The impact of Sub-prime crisis on Latin America: A ... · on Latin America: A structural overview ... It is a ¨stress testing¨ scenario for Latin American countries. • What is

The impact of Sub-prime crisis on Latin America: A structural overview

Paris – February 2008

Sebastián Nieto Parra

Research Associate

OECD Development Centre

2

The Subprime Crisis and OECD countries2

US & Latin America: A new turn to a long story?3

Current Account Channel4

Overview

5

Conclusions6

Financial Channel

Objective1

3

Two core questions

• The Subprime crisis could be interpreted as an exogenousshock for Latin American economies. It is a ¨stress testing¨scenario for Latin American countries.

• What is the impact of this crisis on real sector and onfinancial sector?

• Above all, have Latin American economies improved thecredibility of economic policies during last years?

4




Overview

5

Conclusions6

Financial Channel

Objective1

5

OECD developed countries• Slowdown of the OECD developed countries in 2008. Recovery of GDP

growth would be in 2009.• Risks are on the downside scenario given financial and real factors.

6

OECD Housing Markets• Real housing investment is slowing in most countries.• The upswing in housing markets has been highly correlated across

countries.

7




Overview

5

Conclusions6

Financial Channel

Objective1

8

Latin America and US GDP• Latin American GDP growth is highly correlated to US economic growth.

However, it is not the same across Latin American countries.

9

Latin American countries and US GDP

• US GDP growth exhibit higher correlation with Mexico and CentralAmerica GDP growth than with South America GPD growth.

10

Latin American countries and US GDP

• In the past Latin American exposure to US recessions has beenconsiderable.

• Recessions do not have the same impact as slowdowns.

11

Strong Latin America Internal Conditions

• Today Latin American Internal Demand is acting as a cushion toexternal shocks.

• Private consumption and Private Investment are important drivers ofLatin American economic growth.

12

Supported by the credibility of economic policies

• Credible monetary (inflation targeting policy) and fiscal (sustainabilityof the debt) policies.

• Reduction of inflation rates and fiscal deficits during last years

13


• Favourable external conditions have been exploited to accomplishremarkably good public debt management.

• Buybacks of external debt, international bonds in local currency,…

14


• Excellent debt management improves the Solvency of the State andchallenges the “original sin”.

rhs

15




Overview

5

Conclusions6

Financial Channel

Objective1

16

Current Account Channel

Three determinant aspects:

1. US and Latin America trade channel (Direct)

2. Remittances (Direct)

3. China and Commodity Prices (Indirect)

17

Latin American exports to US• Latin American countries’ partnership with the US is closer than for

other emerging countries.

• This has a high cost in times of recession.

18

Trade channel• More than 40% of Latin American exports are going to the US.• Differences across Latin American countries are considerable:

Mexico, Venezuela, Colombia and Central American countries vs.Argentina, Chile, Brazil and Peru.

0%10%20%30%40%50%60%70%80%90%

100%

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

China EU US Rest of World

Latin American exports by destination

Source: OECD Development Centre based on WITS data , 2008

19

Trade channel and Industrial Production

• The result is a considerable connexion (no connexion) between US andMexican (Brazilian) industrial production.

20

Remittances• Remittances represent a high proportion of recipient country GDP.• Mexico and Central American economies are the Latin American

economies more exposed to a shock of US GDP growth on remittances.

21

Remittances• The volatility of Remittances is lower than for other inflows

towards developing countries.

22

China and Commodity Prices• The impact of China on the World Economy is increasing. Market

participants do not anticipate a considerable slowdown of this economy.

• This is good news for Latin America given its growth trade connexion with China.

China's and India's trade with Latin America(US$ millions)

0

5000

10000

15000

20000

25000

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Source: OECD Development Centre, Latin American Economic Outlook, 2008

Chinese Exports to LAC

Chinese Imports from LAC

Indian Exports to LAC

Indian Imports from LAC

23

China and Commodity Prices• Chinese demand for Latin American commodities as well as

commodity prices are increasing. • Good news in the short term. It could be a bad news in the long

run.

China’s and India’s rising demand for Latin American commodities (US$ millions, 1998-2005)

0

200

400

600

800

1 000

1 200

1998 2001 2003 2005

Agricultural Raw Materials

Food

Ores & Metals


Commodity Prices (100 Basis Index = 1975)

0200400600800

100012001400160018002000

1950

1954

1958

1962

1966

1970

1974

1978

1982

1986

1990

1994

1998

2002

2006


Aluminium

Copper

Petroleum

24

China and Commodity Prices• There are still trade complementarities with Latin American

countries that remain today.

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0.2

0.3

0.4

0.5

0.6

0.7

0.8

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igh

com

pet.

Note: Modified CS and CC coefficients calculated with exports of country i and imports of country j (China, India).Source: OECD Development Centre, Latin American Economic Outlook, 2008

Trade Opportunities with China for selected countries (2000-05)

25


US and Latin America: A long story changing?3


Overview

5

Conclusions6

Financial Channel

Objective1

26

Financial Channel

Two determinant aspects:

• Banking System and Foreign Banks

• Capital Markets

27

Local Banking Systems• Foreign banks in Latin America are more exposed to Sub-prime

Crisis than local banks. In particular US based banks.• Huge difference between Brazilian and Mexican Banks.

28

Capital Markets• High correlation between global risk and Latin American

Sovereign Bond Spreads.• The impact of the Sub-prime Crisis on Sovereign Bond Spreads

has been lower than past experiences (e.g., ENRON case)

29

Capital Markets• Equity returns decreased in Latin American but remain positive

with respect to one year ago (the exception being Colombia).• The risk is on the downside given the volatility of stock markets.

30

Capital Flows and Recommendations

• We have constructed the recommendations given by 12investment banks during the period 1997-2007. All of themimportant players in the emerging bond markets, i.e. marketmakers.

31


• The impact of investment banks’ recommendations on capital flows is positive and significant.

• Investment banks’ recommendations could be used as a leading indicator of portfolio allocations in emerging countries.

32


• An overweight recommendation must be compensated by anunderweight recommendation.

• Investment Banks’ recommendations remain neutral and evenpositive for some Latin American countries.

33




Overview

5

Conclusions6

Financial Channel

Objective1

34

Banks’ Economic Forecasts • Market makers’ forecasts for Latin American economies.• Latin American GPD growth remains positive and above 4,0%,

inflation is contained to within central banks’ targets (twoimportant exceptions: Argentina and Venezuela).

35

Banks’ Economic Forecasts • Exchange rates are stable and there is not an important risk of

huge depreciations in 2008. Are we going towards a “softlanding” in 2009?

• With respect to the euro it is not the same story.

36

Final Remarks • Latin America’s exposure to US economy is considerable given

Current Account channel (Trade and Remittances) and Financialchannel (Banking and Capital Markets) BUT the effect is differentacross countries.

• However the impact of a slowdown in the US Economy may be morereduced than in the past given :

1. Robust Internal Demand.

2. Improvement in the Credibility of Monetary and Fiscal Policies.

3. The increasing role of the rest of the Emerging World in LatinAmerica. Two decades ago, OECD countries represented 70% of theWorld GDP, today they represent “only” 55%.

37

Thank you!

http://www.oecd.org/dev

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Annex 1 Recommendations Database

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Annex 2Recommendations Database

Example: Average of the recommendations given to Brazil by the investment banks (lhs) with respect to the weight of Brazil in the EMBI Global index (rhs).

Documents

The impact of Sub-prime crisis on Latin America: A ... · on Latin America: A structural overview ... It is a ¨stress testing¨ scenario for Latin American countries. • What is