Latin America Risks and Opportunities in the New Global Context

Latin AmericaRisks and Opportunities in the

New Global Context

April, 2014

Carlos G. Fernández ValdovinosCentral Bank of Paraguay

• The “new” international context• Latin America: recent policies and new

challenges• Brief highlights on Paraguay• Summary

Roadmap



Roadmap

• Almost 6 years after the beginning of the largest crisis in the past 80 years, the global economy is still in transition.

• But there are finally some signs (green shoots) suggesting that the worst is over; at least for developed economies.

• Latest projections suggest a more positive outlook, with recovery continuing in the US and, albeit at a somewhat lower pace, Europe.

• Overall, 2014 growth projections are now higher than in the previous year (but with some regional differences).

International context

• The new “normal” poses both positive and negative risks to baseline projections, especially for emerging markets.

• On the upside, the US recovery might be stronger than expected, which could have a significant positive impact on growth rates in LA countries.

• However, faster than expected pace of monetary tightening may lead to abrupt falls in asset prices and, in some cases, capital outflows and currency depreciations.

International context

Source: IMF-WEO update January-2014.

Widespread economic recovery, but with some regional differences.

Recovery is underway…

… but emerging markets will face

some challenges…

Source: Bloomberg, IMF-WEO update October-2013..

China has become an important trade partner for LAC countries, however high growth rates for the Chinese economy may not be sustainable. In addition, rapid credit growth to finance high investment rates has raised concerns over the robustness of the financial system.

The expected deceleration in China had led to a revision in the prices of main commodities. A price moderation for soy and copper is expected in the medium-term. Oil, however, would remain at current levels.

Deceleration in China

Lower commodity pricesIn

dex (

Jan

-1

0=

10

0

US Treasury bond yields

… including more difficult external financing conditions…

Source: Bloomberg.

May 21, 2013Bernanke announces a possible

reduction in the FED’s asset-purchase program

Dec 18, 13Bernanke announces the

withdrawal of the stimulus will begin in early 2014.

Emerging Markets Bond s Index (EMBI)

The FED normalization of monetary policy will remain a key issue in the short term, driving periods of high volatility in emerging markets.

In spite of resilient capital flows, financial conditions have remained tighter after Bernanke’s surprised announcement of an imminent tapering.

Source: Bloomberg, IADB.

… capital outflows and pressures in domestic

currencies

Bernanke’s speech May 21,

2013

Source: Haver Analytics



Roadmap

LAC: improving conditions but some deterioration a the

margin• Financial tensions are bound to arise in emerging economies

after the FED´s announcement. Changing external conditions will have real effects in the economies.

• Overall, U.S. recovery is a positive event, but in the short term increased financial market and capital flow volatility is a concern for emerging markets.

• When combined with domestic weaknesses, the result could be sharper-than-expected capital outflows and exchange rate adjustments.

• Recent “mini-stress” test: the rise in U.S. interest rates since May triggered large changes in exchange rates, sovereign spreads, stock markets, and gross portfolio inflows.

LAC: improving conditions but some

deterioration a the margin

• Nevertheless, the impact was not homogenous across countries: fundamentals matter.

• The region, in general, has buffers to cope with these kinds of shocks thanks to relatively moderate levels of external debt, sizable official reserves, sound banking systems, and flexible exchange rates.

• However, fundamentals have deteriorated in some countries since 2008, following the implementation of counter-cyclical policies.

• Still, the economies remain in better position than in the 1990s.

Changing external conditions will have an effect in LAC

economies …

Source:CBP.

Source:CBP.

… but the overall result over GDP growth

should be positiveLAC6 GDP GROWTH

T0 T1US GDP 1,0% 3,0%Real Interest Rate (TB1Y) -1,5% 2,0%

Variation Rate of Commodity Price Index -0,7% -10,0%

VIX 15,8 20

Total Efect in LA6 0,87%

In the short run, better policies

will be crucial to dampen volatility

Exchange Rate Variation and Inflation

Current Account and Exchange Rate Variation

May announcement showed that fundamentals matter!

Source: Bloomberg..

GDP recovery was relatively faster in LAC ….

International Financial Crisis

Ind

ex (

20

07

=1

00

)

Source: CBP, CBCH

…thanks to improved macroeconomic fundamentals.

Government Debt

International Debt

Inflation

%

Source: IMF e-Library

% o

f G

DP

% o

f G

DP

% o

f G

DP

However, some vulnerability factors

recently increased in the region

General Govermment Structural Balance*

Source: IMF*Argentina, Brazil, Chile, Colombia, Dominican Republic, Ecuador, Guyana, Mexico, Panama, Paraguay, Peru, Venezuela

Current Account Balances in LA

…rising the likelihood of a “sudden stop” episode.

Source: IADB- Andrew Powell-March 2014

The expected cost of a sudden capital stoppage has increased since the pre

Lehman period



Roadmap

Paraguay: sound macro-foundations

to face headwinds • Over the past decade, policy frameworks and economic

fundamentals have been strengthened.• Macro-Policies: government finances are sound,

inflation low, banks are strong, buffers are large, the country is not excessively dependent on portfolio inflows, and a flexible exchange rate regime which makes a huge difference

• Structural Reforms: tax reforms in 1993 and 2013, passage of a fiscal responsibility law, approval of a PPP law to tackle infrastructure bottlenecks.

• The Fed exit from unconventional monetary policy will be a bumpy ride, but Paraguay is in a good position to weather more challenging times.

Strong economic growth for a decade

Paraguay experienced a solid growth in the last decade supported by production and export of raw materials. Still, on top of agriculture, construction and services were also key growth-drivers.

Sound policies and structural reforms increased potential growth rate. Paraguay average economic growth in the last decade is among the highest in the region.

Source: IMF-WEO Oct-2013, Update Jan-2014 and CBP.

Paraguay economic growth 1992-2014*

A central bank committed to low and stable inflation…

Source: CBP.

Monetary Aggregates Inflation Targeting

(Experimental Stage)

Inflation Targetin

g

Paraguay has never experienced high rates of inflation and its currency (the Guarani) recently celebrated its seventieth anniversary.

A history of stable prices

Monetary Regimes in Paraguay

The CBP started the implementation of an IT regime in 2011. The explicit public commitment to control inflation as the primary objective is crucial for greater investor confidence and a more predictable business environment.

…with large buffers to dampen

excessive volatility…International Reserves International Reserves

(% of GDP)

Source: CBP and IMF-IFS. Year 2013, last data available.

Source: IMF-WEO Oct-2013 and CBP.Countries with BB- credit rating by Standard and Poors.

…supported by soundfiscal and external balances

Continued fiscal surpluses (which reduced overtime the level of public indebtedness) compounded by a sharp accumulation of foreign assets has changed the country’s net debtor position vis-à-vis the world.

Paraguay experienced eight consecutive years of fiscal surpluses. This had allowed the country to decrease its public external debt from close to 60 percent of GDP to less than 10 percent, the lowest percentage among economies with the same credit ranking.

Gen Govt Gross Debt (% of GDP)

Rating Credit Watch

Fecha

Ba2 Feb 2014

Ba3 Jan 2013

B1 Dec 2010

B3 + Jun 2010

B3 Apr 2008

Caa1 + Nov 2007

Caa1 Apr 2003

B2 (inicial)

Jul 1999

Rating Credit Watch

Fecha

BB- Dec 2013*

BB- Aug 2012

BB- - Jun 2012

BB- Aug 2011

B+ Aug 2010

B Jun 2007

B- Jul 2004

SD Feb 2003

B- Nov 2002

B Jun 1999

B+ Feb 1999

BB- (inicial)

Oct 1995

Rating Credit Watch

Fecha

BB- + Jan 2014

BB- (inicial)

Feb 2013

Source: Bloomberg

Ratings up

Ratings down

Initial ratings

KEY RESULT: a steady improvement in

credit rating



Roadmap

Summary

• A normalization on monetary conditions in the US is not necessarily a negative event: economic and financial effects will depend on robustness of economic policies.

• In LAC, fundamentals have improved over the past decades and most economies are well prepared to face external shocks.

• However, some countries in the region appear somewhat more vulnerable to certain shocks: those economies experienced a recent deterioration in fiscal and external positions.

Summary

• Growth in the region is projected to remain in low gear, reflecting a less supportive external environment and, in some cases, domestic supply-side constraints.

• In countries with low inflation and anchored inflation expectations, monetary policy should be the first line of defense if downside risks materialize.

• Rebuilding fiscal buffers is a key priority, especially in countries with tight capacity constraints or limited fiscal space; it will also help constrain the continued widening of current account deficits.

Summary

• History teaches that exits from extremely low U.S. interest rates may be smooth or bumpy depending critically on expectations, fundamentals and countries’ capacity to respond.

• Since monetary normalization is a chronicle foretold, authorities should implement policy actions today to minimize potential deleterious effects. This way countries will gain more from the global recovery.

THANK YOU

Documents

Latin America Risks and Opportunities in the New Global Context