Latin America: Solid Growth But Risks Grow

4½ growth predicted for Latin America in 2011

But large risks to the outlook remain

Need to rebuild buffers, with monetary policy nimble

In its Regional Economic Outlook for the region, issued on October 5 in Lima, Peru, the IMF said countries in the region continue to benefit from double tailwinds of easy external financing conditions and still-high commodity prices, although these factors are projected to be less stimulative than before.

So far in 2011, economic activity has moderated from the high levels reached in 2010, but remains above potential in much of the region. Growth has been driven by strong domestic demand, with the commodity-exporting countries of South America leading the way.

More recently, fears of a global slowdown are starting to weigh in on the region’s financial markets, with equities, currencies, and commodities taking a hit.

“We still have as our baseline a situation in which both global liquidity and commodity prices will remain, as we have called them, the double tailwinds for the region,” said Nicolás Eyzaguirre, Director of the IMF’s Western Hemisphere Department. “However, these will be somewhat weaker than in the recent past,” he added. Also, with the fluid situation in the markets, the report notes that downside risks are potentially severe.

Large risks dominate the outlook

The lack of a decisive solution to the closely linked sovereign and bank balance sheet stresses in Europe could worsen confidence and global credit markets conditions, with spillovers to emerging markets. Similarly, in the United States a too front-loaded fiscal adjustment could weaken growth, while an insufficient fiscal adjustment over the medium term could weaken confidence and result in higher interest rates down the road.

Meanwhile, a sharp slowdown in Asia—for example, triggered by an advanced economy recession—could further hit commodity prices, with negative effects on Latin American commodity exporters, the report said.

On the upside, a quick resolution of European stresses and a better outlook for global growth could reignite strong capital inflows, bringing back overheating risks.

Rebuilding buffers

This shift in the global economic environment poses major challenges to policymakers. According to the report, Latin America and the Caribbean should generally stay their present policy course, including maintaining a nimble monetary stance and rebuilding fiscal buffers—but stand ready to shift course should the risks...