Introduction
From 2003 to 2013, Latin America experienced a decade of sustained growth and unprecedented economic and financial stability. The shock from the global financial crisis was short-lived, and the swift recovery of the region fed the perception that countries could sustain higher rates of growth than in the past. A much improved macroeconomic framework, a reduction in financial vulnerability and a broadening of the domestic demand base were seen as key factors of that change. Easy global financing conditions facilitated large capital inflows.
The long commodity price boom played a big part in this. A sustained increase of commodity demand and prices led to significant terms-of-trade gains and boosted real GDP. As Kohlscheen et al (2016) have shown, higher commodity prices tend to appreciate the currencies of commodity-exporting countries, and Latin American currencies rose. Graph 1 shows how commodity prices (blue line) and real exchange rates (dashed line) in Latin America have moved together in the past ten years or so. These circumstances shaped developments in resource-rich Latin American countries with low saving rates – and thus heavy dependence in external financing. The upward trend in commodity prices from 2001 to 2010 was interrupted only briefly during the global recession. However, after 2011 commodity prices fell.
To illustrate these links, Graph 2 (left panel) displays the evolution of the GDP growth, net capital inflows as a percentage of GDP and the annual growth rate of commodity prices since the nineties for the aggregate of Latin American included in our sample. The evolution of net capital inflows has certain similarities to the swing in commodity prices: they increased strongly in the early 2000s, recovered rapidly after the global financial crisis and moderated towards the end of the sample. A certain co-movement is visible among the three variables, in particular during the last decade.
The sharp slowdown in growth in most countries of the sample has come as a surprise to many. The co-movement between the variables in Graph 2 suggests that not only the current disappointing growth but also the robust recovery from the crisis is closely linked to the reversal in the external conditions. The fall in commodity prices, which was not anticipated, has severely affected growth prospects, it is remarkable how growth forecasts have been systematically revised downwards in the region coinciding with the reversal in commodity prices (Graph 2, right panel). Let us take for instance Brazil, a country whose share of commodity exports has averaged more than 60%2 in the last decade. Graph 3 shows the strong positive correlation between changes in commodity prices and growth rates in Brazil.
The correlation is even stronger with the changes in the growth forecasts, suggesting that economic performance is perceived to be closely associated with the evolution of commodity prices. Expectations of long-term growth in Latin America, boosted by the boom in commodity prices, have been scaled back. The IMF’s five-year ahead forecasts, which can be seen as a proxy for the long-term expectations of potential growth, have been revised down from 4% to 3%. This paper identifies two key variables which may have boosted growth rates in Latin America above sustainable levels. It follows the spirit of recent work in advanced economies in incorporating financial cycles into the estimation of the output gaps (see Claessens et al (2011), Borio (2012), Borio et al (2013, 2014) or Rabanal and Taheri (2015)).
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