Watching Out for Overheating in Latin America

Growth is moderating, yet still remains above potential

Overheating pressures emerging in much of the region, including inflation worries

Higher fuel and food prices adding to challenges

In its Regional Economic Outlook for the region, issued on May 3 in Mexico City, Mexico, the IMF said that the region continues to grow at a robust pace, led by rapidly expanding domestic demand.

“The main economic risk in the case of Latin America is complacency,” said Nicolás Eyzaguirre, head of the IMF’s Western Hemisphere Department, in a video interview. “The region is growing a bit beyond its possibilities so if it does not begin to put the brakes on and continues at this pace, economies could eventually overheat,” he added.

For the Unites States, the near-term outlook for growth has become somewhat more favorable, although new risks have emerged. A sharp and prolonged increase in oil prices could significantly slow the U.S. and global recovery. In addition, the report states that the medium-term budgetary outlook remains troublesome and there is a need to reach early political consensus on a comprehensive and balanced fiscal consolidation plan.

Within Latin America and the Caribbean, economic performance will be less uneven in 2011. South America’s commodity exporters will continue to lead the expansion, though there are signs that the recovery is finally gaining some traction in economies with closer real links to advanced economies (Central America and the Caribbean), where recovery has lagged.

Overheating risks

According to the report, overheating risks stand out in much of Latin America. Growth remains above trend and domestic demand has been growing even faster, pushed not only by unprecedented favorable external conditions but also by economic policies that have been quite stimulative and are only gradually normalizing. Early signs of overheating pressures and possible excesses are appearing in several areas:

• Inflation is rising in much of the region. Many central banks have been raising interest rates, but more rate hikes will be needed to contain demand pressures and limit spillovers from higher food and fuel prices into core inflation and expectations.

• Current account deficits are widening in many countries. Even in those benefitting from higher commodity export prices, import growth has been outpacing exports. While current account deficits are not yet excessive, their movement in that direction will need to slow. Fiscal...