative to its equilibrium level, and sell dollars (draw down international reserves) when it is undervalued. Because sterilized intervention is thus motivated, the worries about its potentially large quasi fiscal costs are exaggerated. The report in effect shows that once capital gains and losses are appropriately taken into account, sterilized intervention by LAC inflation targeters over the past decade has yielded rather small costs or, in a few cases, profits—although the efficiency of intervention cannot be judged solely by financial returns. Moreover, while gauging the effectiveness of interventions remains an empirical challenge, recent research suggests that interventions can in fact influence currency movements—by dampening deviations and overshootings.
Given this fundamentally changed macro-financial policy setup, the depreciations of LAC currencies should no longer be interpreted as a sign of financial distress and harbinger of a crisis. They should rather be seen, at least for the inflation targeting LAC countries, as a salutary part of a more efficient and employment-friendly process of macroeconomic adjustment to a downturn induced by adverse external developments. Indeed, a case can be made that externally-driven economic slowdowns or recessions in the region will increasingly look more like the down phases of run-of-the-mill business cycles typical of advanced economies. In this sense, the tendency to analyze LAC’s macro- financial vulnerability today using categories that were applicable to the LAC of the 1990s is deeply flawed, for it ignores the silent institutional and policy reconfiguration that has led to a very different and much improved macro- financial immune system.
That is the good news for LAC. The bad news, of course, is that not all, not even most, countries in the region partake of this improved macro-financial resiliency. To be sure, inflation targeting LAC countries are, in some sense, the region’s backbone—they include at least Brazil, Chile, Colombia, Mexico, and Peru, which jointly account for 70-80 percent of LAC’s population and GDP. But they represent only a small fraction of the total number of countries in the region. Unfortunately, non-inflation targeting countries will have a much more reduced capacity to cushion the downturn. This group includes countries in Central America and the Caribbean that are too small and open to be able to realistically develop an independent monetary policy, a situation that is aggravated where the room for countercyclical fiscal policy is also nonexistent due to government over indebtedness and/or financial system fragility. Some countries in South America will also find themselves with little or no monetary policy maneuvering room, as they have not developed the institutional and policy matrix to support full-fledged inflation targeting and yet are significantly integrated into international financial markets. Other South American countries like Bolivia, while not full-fledged inflation targeters, are insulated in a different way—by being much less financially globalized and by having built strong fiscal savings that can be tapped in case of need.
In sum, when it comes to shock-absorption capacity vis-à-vis the souring of the external environment, pessimism does not seem warranted. Rather, a cautious optimism appears more appropriate, based on the obvious improvements in much of the region’s macro-financial immune system. The associated ability to let the exchange rate depreciate without fear and conduct countercyclical monetary policy can definitely help cushion the cyclical component of the downturn, but it is by itself vastly insufficient to solve the deep-seated structural deficiencies that hinder LAC’s ability to move to a higher growth path. Indeed, for all its virtues, low macro-financial vulnerability may coexist with anemic growth over long periods of time—a sort of low savings-low productivity-low growth trap that would put the brakes on the pace of social progress that LAC achieved in the past decade. Absent a big push in the productivity agenda, the region risks falling into such a trap in the years to come. This, rather than the macro-financial ghosts of the 1990s, remains the main regional challenge looking forward.
