Emerging Markets Macro Comment Looking At Latin America

22 May 2009

Emerging Markets Macro Comment Serdar Küçükakιn, Senior Economist

Looking at Latin America •

Growing differences between countries

•

Monetary policy is effective

In this comment we will focus on Latin America. Firstly, we

Argentina also continues to point in the direction of a sustained

will differentiate between two groups of countries when it

contraction in manufacturing activity. Industrial production

comes to the economic outlook, while secondly we will

contracted 1.1% mom in March. Other indicators, such as

challenge the view held by some (and not so few) market

cement, automotives, steel and electricity consumption, all

participants that monetary policy is not particularly

suggest that activity is continuing to flounder. More importantly,

effective in Latin America.

the political instability ahead of the June mid-term elections and the highly uncertain outlook that might develop afterwards

Differentiating between countries

do not bode well for a quick turnaround in confidence and

While economic performance in the final-quarter of 2008 was

domestic spending.

dismal in practically all countries in the region, data for the first quarter of 2009 suggest that the subsequent dynamics diverge

From a structural standpoint, several characteristics could

between two groups of countries. For some time, we have

account for the differences between the two groups of

made a distinction between the inflation-targeting countries,

countries, with economic proximity to the US being an obvious

such as Brazil and Chile, and countries such as Argentina (and

factor. Its economic ties with the US mean Mexico is suffering

Venezuela), where politics and debt concerns are relevant

relatively more, while the relative importance of “cyclical

economic drivers. At the current juncture, however, another

sectors”, such as the automotive sector, in Brazil may also

source of differentiation is emerging: in a few countries the

explain the magnitude of the turnaround. Changes in the fiscal

business cycle appears to be bottoming out, while others

policy applying to this sector account for some of the rebound

continue to be under considerable stress.

in Brazil. Since November last year, the government has given two tranches, totalling BRL 2.5 billion (USD 1.23 billion), of tax

Industrial production gives a fairly timely picture of activity

cuts on vehicles.

dynamics. Actual data show that industrial production in Brazil troughed in December 2008, with a colossal 20% contraction in

Other differences between the two groups of countries are

the period September - December. Since the beginning of

attributable to policy and its effectiveness, especially with

2009, however, industrial production has actually grown in

regards to monetary policy. Countries with more credible

every month on a mom basis. March industrial production in

monetary policies (i.e. inflation-targeting regimes) have been

Chile meanwhile increased by 15.1% mom, which was the

able to ease monetary policy considerably. Since January this

steepest monthly increase since March 2007. Furthermore,

year Brazil has cut its Selic rate by 350 basis points to 10.25%,

Chile is implementing a massive fiscal stimulus package of

which is the lowest level since inflation-targeting started in

USD 6 billion (GDP 3.3%), which will also lend a helping hand

1999. In Chile the central bank has also been easing

to growth.

aggressively. Since the start of the year the policy rate has been cut by a total of 700 basis points to 1.25%. Despite the

Mexico and Argentina show a different picture and, in our view,

fact that the policy rate has already reached a very low level,

are still in contraction mode. March industrial production in

further cuts are expected.

Mexico declined by 2% in March. Furthermore, the fact that manufacturing activity has continued to fall in the US suggests

The central banks of Argentina and Venezuela do not have an

more weakness is in the pipeline for Mexico (around 80% of

explicit policy rate that they communicate with market

Mexican exports go to the US). The swine flu epidemic also

participants. In the case of Venezuela, the main instrument for

points to the same conclusion. While it is very difficult to

monetary policy has been the use of international reserves,

calculate exactly the negative effect that the epidemic will have

because policymakers have frequently used changes in the

on economic activity, it is clear that it could bring additional

exchange rate to deal with the expansion of money caused by

downdraft forces.

fiscal expenditure.

SERDAR KÜÇÜKAKΙN +31 (0)20 629 5086

ECONOMICS DEPARTMENT

22 May 2009 Summing up, countries such as Brazil and Chile, which

between the debt of the financial systems of emerging Europe

generally have sound fiscal and monetary policies, in

and that of Latin America, and nobody has questioned the

combination with fairly strong starting positions, are most like

effectiveness of policy rate cuts in emerging Europe. This claim

to bottom out first. Countries such as Argentina and Venezuela

could sound somewhat emotional, but we will also outline

on the other hand, with their populist policies and practically no

some “rational” arguments below as to why we believe that

access to international capital markets because they have

rate cuts in Latin America do matter.

previously defaulted on some of their foreign debt, will most probably bottom out later. Compared with these two groups of

Financial debt

countries, Mexico is somewhere in the middle. It generally has

% GDP

sound macro-economic policies in place, including, for example, an inflation-targeting central bank. However as explained above, the country is suffering greatly from its close economic ties with the US. Effectiveness of monetary policy Inflation-targeting central banks in Latin America, as explained

300 250 200 150 100 50 0

above, have cut rates aggressively and are expected to

US

Euro zone

continue to relax monetary conditions. However, there has Bank assets Private debt securities

been some discussion among market participants about the effectiveness of monetary policy in these countries. The concerns relate to past experience with the region, as well as

Latin Asia Emerging America Europe Stock market capitalisation

Source: IMF

to the current maturity of the region’s financial system. We understand where these concerns come from as, in the past,

Firstly, lower interest rates cause individuals and businesses to

the instable economic environment in the region meant there

alter their spending and investment decisions, even if their

was little scope for a counter-cyclical monetary response.

bank balances are small. In the current economic setting of a

Indeed, past crises in the region have tended to expose a

full-blown credit crisis in the eurozone and the US, the

widespread lack of confidence in the banking system. This lack

traditional transmission channel of monetary policy through the

of confidence in turn led to higher rather than lower interest

banking system is actually working better in Latin America than

rates for the sake of financial stability. Since then, however, a

in the eurozone and particularly the US, and there are no signs

lot has changed in the region. Many countries, including Brazil,

of disruption in the process of money creation. The monetary

have been operating sound macroeconomic policies for years.

multiplier for countries such as Mexico and Chile has remained

Indeed, the fact that many central banks in the region are now

virtually unchanged at around 8.5 in the past couple of months,

targeting inflation is strong evidence that something has

while the monetary multiplier in Brazil was boosted by the

changed structurally because an inflation-targeting regime is

central bank’s decision to lower reserve requirements by 30%

only possible in a stable, or at least relatively stable, macro-

last September from around 5 at the start of 2008 to almost 8

economic environment.

currently

The second concern relates to the (allegedly) limited financial

Secondly, to the extent that rate cuts can lead to a depreciation

debt in Latin America. Market participants expressing this

of the local currency, monetary policy decisions can boost the

concern tend to make a comparison with fully developed

competitiveness of exports and import-competing sectors.

economic blocs such as the US and the eurozone. To us, this

Dismissing the effectiveness of monetary policy means

is like comparing apples and oranges. Latin America is an

ignoring these two (key) channels of monetary policy

emerging region and so, compared to that of the eurozone and

transmission.

especially the US, its financial system is understandably less developed. As the above graph shows, there is little difference

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SERDAR KUCUKAKIN +31 (0)20 629 5086

ECONOMICS DEPARTMENT