Difficult balance between growth, inflation in the C'bean — World Bank report

Friday, October 13, 2017

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WASHINGTON, United States (CMC) — A New World Bank report has found what it describes as a “difficult balance” between growth and inflation in Latin America and the Caribbean, with the region's economy expected to grow again this year after suffering a significant gross domestic product (GDP) contraction of 1.3 per cent last year.

“Still, with a global environment that remains rather neutral to growth in the region, policy makers will need to walk a fine line to increase growth while ensuring protection of the most vulnerable,” according to the semi-annual report titled “Between a Rock and a Hard Place: The Monetary Policy Dilemma in Latin America and the Caribbean”.

In the report, the Washington-based financial institution's Chief Economist Office for Latin America and the Caribbean explores the potential of monetary policy to support growth without risking hard-won gains in the battle against inflation.

For Latin America and the Caribbean, market analysts forecast GDP growth of 1.2 per cent for 2017 and 2.3 per cent for 2018.

Growth in Central America and the Caribbean is expected to remain at just below four per cent in both 2017 and 2018, the World Bank said.

“External drivers of growth, such as high commodity prices, aren't playing a major role and the region will need to rely on home-grown sources for growth,” said Carlos Vegh, World Bank Chief Economist for Latin America and the Caribbean.

“Reforms in labour markets and education, higher infrastructure spending and addressing the fiscal situation are key.”

The report finds that 28 out of 32 countries in the region will show a negative overall fiscal balance in 2017, noting that average debt ratios are expected to stand at 58.7 per cent of GDP, with six countries having ratios above 80 per cent.

The report notes that the recent string of natural disasters in the region will only add to existing fiscal pressures in light of the staggering losses.

“While countries in the region still need to make fiscal adjustments to adapt to the new post-commodity boom reality, many countries are right to do it gradually and thus avoid a new recession,” Vegh said, adding “this naturally tends to put more of the burden on monetary policy to help reactivate the economy.”

The report identified a critical monetary policy dilemma faced by countries in Latin America and the Caribbean.

It stated that industrialised nations could reduce interest rates to stimulate the economy without worrying about currency depreciation, a rise in inflation or macroeconomic instability.

“But this countercyclical monetary policy is not as easy an option in the region – something reflected in the fact that several countries in South America are still procyclical,” the report noted.

“While raising interest rates in bad times helps prevent currency depreciation and keep inflation in check, it ultimately also weakens the economy.”

The report said central bank independence, low levels of dollarization and credibility in the markets is the answer to how emerging markets, such as those in the region, solve this fundamental monetary policy dilemma.

It stated that while this takes time, some regional countries are already able to adopt countercyclical monetary policy during economic downturns “without the fear of potentially making things worse for those most vulnerable”.

The report also noted that other financial instruments, such as lowering legal reserve requirements to stimulate the economy in bad times, have proven helpful in countries that are still procyclical.

“These measures can help them respond counter cyclically to a slowdown.”

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