Latin America and the Caribbean (LAC) continue to show a relatively strong economic performance despite the current slowdown in economic growth – mainly due to the Eurozone crisis and China’s slower growth. For example, the latest IMF projections estimate real GDP growth in LAC to be 3.4% for 2012 and 4.2% for 2013, compared with just 1.4% and 1.9% in the advanced economies,1 respectively (IMF 2012).
Furthermore, while OECD countries are struggling to get their fiscal accounts back into sustainable territory,2 LAC’s recent history has been one of observed strong fiscal positions, with budget deficits and public debt declining as a ratio of GDP. Figure 1 shows clearly these divergent trends. Overall budget deficits are projected to be on average around 2.6% of GDP in 2011 in LAC, while in the advanced economies the average is 6.5% of GDP. Furthermore, while debt-to-GDP ratios in the advanced economies are on the rise – being in 2011 already more than 30 percentage points above its pre-crisis levels – average debt ratios are just marginally (three percentage points) above its 2007/2008 levels in LAC.
Figure 1. Fiscal indicators in LAC versus advanced economies
Source: IMF WEO, April 2012. (*) Forecast.
However, the good economic performance and sound fiscal positions are interconnected and at least partially due to the strength of commodity prices linked to the dynamism of some emerging economies such as China (Levy Yeyati and Cohan 2012; Reisen 2011). In this context, and given the current risks in the global economy, we see two questions arising:
- What is the current stance of fiscal policy across countries in Latin America? Is there room for to countercyclical fiscal policies (as in 2008/2009)?
- What should countries do to prepare for potential shocks?
In order to shed some light on these two questions, we have updated our estimates of adjusted budget balances for eight countries in LAC, Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico, Peru, and Uruguay (see Daude et al. 2010 and 2011). Our estimates control for the effect of the business cycle based on automatic stabilisers estimates using the OECD methodology (Girouard and André 2005), and extraordinary (over the trend) commodity revenues, considering both, taxes and other public revenues (as in Vladkova-Hollar and Zettelmeyer 2008).
As stated by many analysts during the crisis (although all of us did so with forecasted and not official budget data), Latin America implemented quite active counter-cyclical fiscal policies in 2009 and 2010. According to our estimates, the fiscal impulse in 2009, measured by the increase in the cyclically- and commodity-adjusted primary budget balance,3 reached more than five percentage points of GDP in Chile, 2.4 percentage points in Costa Rica and Peru and 2.3 percentage points in Colombia (see left panel in Figure 2). This stabilising fiscal response was at odds with the economic history of the region, and comparable to the policies implemented in OECD economies.
Figure 2. Fiscal Impulse and output gap in 2009 and 2011 in selected LAC economies
In 2011, economic recovery became widespread in the region. Most countries have managed to close their negative output gap. This situation would usually call for countries to withdraw discretionary fiscal stimulus (sustaining demand is no longer needed), and even start rebuilding their fiscal ‘resilience’ to have the levers to respond to a deterioration of the international economic environment, both from developed economies (notably the US and Europe), or from emerging economies (due to weaker demand for commodities, for instance).
Our analysis shows that there are significant differences in the way fiscal policy in being handled in the recovery in the region (see right panel in Figure 2). Three groups can be identified, in the sample of countries for which we have our estimates.
- First, Brazil, Chile, Colombia and Peru seem to be effectively rebuilding its fiscal space, in a period when they have regained a positive, albeit limited, output gap.
- Second, Mexico and Uruguay have stopped implementing discretionary stimulus (neither expansive nor contractive), although in the latter case some extra savings could have been helpful, given Uruguay’s positive output gap.
- Third, Costa Rica and Argentina seem to be implementing procyclical fiscal policy in the ‘traditional emerging economies’ way that characterised the previous decades: in the former case increasing fiscal savings despite its weak economic situation and in the latter being expansionary despite strong growth.4
This analysis corroborates the conventional view that it is easier to be counter-cyclical in downturns than in recoveries. In other words, at least in some Latin American countries, the pro-cyclicality bias in fiscal policy is not a thing of the past.
This caution is also recommended when analysing debt stock and country’s financing conditions (which depend in part on its credibility), a key determinant of fiscal space. From this point of view, there continue to be important differences in the region (see Figure 3). While most countries have been able to reduce their debt levels towards the pre-crisis levels, some others are struggling with fiscal sustainability. But even if debt-to-GDP ratios seem very low, most Latin American economies collect significantly less taxes than OECD economies (19% of GDP versus around 34%, respectively).5 Thus, a country with a debt level of 40% of GDP and that collects only 16% of tax revenue has actually a debt-to-revenue ratio (250%) higher than that of Portugal (around 239%) or Spain (around 195%). Thus, beyond Jamaica, more countries in the region cannot take fiscal sustainability for granted.
Figure 3. Gross Debt to GDP (percentage)
Entering into the second question – what countries should do – this brief analysis points out the relevance of fiscal institutions. In terms of policy frameworks, among the good performers, Chile and Peru have had well-established fiscal rules for now almost a decade and a half (with several fine tunes over the years), which made it easier to rebuild the room for manoeuvre and even preserve infrastructure investment (Carranza et al. 2011; Marcel et al. 2001 and 2012). Colombia has just implemented its own one, combining objectives of debt reduction/sustainability and reducing pro-cyclicality with measures to improve the handling revenue windfalls linked to commodities.
Therefore, measures to strengthen fiscal institutions are needed. These improvements could range, conditional on the institutional capacity, from better fiscal statistics and multi-year budgeting, to reinforcing fiscal rules which ensure automatic and symmetric fiscal responses, or even introducing independent fiscal councils. This recommendation stems also from the practice of policymaking. When policymakers took the decision on the budget, fiscal policy might actually have been pro-cyclical, but turn out adequate due to unforeseen shocks (Dos Reis et al. 2007). For example, what by the end of 2011 might have seemed an excessively loose fiscal policy, might turn out to be an ex-post prudent stance today, mainly because the outlook for GDP growth and commodity prices have changed. A good example in this regard is Brazil. While in September 2011, output for 2012 would have been considered basically at its potential (-0.1% below), by April 2012 the output gap estimate was around -0.5% and in July 2012 it is now close to -1% (see Figure 4).
Figure 4. Output gap estimates for Brazil
Far from being deterrents of strong public policies, solid fiscal institutions make sure that key public programs have sustainable financing and are not disrupted. Many upcoming policy reforms in the region, from expanding social protection schemes to better infrastructures, to mention just two, demand a brave move in this direction. And it is better to take steps in this direction in relatively good times as the ones we are living in.
Carranza, L, C Daude, and A Melguizo (2012), “Public infrastructure investment and fiscal sustainability in Latin America: incompatible goals?”, Journal of Economic Studies (forthcoming), OECD Development Centre Working Paper.
Daude, C, A Melguizo, and A Neut (2010), “Fiscal policy in Latin America: Better after all?”, VoxEU.org, 8 October.
Daude, C, A Melguizo, and A Neut (2011), “Fiscal policy in Latin America: Countercyclical and sustainable?”, Economics: The Open-Access, Open-Assessment E-Journal, 5:2011-14.
Dos Reis, L, U Panizza and P Manasse (2007), “Targeting the Structural Balance”, IDB Working Paper No. 598..
Girouard, N and C André (2005), “Measuring Cyclically-adjusted Budget Balances for OECD Countries”, OECD, Economics Department, Working Paper 434.
IMF (2012), World Economic Outlook, Update, 16 July.
Levy Yeyati, E and L Cohan (2012), “What have I done to deserve this? Global winds and Latin American growth”, VoxEU.org, 12 January.
Marcel, M, M Cabezas, and B Piedrabuena (2012), “Recalibrando la medición del balance estructural en Chile”, IDB Publications 73838.
Marcel, M, M Tokman, R Valdés, and P Benavides (2001), “Balance estructural del gobierno central. Metodología y estimaciones para Chile: 1987–2000”, Estudios de Finanza Públicas, Ministerio de Hacienda, Gobierno de Chile..
OECD (2012), Economic Outlook Volume 2012 Issue 1, June, OECD Paris.
Reisen, H (2011), “The renminbi and poor-country growth”, VoxEU.org, 5 December.
Vladkova-Hollar, I and J Zettelmeyer (2008), “Fiscal Positions in Latin America: Have They Really Improved?”, International Monetary Fund, Working Paper, WP/08/137.
1 This group includes: Australia, Austria, Belgium, Canada, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hong Kong SAR, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Malta, Netherlands, New Zealand, Norway, Portugal, Singapore, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Taiwan Province of China, the UK, and the US.
2 See OECD (2012) for the adjustments needed -- quite significant in several cases -- to stabilise debt-to-GDP ratios around 60% by 2030.
3 We would like to thank Mauricio Soto (IMF) for providing us the primary budget balance series.
4 The preliminary information for 2012 seems to be consistent with this observation for 2011.
5 See Revenue Statistics in Latin America: http://www.latameconomy.org/en/lac-fiscal-initiative/revenue-statistics-in-latin-america/#c18188.