Latin America OutlookLatin America Outlookwith special reference to Argentina and Chilewith special reference to Argentina and Chile

Guillermo A. CalvoGuillermo A. Calvo

Research DepartmentInter-American Development BankWashington, April 11, 2001

22

Outline of the PresentationOutline of the Presentation

The Big PictureThe Big Picture

ForecastsForecasts

Understanding Argentina in the light of ChileUnderstanding Argentina in the light of Chile

The Big Picture

Slowdown in output and investmentSlowdown in output and investment

Linked to rising interest rate spreadsLinked to rising interest rate spreads

Spreads have increased by more than Spreads have increased by more than 350 basis points since September 1997350 basis points since September 1997

Impact of US recession on capital flows:Impact of US recession on capital flows:

lower Foreign Direct Investmentlower Foreign Direct Investment

higher portfolio flowshigher portfolio flows

but impact is not seriousbut impact is not serious

55

Deceleration RecoveryRecession ?

Seasonally Adj. GDP, Annualized Quarterly Growth Rate

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1996

.I

1996

.II

1996

.III

1996

.IV

1997

.I

1997

.II

1997

.III

1997

.IV

1998

.I

1998

.II

1998

.III

1998

.IV

1999

.I

1999

.II

1999

.III

1999

.IV

2000

.I

2000

.II

2000

.III

Gro

wth

Rat

e

LAC’s output recovery LAC’s output recovery

66

*Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela

Deceleration RecoveryRecession

s.a. Investment, Annualized Quarterly Growth Rate

-30%

-20%

-10%

0%

10%

20%

30%19

96.I

1996

.II

1996

.III

1996

.IV

1997

.I

1997

.II

1997

.III

1997

.IV

1998

.I

1998

.II

1998

.III

1998

.IV

1999

.I

1999

.II

1999

.III

1999

.IV

2000

.I

2000

.II

2000

.III

Gro

wth

Rat

e

LAC’s investment recoveryLAC’s investment recovery

?

77

Deceleration

LA Eurobond Index Spread, Quarterly Averages

200

300

400

500

600

700

800

900

1997

-I

1997

-II

1997

-III

1997

-IV

1998

-I

1998

-II

1998

-III

1998

-IV

1999

-I

1999

-II

1999

-III

1999

-IV

2000

-I

2000

-II

2000

-III

2000

-IV

LAC’s business cycle is closely linked to interest LAC’s business cycle is closely linked to interest rate spreadsrate spreads

RecoveryRecession ?

88

LAC Spreads have consistently ratcheted upLAC Spreads have consistently ratcheted up

0

100

200

300

400

500

600

700

30 Sep.97 31 Jul. 98 10-Apr-01

284

186

470

650

180366

Average includes Argentina, Brazil, Colombia, Mexico, Uruguay y Venezuela

99

Impact on capital flows to LAC of a 1% expansion in US growth and a 1% reduction in US interest rates

1.69

0.90

0.03

2.60

0.0

0.5

1.0

1.5

2.0

2.5

3.0

US Growth US Interest Rates

US and LACUS and LAC

FDI

PortfolioFlows

1010

In a “typical” US recessionIn a “typical” US recession

Output falls 3.3%Output falls 3.3%

Real interest rates fall 1.4%Real interest rates fall 1.4%

1111

Net impact on emerging markets growth rate of a “typical” US recession

-0.25%-0.38%

-1.60%-1.80%

-1.60%

-1.40%

-1.20%

-1.00%

-0.80%

-0.60%

-0.40%

-0.20%

0.00%LAC Developing Countries Industrialized Asia

Thus, if the US catches a coldThus, if the US catches a cold LAC will just sneeze! LAC will just sneeze!

Market Forecast

Market Forecast 2000-2001

Argentina

Brazil

Chile

Mexico

Venezuela

Colombia

Peru

Bolivia Costa Rica

Dominican Rep.

Ecuador Panama

ParaguayUruguay

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5

GDP growth, 2000

GD

P g

row

th,

20

01

Market Forecast 2001: Actual vs 3-months ago

Argentina

Brazil

Chile

Mexico

Venezuela

Colombia

Peru

1

1.5

2

2.5

3

3.5

4

4.5

5

5.5

6

1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 63-months ago Forecast (2001)

Act

ua

l Fo

reca

st (

20

01

)

0 1 2 3 4 5 6

Mexico

Brazil

Colombia

Chile

Peru

Venezuela

Argentina

Market Forecast 2001 (Forecast Range)

Understanding Argentina in

the Light of Chile

1717

Equals in Bust, Unequals in RecoveryEquals in Bust, Unequals in Recovery

Similar recessionSimilar recessionBoth countries suffered from Both countries suffered from similar similar Sudden stopSudden stop, and , and sharp growth slowdown in sharp growth slowdown in 1999.1999.

However, recovery in 2000/1 However, recovery in 2000/1 has been much faster in Chile.has been much faster in Chile.

1818

Why did Argentina Perform Worse than Chile in the Recovery? Alternative Hypothesis:

• Political Factors?

• Terms of Trade?

• External Financial Constraints?

• Exchange Rate Regime?

• Degree of Openness?

• Fiscal Performance and Level of Public Debt?

The Anatomy of the Recession/Recovery Cycle: GDP(s.a. GDP, 1998.II=100)

94

96

98

100

102

104

106

19

98

:2

19

98

:3

19

98

:4

19

99

:1

19

99

:2

19

99

:3

19

99

:4

20

00

:1

20

00

:2

20

00

:3

20

00

:4

Chile

Argentina

The Anatomy of the Recession/Recovery Cycle: the Full Picture(s.a. components of demand, 1998.II=100)

70

80

90

100

110

120

19

98

.II

19

98

.III

19

98

.IV

19

99

.I

19

99

.II

19

99

.III

19

99

.IV

20

00

.I

20

00

.II

20

00

.III

20

00

.IV

exports

rest of domestic demand

investment

Chile

75

80

85

90

95

100

105

1998

:2

1998

:3

1998

:4

1999

:1

1999

:2

1999

:3

1999

:4

2000

:1

2000

:2

2000

:3

2000

:4

exports

consumption

Argentina

investment

Terms of Trade (1997-II = 100)

85

89

93

97

101

105

1997

-II

1997

-III

1997

-IV

1998

-I

1998

-II

1998

-III

1998

-IV

1999

-I

1999

-II

1999

-III

1999

-IV

2000

-I

2000

-II

Chile

Argentina

Private Capital Flows(4 quarters, millions of US dollars)

-1000.0

0.0

1000.0

2000.0

3000.0

4000.0

5000.0

6000.019

96.I

1996

.III

1997

.I

1997

.III

1998

.I

1998

.III

1999

.I

1999

.III

2000

.I

2000

.III

Ch

ile

0

2000

4000

6000

8000

10000

12000

14000

Arg

en

tina

Chile

Argentina

90

100

110

120

130

Jan

-97

Ap

r-9

7

Jul-

97

Oct

-97

Jan

-98

Ap

r-9

8

Jul-

98

Oct

-98

Jan

-99

Ap

r-9

9

Jul-

99

Oct

-99

Jan

-00

Ap

r-0

0

Jul-

00

Oct

-00

Jan

-01

Chile

Argentina

Real Exchange Rate (vis a vis the U.S. dollar, jan 97 = 100)

-3%

-1%

1%

3%

5%

7%

Ja

n-9

7

Ap

r-9

7

Ju

l-9

7

Oc

t-9

7

Ja

n-9

8

Ap

r-9

8

Ju

l-9

8

Oc

t-9

8

Ja

n-9

9

Ap

r-9

9

Ju

l-9

9

Oc

t-9

9

Ja

n-0

0

Ap

r-0

0

Ju

l-0

0

Oc

t-0

0

Ja

n-0

1

Chile

Argentina

Inflation (CPI, 12 month rate)

Degree of Openness

0%

10%

20%

30%

40%

50%

60%

Exp + Imp over GDP Exp over GDP

Chile Argentina

The Track Record on Fiscal Discipline(Fiscal Surplus, % of GDP)

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Chile

Argentina

Boom Recession Post-recession

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Debt/GDP

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

500%

Debt/Exports

Public Debt Levels at the Start of the Recession

Chile

Argentina

2828

Why did Argentina Perform Worse than Chile in the Recovery? Tentative Conclusions:

• Exchange Rate Regime and Public Sector Nominal Stickiness.

• Degree of Openness

• Fiscal Performance and Level of Public Debt

2929

Aggravating Factor for Argentina:Aggravating Factor for Argentina:MercosurMercosur

Brazil has the option of Brazil has the option of devaluing its currencydevaluing its currency

thus, FDI aimed at Mercosur is thus, FDI aimed at Mercosur is more likely to go to Brazil, more likely to go to Brazil, making it more unlikely for making it more unlikely for investment to recover in investment to recover in Argentina.Argentina.

The Cavallo Plan

Short Run• Leadership and political consensus

• Higher taxes (on checks) to promptly correct fiscal imbalances and meet IMF targets

• Expansive monetary policy (lower liquidity requirements).

• Higher tariffs and tax exemptions to reactivate selective sectors

Long Run• Deregulation

• Expenditure rationalization and tax reductions for all sectors

• Open up the economy to trade beyond Mercosur

3232

Possible Trouble Spot:Possible Trouble Spot:Loose MoneyLoose Money

Expanding domestic credit may Expanding domestic credit may result in lower international reserves,result in lower international reserves,

which increases the vulnerability of which increases the vulnerability of the financial sector,the financial sector,

results in higher interest rate results in higher interest rate spreads,spreads,

lower investment and growth.lower investment and growth.

3333

Currency BasketCurrency Basket

It may be good for trade,It may be good for trade,

but it increases financial vulnerability if the financial but it increases financial vulnerability if the financial sector continues being highly dollarized.sector continues being highly dollarized.

Moreover, it may generate excessively high dollar/peso Moreover, it may generate excessively high dollar/peso exchange rate volatility.exchange rate volatility.

Raising the issue at present may cause confusion, and Raising the issue at present may cause confusion, and suspicion that it might result in devaluation vis-a-vis the suspicion that it might result in devaluation vis-a-vis the dollar,dollar,

which may result in a greater loss of bank deposits.which may result in a greater loss of bank deposits.

3434

Argentina: Bank DepositsArgentina: Bank Deposits

Bank Deposits Total

82000

83000

84000

85000

86000

87000

88000

89000

31-J

an-0

1

03-F

eb-0

1

06-F

eb-0

1

09-F

eb-0

1

12-F

eb-0

1

15-F

eb-0

1

18-F

eb-0

1

21-F

eb-0

1

24-F

eb-0

1

27-F

eb-0

1

02-M

ar-

01

05-M

ar-

01

08-M

ar-

01

11-M

ar-

01

14-M

ar-

01

17-M

ar-

01

20-M

ar-

01

23-M

ar-

01

26-M

ar-

01

29-M

ar-

01

01-A

pr-

01

04-A

pr-

01

07-A

pr-

01

10-A

pr-

01

millions

3535

Argentina: International ReservesArgentina: International Reserves

Central Bank Reserves

23

23.5

24

24.5

25

25.5

26

26.5

27

27.5

28

31-J

an-0

1

3-F

eb-0

1

6-F

eb-0

1

9-F

eb-0

1

12-F

eb-0

1

15-F

eb-0

1

18-F

eb-0

1

21-F

eb-0

1

24-F

eb-0

1

27-F

eb-0

1

2-M

ar-

01

5-M

ar-

01

8-M

ar-

01

11-M

ar-

01

14-M

ar-

01

17-M

ar-

01

20-M

ar-

01

23-M

ar-

01

26-M

ar-

01

29-M

ar-

01

1-A

pr-

01

4-A

pr-

01

7-A

pr-

01

10-A

pr-

01

Billions

Latin America OutlookLatin America Outlookwith special reference to Argentina and Chilewith special reference to Argentina and Chile

Guillermo A. CalvoGuillermo A. Calvo

Research DepartmentInter-American Development BankWashington, April 11, 2001