Economic Survey of Latin America and the Caribbean 1997-1998

1. Introduction

The year 1997 was a highly successful one for many economies in Latin America and the Caribbean, thanks to both a strong expansion of output and low inflation. As predicted earlier, however, external shocks, combined with the effects of policies designed to deal with incipient disequilibria in several countries, have made it impossible to repeat that performance this year.

The region’s average growth rate of 5.3% in 1997 was one of the highest in the past two decades; it is notable that this expansion was led by the robust growth of both investment and exports. At the same time, inflation fell to 10.4%, the second-lowest level in the last half century, and labour markets showed a moderate improvement. Capital inflows reached an all-time high of nearly US$ 80 billion, which was enough to cover the widening current account deficit (US$ 63 billion) and to permit a substantial increase in international reserves. Over two thirds of these flows consisted of direct investment, the most stable kind of foreign capital.

In 1998, by contrast, the region’s economies are expected, to grow only around 3%, on average which is slightly lower than the norm for the decade. Under these conditions, it is likely that unemployment will again begin to increase. Inflation, which had been falling rapidly until 1997, crept back up to 10.9% in the 12 months to June 1998, although it may recede in the second half of the year, once the food price increases caused by natural disasters have abated. The current account deficit will widen further to around US$ 75 billion (3.7% of GDP, compared to 3.2% the year before), but capital inflows will still be more than enough to cover the gap.

Two types of external shocks have affected the region --and much of the rest of the world as well-- in the current biennium. The first has been generated by the climatic phenomenon known as El Niño, which, by warming ocean currents, has caused both severe floods and droughts in different places. In a number of Latin American and Caribbean countries, El Niño has disrupted agricultural production and fishing, wreaked havoc in forestry and ranching activities and destroyed infrastructure and housing stock. The results include depressed growth rates, increased inflation and pressures on the balance of payments owing to both lower exports and higher imports.

The other shock has been the financial crisis that began in Thailand in June 1997 and thereafter expanded to include large devaluations, recessions and inflation in many of the developing countries of East and South-East Asia. The continuing stagnation of the Japanese economy has only exacerbated the problems of its neighbours. As noted in an earlier ECLAC study, (1)   the repercussions of the Asian crisis have been transmitted to Latin America through three channels: trade (a decline in the volume of exports to Asia, lower commodity prices, competition from cheap Asian exports, negative spillovers from intraregional effects in Latin America itself); finance (speculative attacks on exchange rates, weakening stock markets, scarce and/or more expensive foreign capital); and policy responses (tighter fiscal and monetary policies).

These processes have tended to lower the countries’ growth rates and increase their current account deficits, as well as raising the cost of financing those deficits. The ECLAC study tried to separate out the effects of the Asian crisis per se from other phenomena, including El Niño, lower oil prices (only partially due to weaker demand in Asia) and the fact that some of the countries in the region had to take steps to prevent their economies from overheating. Thus, a comparison was made between projections for 1998 prepared in September 1997 (before the Asian crisis hit Latin America) and in March 1998 (after serious repercussions had begun to be felt). According to this analysis, growth would have declined by about 1% in 1998 even without the Asian crisis, but the crisis will subtract another 1%-1.5% (see figure I.1). Given the negative terms-of-trade effect, the rate of increase in gross domestic income will slow even more than GDP growth.

The Latin American and Caribbean Governments have been quick and decisive in their response to these external shocks, and in consequence, their impact so far has been relatively mild. At the same time, it should be pointed out that there has been a clear policy bias towards reducing demand rather than adjusting relative prices, especially the exchange rate. This choice has negative implications for growth rates in the region, at least in the short run, although it also has a positive impact on inflation.

The best-known example is Brazil’s reaction when the reais was attacked in October 1997. Within days, the Government announced a package of measures to defend the currency, which is considered to be the linchpin of the stabilization programme that brought inflation under control. The measures centred around a sharp rise in interest rates and cuts in government expenditure, which led to a slowdown in growth but avoided major financial difficulties of the sort that have undermined a number of Asian economies. It should be pointed out that Brazil was able to undertake these measures because it, like many other Latin American and Caribbean countries, had substantially strengthened its banking system in recent years.

Although sound economic management and other preventive measures have warded off a crisis in the region thus far, a cautious attitude should be maintained for several reasons. First, the recessions in East and South-East Asia now appear likely to last longer than originally foreseen and could worsen. Second, additional problems could emerge, such as a further weakening of the banking sector in Japan, a devaluation in China, or a spread of the contagion to other countries, as occurred in Russia in August 1998. Third, the Asian crisis may have repercussions on the United States and European economies that have not yet been manifested, which in turn would have a negative affect on Latin American exports. Finally, further weather problems ("La Niña") and the continuation of weak commodity prices could be very damaging to certain countries in the Latin American and Caribbean region.

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Note:

(1) ECLAC, Impact of the Asian Crisis on Latin America (LC/G.2026), May 1998.