International price volatility and economic policy challenges in Latin America and the Caribbean

Includes bibliography

Capital Flows to Latin America and the Caribbean: Recent Developments

For six years, the global economy has been driven by the U.S. Federal Reserve’s policies of easy money. Liquidity has flowed from developed to developing economies, financing infrastructure and corporate investment and allowing consumers to indulge in credit-fuelled retail spending. Thus the effective ending of the Fed’s third round of asset purchases (QE3) at the end of October represents both a watershed and the beginning of a new stage in the world economy. The end of asset-purchases comes at a challenging time for emerging markets, with China’s economy slowing, the Euro zone struggling to avoid a recession and the Japanese economy already in recession. The unwinding of the U.S. monetary stimulus, while the European Central Bank and the Bank of Japan step up their monetary stimulus, has underpinned an appreciation by the U.S. dollar, in which most commodities are priced. An appreciated dollar makes dollar-denominated commodities more expensive to buyers, thereby creating pressure for sellers to lower their prices. Latin American markets ended the third quarter of 2014 under pressure from a stronger U.S. dollar. In this changing external context, there are many signs that a slowdown in Latin American and Caribbean (LAC) financial markets, particularly debt markets, which have been breaking issuance records for the past six years, may slowdown from now on. Commodity prices – including those of oil, base metals and some goods – are in a prolonged slump. The Bloomberg commodity price index, a benchmark of commodity investments, has fallen to a five-year low as China’s economy slows down, and with it the demand for commodities. Investment into the LAC region has decelerated, in large part because of a deceleration of mining investments. Latin American currencies have suffered depreciations, as current account deficits have widening for a number of countries. And LAC companies, having issued record amounts of foreign currency bonds may now struggle to service their debt. In October, credit-rating agency Moody’s downgraded the bonds of Brazil’s Petrobras to tow notches above speculative grade because of the impact of falling oil prices and the weaker real on its debt. Growth prospects look brighter in 2015 relative to 2014, but a strengthening U.S. dollar, uneven global growth and weakness in commodity prices are skewing the risk toward the downside for the 2015 forecasts across the region. The Institute of International Finance expects the strengthening of the dollar to have a divergent impact across the region, however, depending on trade and financial linkages. The Institute of International Finance, Capital Flows to Emerging Markets, October 2, 2014. A stronger dollar lifts U.S. purchasing power, supporting exports, growth and capital inflows in countries with close trade links to the U.S. economy. However, rising dollar financing costs will increase pressure on countries with weak external positions. Given the effects of falling oil prices and a stronger dollar, some companies in the region, having issued record amounts of foreign currency bonds, may now struggle to service their debts. Prospects of Fed rate hikes resulting in tighter global liquidity amid the rapid rise in the corporate external bond stock has indeed raised concerns over some companies. However, there is still a shortage of bonds at a global level and the region still enjoys good economic policy management for the most part, so LAC debt markets may continue to enjoy momentum despite occasional bursts of high volatility – even if not at the record levels of recent years.

Economic growth and real volatility: The case of Latin America and the Caribbean

Using a new database of quarterly data for 21 countries of Latin America and the Caribbean for the 1990-2012 period, this document shows that the duration of GDP contractions appears to be a rather robust indicator of real volatility, and is negatively correlated with long run growth in Latin America and the Caribbean during the period. These results are consistent with different theoretical hypotheses in the literature that relate the duration of GDP contractions with economic growth. They also show that the relationship between real volatility and economic growth in the region is robust to the inclusion of external variables that control for external uncertainty and volatility.