Prospects

The Caribbean & Latin American Economy

The World Bank
Global Economic Prospects 2010: Crisis, Finance, and Growth.

Thanks to sound macroeconomic fundamentals in place before the onset of the crisis, the Latin America and Caribbean region has been able to weather the global financial crisis much better than previous external shocks. Nevertheless, economic activity in the region decelerated sharply in the aftermath of the crisis. For the 2009 calendar year, GDP is estimated to have fallen 2.6 percent, following an expansion of 3.9 percent in 2008. This aggregate result masks a high degree of heterogeneity among countries in the region with respect to the timing and magnitude of the contraction in domestic output. Central American economies (including Mexico) were the worst affected, with output contracting a sharp 6.4 percent, while growth in the Caribbean economies stagnated.
In the immediate aftermath of the crisis, the region was hit by a sharp slowdown in private capital inflows, while increased uncertainty and credit tightening led to a marked contraction in private consumption and private investment. The capital outflows induced sharp depreciation of currencies in the region, a decline in equity markets, and much higher borrowing costs. Nevertheless, the region managed to avoid falling into a balance of payments and/or financial crisis.
Private consumption contracted by nearly 2.0 percent, while fixed investment declined sharply by 13.6 percent, after growing at double-digit rates in the previous years. The region was also affected by the collapse in external demand for commodity exports, falling commodity prices, lower remittance inflows, and declining tourism activity. The decline in domestic demand translated into a sharp 15.8 percent contraction in import volumes. As a result, and despite an 11.2 percent contraction in export volumes, net trade contributed 1.6 percent to growth. Reflecting these developments industrial activity fell rapidly, plunging at a 20 percent saar rate in the last quarter of 2008 and at 16 percent in the first quarter of 2009.


Countries that rely heavily on trade with the United States were especially hard hit by the crisis. Mexico's economy suffered the steepest contraction in the region (7.1 percent) and its worst economic performance in seven and a half decades, both because of its close economic ties with the United States in the sectors most affected by the crisis (construction, automotive, and electrical appliances) and because of the AH1N1 flu outbreak in the second quarter of 2009, which hit the tourism sector especially hard and is thought to have cut into overall GDP by 0.5 percent. Furthermore Mexican firms suffered foreign derivatives losses in December 2008 after the global crisis drove the peso to record lows. Exports collapsed in the first half of the year, dragging output down 7 percentage points, while the collapse in import volumes boosted growth by close to 9 percentage points. In 2009 private consumption is estimated to have contracted by 6.9 percent, as the labor market was severely affected by the economic slowdown, with formal unemployment almost doubling to 6.1 percent by September, and as remittances fell 13.4 percent in the first nine months of the year.
In Argentina, the global recession in conjunction with policy-related uncertainty took a toll on investment and trade. Collapsing imports and declining fiscal revenues point to weak domestic demand and relatively poor output performance in the first half of 2009, while a severe drought added to the economy's weak performance.
In República Bolivariana de Venezuela, GDP is estimated to have declined 2.4 percent as a result of the collapse in external demand, weak private consumption, and lower investment spending. Manufacturing and retail sales plunged because of weak domestic demand, and output fell at a 4.5 percent annualized pace in the third quarter of 2009. The oil sector is becoming increasingly dominant in the economy. Supply bottlenecks, a difficult business environment, and a lack of private investor confidence are undermining new investment, impairing much-needed economic diversification.


Strong retrenchment in private investment spending and a steep drawdown in stocks (close to 1 percent of GDP) caused Chile's output to decline 4.7 percent year-on-year in the second quarter of 2009. Marked weakness in domestic demand resulted in a sharp contraction in imports that exceeded the plunge in exports.
Countries in Central America and the Caribbean were afflicted by the recession in the United States and major economic partners in the European Union, particularly Spain, which has resulted in a contraction in trade, tourism, FDI, and remittances. The Caribbean economies contracted only 0.1 percent in 2009, down from the 3.6 percent growth recorded in 2008. Jamaica recorded one of the sharpest declines in GDP in the subregion, attributable to its heavy dependence on the U.S. economy (remittances declined 17 percent in the first half of 2009), and to sharp cuts in mining production. In the Dominican Republic, economic performance deteriorated sharply, with output down by 0.1 percent after 5 percent growth in 2008, reflecting developments in the U.S. economy that affected remittances, FDI, and tourism. The improvement in the terms of trade, as the oil price declined, has however had a positive impact on economic performance. Caribbean economies benefited somewhat from the AH1N1 outbreak in Mexico as visitors shifted holiday destinations from Mexico to the Caribbean islands, and  in the early stages of the crisis, tourism and offshore financial services proved somewhat resilient.
The Central American economies, excluding Mexico, contracted 1.0 percent in 2009. External demand for their exports was hit by the global economic crisis, while remittances and tourism revenues also declined. Costa Rica's economy was afflicted by a 10.3 percent decline in U.S. tourist arrivals in the first nine months of 2009, but investment in the services sector continued and back-office services were resilient. The decline in tourist arrivals has prompted large price cuts for tourism packages as countries competed for a declining number of tourists. Remittances have also suffered because of weak labor markets in high-income countries. Compared with a year earlier, remittances to Guatemala and El Salvador were down by 9.5 and 10.3 percent, respectively, during the first half of 2009. In the first quarter of 2009, FDI inflows to Costa Rica fell by 19 percent (year-on-year), and by 41 percent to the Dominican Republic.


In response to the crisis, many governments in the region implemented countercyclical macroeconomic policies in an effort to support domestic demand, with government spending being the only demand component that grew in 2009. The aggressiveness of the fiscal policies implemented depended on the fiscal space available in each country and the extent to which they had access to financial markets. That said, the region entered the crisis much better prepared with respect to both the fiscal and external accounts. In Mexico, the declining oil revenues constrained the countercyclical response. In Chile, fiscal stimulus has helped limit the output contraction, and the government also provided credit support to SMEs through the development bank Banco Estado. The implementation of the fiscal stimulus in Peru was to some extent hindered as budget appropriation and distribution rules limited the increase in government spending, even as procurement rules have become more lax. Furthermore the government provided credit support to SMEs through the development bank Banco de la Nación to help ease the impact of the credit crunch.
To support domestic demand at the time external demand was collapsing, countries more integrated in the global economy lowered interest rates aggressively and allowed real exchange rates to depreciate. During the monetary-easing cycle, the central bank of Colombia cut rates by a cumulative 6.5 percentage points. Chile cut rates by 7.75 percentage points since the beginning of 2009, while Peru also eased monetary policy substantially. Brazil cut the SELIC12 rate by an unprecedented 500 basis points to 8.75 percent.


As elsewhere, many economies in the region show signs that the recession bottomed out in the second half of 2009, with external demand rebounding faster and more strongly than initially anticipated.

In Mexico, the rate of contraction moderated the second and third quarters, supported by less dramatic output declines in the manufacturing and service industries. In Argentina, an improved external environment has ignited a modest recovery and led to improvements in external balances, as commodity prices firmed and demand for exports increased, in particular from its main trading partner Brazil. In Chile significant fiscal and monetary stimulus contributed to the moderation in output contraction to 1.7 percent year-on-year in the third quarter, bringing the decline in GDP over the first three quarters of the year to 2.7 percent. In Colombia the improved external environment and the lagged effect of aggressive monetary easing helped the economy recover in early 2009. Output growth in the first two quarters of 2009 was also boosted by strong growth in public investment spending, even though private consumption and investment remained weak. In Peru a significant rebuilding of inadequate stocks is projected to contribute to growth in the second half of 2009. Uruguay's economy expanded by 0.5 percent in the second quarter of 2009 relative to the previous quarter, bolstered by growth in construction and transportation, reflecting the impact of several megaprojects, which offset output declines elsewhere, particularly in energy, agriculture, and manufacturing.
Corporate and sovereign spreads have retreated to precrisis levels in countries more integrated into the global financial system—demonstrative of a return of investors' confidence, while access to the international debt market has also improved. Lower-rated countries in the region continue to be perceived as risky by investors and this is reflected in spreads remaining above pre-crisis levels.


Overall capital inflows to the region have returned, especially in economies that proved resilient to the crisis, such as Brazil, with total capital inflows rising to $57.4 billion in the fourth quarter of 2009, up from $15.7 billion in the second quarter. Bond issuance increased almost sixfold nearing $30 billion, while equity inflows more than tripled to $14.8 billion. Bank lending recovered modestly, totaling $13.2 billion, down 33 percent compared with the second quarter of 2008.