Itaú BBA - What Now for Latin America? - Speech by Ilan Goldfajn

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What Now for Latin America? - Speech by Ilan Goldfajn

May 20, 2015

Previous cycles are gone, there is a need to offer new sources of growth in LA

I would like first to thank Alejandro Werner and David Lipton (from the IMF), Mauricio Cardenas (Colombia’s Finance Minister) and José Uribe (governor of Colombia’s central bank) for the invitation to be here. It is a great pleasure for me personally, and I am honored to have the opportunity to speak with you at this lunch.

Given my profession, I interact with investors on a daily basis. In the last couple of years, investors in Latin America have realized that the previous trend is over and that something new is on the way. I have sensed the investor community growing more anxious than usual, and it reminded me of an old joke by Rudi Dornbusch.

Investors are anxious for answers. They don´t have patience for long, sophisticated ones:

- Tell me how you see LA now, but very short; give me your one-word answer.

- In one word? Good.

- That’s it? OK, now tell me in two words. 

- Not good.

Here we are, at the end of cycles, and you may call them super-cycles. Commodity-boom and easy-money cycles are gone (or about to go). The trend is over. Important commodities for Latin America (LA) are down, copper 40% from the peak, iron ore 70%, soybean 40%, and oil 50%.

After years of relentless appreciation in LA currencies, depreciation is now the norm. On average, the main four floating currencies of the region – BRL, CLP, COP and MXN – weakened by 62% in nominal terms against the dollar from their peak. Spreads for credit default swaps are on average 100 bps above their lowest levels (for the same four countries). The main stock exchanges of the region are down on average by 43% in dollar terms from their peaks.

We are entering a new reality in LA. The problem is that in LA “reality is stranger than fiction,” to quote Mark Twain. In other words, fiction is at disadvantage in LA: “The problem with fiction (relative to reality) is that it has to be plausible,” to quote Tom Wolfe. And here we are, ladies and gentlemen, in the land of the great Gabriel Garcia Marquez, who knew a thing or two about magical realism.

Who could imagine, as an example, that in Brazil the very same government that created the “New Matrix of Economic Policy” (and ran it deep) would now nominate a Chicago PhD to run policies in the exact opposite direction? It’s magic! Or who would imagine that Kirchner’s popularity would improve now, close to the finish line, after all that has happened? This is more than magic! Or who could imagine that Mexico would finally embark on reforms, and that growth would not be there (not yet, at least)? Or even imagine that Chile would start with a government capable of making us believe that it is back in Latin America? Now both Brazil and Chile are reversing course, with the help of our good friends Joaquim Levy and Rodrigo Valdes (respectively). Now we wonder who will be the next savior in LA during these tougher times.

It seems now is the ideal time to think about the future, between global cycles.  Where we are heading?

Thinking about this, I came up with five issues for LA going forward. Not sure why five, but it seems a magical number to use.

The five issues are these: i) How solid is LA? How many buffers has LA really created during the boom? ii) How do we react to the current growth deceleration? iii) Does the new reality threaten the last decades’ income gains? iv) Will politics be an important issue ahead? v) What will likely drive growth?

  1. How solid is LA? How many buffers has LA created during the boom? 

Some papers have been written on new buffers (Goldfajn & Resende, 2012[1]; De Gregorio & Alvarez, 2013[2]), in line with the argument that “this time is different,” which is always dangerous.

This time around, LA may claim:

  1. Reserves are indeed higher. Brazil, Chile, Colombia, Peru and Mexico have combined around USD 700 billion in reserves.

  2. Public Debts are lower or flat, in general. In Peru the net debt of the general government is 35 p.p. lower as a percentage of GDP than it was in 2003; in Chile the government is now a net creditor; in Brazil net debt also fell, but reversed course in the last years. In Argentina indebtedness fell too, for a different reason.
  3. Better public debt composition, in terms of maturity and denomination (away from the “original sin” of public sector dollar debts). In Mexico, the average maturity of government securities rose from around 860 days (year-end 2002) to around 2,900 currently. In Brazil, the non-financial public sector still has a net long dollar position worth 8.4% of GDP; in 2003, there was a net short USD position worth 10.3% of GDP.

  4. Better rules and institutions: Fiscal rules exist in Chile, and more recently Colombia and Peru have adopted countercyclical fiscal frameworks. Mexico is also moving to create more counter-cyclical mechanisms in its fiscal policy. IT regimes were solidified. In Chile, Mexico, Peru and Colombia there is both de facto and de jure central bank independence. Monetary policy credibility has allowed countries to use exchange rates as a shock-absorber.

  5. Room for countercyclical policies. This is the proof that’s in the pudding. The reaction in 2008 was countercyclical, and the economies recovered fast. This time around governments are also trying. We observe expansionary fiscal policy in Peru this year. And real interest policy rates (using 12-month inflation expectations) are close to zero in Chile and negative in Mexico. Also, we observed substantial depreciation in Colombia and Chile, but inflation expectations remained around the target center for the medium term. 

But not everything created in LA during the boom was a buffer:

Did we borrow too much at the end? BIS numbers show a lot of cross-border claims on LA: Brazil, as an example, has borrowed over USD 300 billion (almost equally split between loans, debt securities and offshore issuances). Compared with reserves, short-term cross-border debts amount to 15% in Brazil, 49% in Chile, 27% in Colombia, 33% in Mexico and 11% in Peru. But where is this debt? Why do we hear no cries of pain from corporates? Borrowed so long-term that the pain is far away?

  1. Reserves for what?  Countries do not really want to use reserves this time; they prefer to adjust faster. LA real floaters such as Chile and Colombia are not intervening, at least not in this depreciation leg.  But other examples of intervention exist:  Brazil, Mexico and Peru are examples of intervention. Brazil has recently reversed course and decided to stop intervention. The role of the exchange rate is quite important, and floating regimes seem to help quite a bit (even with all their problems).

  2. Current account deficits are high. In 2014, Colombia 5.2%, Brazil 4.4%, Peru 4.1% and Mexico 2.1%. Some countries did not save or invest during the good times (Brazil was a greased machine of distribution for terms-of-trade gains, but it did not invest the proceeds). Others did more investment. The investment rates in the years 2000-2013 were: in Chile 22%-24%, Colombia 15%-25%, Peru 19%-28%.

  3. Commodity boom illusions. Even in the better cases, there may be some commodity illusions.;
  1. Countries invested more…but in commodities. Now with prices falling, investments are slowing down sharply. What is the impact on potential growth?

  2. Link to point i): productivity gains were concentrated in commodity production. What’s the impact on potential growth?

  3. Some sectors had “natural” hedges against the USD because of exports. But commodity prices fell, and there was no hedge against that.

Lesson: The region did create some buffers. These buffers may smooth sudden stops in capital flows, and even prevent crises. But they are not a panacea. They are ill-suited to smooth growth declines, certainly when the underlying shocks are permanent. Some countries, like Brazil, are in a different situation. They embarked on pro-cyclical policies after the global financial crisis, which depleted most of their buffers.     


  1. How to react to the deceleration? Accept the end of the cycle or happily indulge in denial? How much to accept and how much to fight back?

The economies of the region have definitely decelerated, from Venezuela and Argentina to Chile and Peru. The common factor here is the end of the commodity boom, but also the end of the region´s ammunition (i.e., buffers). The region as a whole is in its fifth year of growth decline, as forecasted by the IMF. Brazil is facing its most severe recession in decades. Colombia was the last man standing, but the oil-price collapse took care of that. How much should one accept that the shock is permanent, rather than temporary? And if it is permanent, how much to smooth over time the decline towards the new potential output growth?

  1. The commodity boom seems definitely over (along with the deceleration in China). The consensus forecast points to price stability going forward, but history has taught us to beware of undershootings.

  1. The easy-money cycle is also starting to end, at least in the U.S. Europe and Japan still have another two years to go. Even in the U.S., we are not sure about the timing. But there is no doubt that the liftoff will come at some point.

  2. Even the Brazilian soccer super-cycle may have ended. We hope not, but Colombian James Rodrigues surely deserves his glorious moment. 

  3. The economies of the region have accepted the new reality. Policymakers are not embarking on more countercyclical policies. Governments are allowing their exchange rates to depreciate to adjust to the new reality. Interest rates cuts and fiscal stimuli are things of the past.

    1. Currency depreciation is limiting further monetary easing. The central banks of Chile and Mexico are debating on when to remove monetary stimulus, even though their economic recoveries are disappointing. In Colombia the levels of inflation and of the current account deficit are making the central bank cautious.

    2. Current and future revenue declines are making fiscal expansion less appealing, as the drop in commodity prices dims medium-term prospects. In Mexico and in Colombia, governments are preemptively curbing expenditures due to the future revenue losses related to oil prices. Responsible governments are now adjusting.

Recommendation: make adjustments immediately, and accept the new reality. In the past, several LA economies went with denial and worsened their situations (as in Brazil, up to 2014). Smoothing the shock could in principle provide a cushion, but any delay in facing the inevitable  will likely introduce more uncertainty and impact investment and consumption decisions, which would actually hurt growth.  


  1. In the last decade we had higher wages, income gains and better distribution. Does the new reality threaten these gains? Should we expect a reversal? 

    1. We are coming off a very good run. In recent years, pretty much all LA countries advanced in terms of labor income gains, as well as in distribution and the alleviation of poverty. There are several reasons for that:

      1. A better external environment, which converted terms-of-trade gains into wage gains.

      2. To a lesser degree, income transfers and other social programs, like the Bolsa Família in Brazil, provided an additional push.

      3. The income share of the richest 10% fell to 38% from about 43% (average Argentina, Brazil, Chile, Colombia, Mexico, Paraguay, Peru and Uruguay). The number of people below the poverty line fell to 9% from about 22% at the beginning of the super-cycle.

Challenge: Governments face a real challenge in maintaining these trends under the new global scenario. Some governments (like Brazil) have to adjust productivity to income gains. New sources of growth are needed, but they may take time to yield results. There will be political pressure in the meantime. 


  1. Politics will be an important issue moving forward. One cannot look ahead without emphasizing the importance of political support. I have the feeling that the recent protests, the declining popularity of leaders and corruption allegations across the region are endogenous to the economic situation. It is not a coincidence that all this is happening now that the super-cycles are over. Protests were the reaction of wanting more, now popularity is falling as a reaction to fears of worsening conditions (protests against mining projects in Peru; against violence in Mexico; corruption in Brazil; the price of education in Chile). There are three issues to consider:     

  1. “Populism back to the mean”: The countries that saved during the good years may now try moving toward more popular measures, while the rest have no option but to face market discipline. The recent experience in Chile, however, shows that going in the direction of more popular measures is not a real option if the global trend is against you. Presidents look good at the peak of the cycle, but not after the bust.

  2. Politics in the long run: In countries with enlarged middle classes, are we going to move from “the state should give us more” to “protect us from the state”?

  3. Is populism a real risk ahead? Not really, in my view. Populism grows during booms, and it has a rough time during busts. To quote Margaret Thatcher: “The problem with socialism is that you eventually run out of other people's money.”

  1. What should drive growth? Productivity/efficiency, infrastructure, education, institutions, trade openness, saving levels? These measures need to be put into practice and become more than just buzz words (move away from generic recommendations and focus on specific programs). The measures need to take into account how the economic context might look for the region in the future.

  1. What future changes we can envisage?

    1. Dutch disease rebound? More diversification or complexity? At least with the current prices, commodities will continue playing an important role in the region. Energy projects in Mexico, Argentina and Brazil are promising, as well as metal mining projects in Peru. But will the exchange rate depreciation produce a more diversified or complex trade pattern? Maybe manufacturing will recover from years of decline. Having more depreciated currencies may be an important factor for competitiveness, but that alone is not enough. More needs to be done to regain a greater competitive edge. In this regard, infrastructure projects (not only for commodity exporters) seem very important to complement the more depreciated currencies.

    2. How will trade in South America look in the near future? Less China, more U.S.? Is it that China-LA trade peaked, and now it is slowing down with the China deceleration? It seems reasonable to expect some reversal in trade, but not entirely, because a comparative advantage in commodities will still exist.

    3. What is the role of globalization/opening? Export recovery away from commodities may take some time (with the exception of Mexico). The focus needs to be on increasing competition and productivity at home (Brazil needs to find new markets, but also to improve domestic production). The exchange rate depreciation may provide a good umbrella for opening and focusing on competitiveness and efficiency.

  2. How to provide new sources of growth? 

Beyond the natural sources of growth coming from changes in relative prices (and the new global context), countries should concentrate on removing the supply-side constraints.

  1. Savings are scarce. Gross national savings in Latin America are currently only around 18%. Brazil’s large economy with a saving rate of only around 16% brings down the average rate of the region. Relying on more foreign savings would increase current account deficits. If the saving issues are not dealt with, the region will be capital-constrained.

  2. Demographics in the region are not favorable anymore. In Brazil, working-age population growth will slow to 0.7% per year from 2020 to 2025, down from 1.0% in 2015 to 2020. In Chile, it would grow by only 0.2% per year in 2020-2025, according to U.N. statistics. While working-age population growth will not be so low in the other LA countries, it will increase less than it has recently.    

  3. Excess intervention introduces uncertainties and curbs private investment. There is already uncertainty generated by the global economy, so policymakers should be careful not to introduce additional layers of risk. Recessions are the result of this bad timing.

  4. Potential growth is limited. Using consensus estimates for productivity, we project that the region would grow around 3% from 2019 to 2025. In this assumption, we forecast that Peru’s economy would grow by 4.5% (from 5.8% in 2003-14), Argentina – if the next government implement changes – would grow by 3.0% (down from 4.4% in 2003-14), Chile would expand 3.7% (from 4.4%), and Colombia would grow by 3.4% (from 4.7%). 

  5. Need to put productivity/efficiency back on the agenda. Private sector companies are already working to become leaner and better-equipped for the new reality (this is the case of Brazil). Survival instincts are at play once we no longer see optimistic sales forecasts. Governments should follow the lead: improve governance, remove rigidities inefficiencies, red tape and uncertainties. Labor/Tax reforms in Mexico and Colombia are already helping to foster formalization, while changes in outsourcing rules in Brazil would be very good. In the long run, education improvements are going to be key. And in the new global reality, countries with more support for reforms will outpace the rest of the region. Differentiation will dominate. 


In sum, the previous cycles are gone, or about to do so. Economies are decelerating, people are unhappy. There is quite a bit of uncertainty over where the region is heading.

These are the main takeaways:

Policymakers need to react appropriately in the short term. There is no denying that chances to return to previous sustainable growth levels are now more limited. Policymakers need to allow relative prices to adjust (FX rate). If discipline was lost recently, then they need to correct course immediately (as in Brazil). This is not the time to make promises beyond the existing means. But it is necessary to offer some realistic vision of the future, based on new sources of growth.

The best way to recover growth is to work out current supply constraints. If there are no savings, no favorable demography, then it is vital to put productivity and competitiveness back on the agenda. Education improvements are also essential, but these will take longer to materialize. Meanwhile, the agenda needs to focus on dispelling uncertainties and removing rigidities. Beware of excess intervention, because it may backfire. The key is to give private investment the right incentives to grow. Infrastructure projects need to be offered immediately. Use the new exchange rate levels (within floating) to help gather support to open your economy (if you haven´t done so already) and to spur competitiveness.

Commodities will still play an important role in LA. But the future looks quite different from the past. And the future may not be so far away. As the global economy recovers, led by the U.S., we may already be seeing a new cycle slowly and steadily in the making. Now is definitely the time to look ahead.


Ilan Goldfajn, Chief Economist and a partner of Itaú Unibanco.


[1] João Pedro Resende & Ilan Goldfajn (2012): Latin America during the crisis: The role of fundamentals.

[2] Roberto Alvarez & Jose De Gregorio (2013): Why did Latin America and developing countries perform better in the global financial crisis than in the Asian Crisis?


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