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April 27, 2004
js-1476 John B. Taylor
Under Secretary of Treasury for International Affairs
Fitch Ratings’ Latin America Conference
New York City
April 27, 2004
Supporting Economic Growth in Latin America Thank you very much to Fitch Ratings for inviting me to speak at this conference. I traveled to the region last week, and it is a pleasure to be here today to talk about Latin America’s economic performance and prospects, including recent positive developments. I’d like to begin by discussing those improvements and outlining some of the factors that I think underlie them. I would also like to discuss U.S. efforts to reinforce the region’s economic recovery and help the countries of Latin America lay the foundation for sustained growth.
Recent Improvements and the Causes
As you know, financial conditions have firmed substantially during the last year and a half. Average risk spreads for Latin American countries have come down dramatically, from over 1,300 basis points above U.S. Treasuries in the fall of 2002 to under 600 basis points today. Capital flows, which fell during 2002, bounced back in 2003. Several Latin American governments have already successfully completed a large portion of their planned external issuance for this year at attractive interest rates. Many currencies in the region have stabilized or, in the cases of Brazil and Argentina, strengthened substantially. And equity markets in major economies turned in strong performances in 2003.
Stronger fundamentals and better economic policies have underpinned the stronger financial indicators. The ratings agencies have taken note of these changes. Three of the seven largest economies—Brazil, Chile, and Ecuador—received ratings upgrades during 2003 and 2004.
First, economic growth in the region is picking up along with the recovery in the global economy. Following flat real GDP in 2002, the region grew 1.7 percent in 2003 and is expected to grow 3.5-4.0 percent in 2004. Brazil grew at over 6 percent in the fourth quarter.
Growth rates in Mexico, Chile, most of Central America are expected to rise by more than a percentage point this year. And economic recovery in Argentina and Uruguay accelerated to annual rates in excess of 10 percent in the fourth quarter of 2003.
Second, countries’ external balances are strengthening. In 2003 the current account as a share of GDP for the region swung into surplus in 2003 for the first time in decades. This improvement was powered in several countries by strong growth in exports, with exports increasing 21 percent in Brazil and 17 percent in Peru in 2003. Central banks in the region have used the opportunity to increase their accumulation of foreign reserves to provide a cushion against future market turbulence.
Third, authorities in the region have pursued good fiscal and monetary policies. Six of the seven largest economies—Brazil, Argentina, Colombia, Ecuador, Chile, and Peru—successfully increased primary budget surpluses to bring down debt levels over time and reduced or maintained low inflation in 2003.
Venezuela is the exception. It is remarkable—and tragic—to consider that per capita income in Venezuela is 25 percent lower than it was in 1998, even though oil prices have increased markedly over that same period of time.
Achievements in monetary policy in Brazil and Argentina merit particular attention. Both countries experienced large currency depreciations in 2002. Yet sound monetary management prevented these depreciations from turning into inflationary spirals. We saw a bulge in inflation in both countries as the effects of the depreciation worked their way into consumer prices, followed by a rapid and sustained reduction in inflation resulting from effective monetary restraint. These prudent policies enabled Brazil’s central bank to achieve inflation of 9.3 percent in 2003 when market inflation expectations at the beginning of that year exceeded 13 percent. And they enabled Argentina to reduce inflation from 41 percent in 2002 to less than 4 percent in 2003.
In Brazil, improved confidence in fiscal policy and the downward trend in inflationary expectations have enabled the central bank to aggressively cut interest rates over the last 10 months. Real interest rates are now less than 10 percent, helping to spur faster economic growth and higher levels of investment.
Fourth, while debt levels in the region remain high, countries are taking steps to strengthen their debt profiles and deepen their domestic capital markets. Brazil has substantially cut the portion of its debt that is linked to the exchange rate and increased the portion of fixed-rate, real-denominated debt. Brazil’s consolidated interest expense has declined from 13.9 percent of GDP during the first two months of 2003 to 8.2 percent for the same period this year. Mexico issued its first 20-year fixed-rate, peso-denominated bond in last year. Latin American countries have played a leading role in making bonds with collective action clauses the market standard, with Brazil, Colombia, Peru, Panama, Costa Rica, Uruguay, and Venezuela following Mexico’s pioneering issuance in February 2003.
Finally, countries have made progress on important structural fiscal reforms aimed at locking-in improvements in macroeconomic policy. Argentina and Peru have taken steps to fight tax evasion and improve tax compliance needed to avoid the pattern of ever-increasing tax rates chasing ever-lower collections. Brazil and Colombia have moved forward with reforms of public pensions, freeing up savings that can be used to reduce public debt or increase key infrastructure investments. Colombia, Ecuador, and Peru have passed fiscal responsibility laws that improve their control and capacity to implement spending and budget targets. Peru has made progress implementing a framework for fiscally-prudent decentralization, and Honduras has passed legislation that establishes executive control over the growth of public wages.
More remains to be done in the region to lock in sound public finances, which is the single most important defense against the financial crises that have periodically set Latin America back. Many of the leaders around the region who we talk to clearly understand that imperative.
Some observers have attributed the improvements in Latin American markets to excess global liquidity and the search for yield; they predict that an increase in industrialized country interest rates will cause a sharp fall in the region’s financial markets. Liquidity in global markets may be a factor, but I do not think it is the predominant one. I see fundamentals and policies as the most important factors in these changes. Moderate increases in interest rates driven by the acceleration in global growth are anticipated and should not surprise markets. Faster global growth itself will be an overriding positive for the region. Countries that maintain good policies are positioned to benefit from stronger global economic conditions, as prices for their commodities and demand for their exports in industrialized countries increase further.
The Microeconomic Agenda
As economies stabilize, the agenda for the region is clearly broadening to focus on microeconomic barriers to growth. By that I mean factors that constrain entrepreneurs and the formation of capital, both physical capacity and human capital. This is a region with enormous scope for faster growth and higher living standards based on rising productivity growth.
What are the elements of the microeconomic agenda? They boil down to making markets for inputs and output work better. Banks have to be sound and do a better, more efficient job of intermediating capital and broadening access to new, productive entrepreneurs. Labor markets have to operate efficiently and flexibly so that labor moves from the informal to formal sector. The tax, legal, and regulatory environment has to provide a basis for risking capital, especially in large, multi-year infrastructure projects. The judicial system has to enforce contracts predictably and fairly. Governments have to invest productively in health and education for their people. Markets for tradable goods and services have to be open to competition, especially given the vast potential for all economies in the region to benefit from further integration. And businesses need a simple, efficient regulatory system. It takes an average of over 70 days to start a business in Latin America.
Peru has made steady progress improving the financial system’s regulatory framework and banking supervision, helping to underpin a deepening of domestic capital markets and the gradual reduction in the level of financial dollarization. Colombia completed a labor market reform aimed at helping draw jobs into the formal sector by reducing severance payments, cutting overtime pay, and reducing nonwage labor costs. Brazil’s government is embarking on an important program to streamline and simplify the process of business registration, which ultimately will require a business to register only once, and has made judicial reform a top priority for this year. In short progress is being made. But a great deal remains to be done.
U.S. Economic and Financial Policies Toward Latin America
The Bush administration has acted consistently and quickly to support countries that are doing the right thing on economic policy. Pro-growth policies work and deserve our support. We put the emphasis on accountability and ownership.
This has guided our approach to IMF engagement in the region. U.S. support for IMF programs for Colombia and Brazil in 2002 are two good examples. In both instances, the governments themselves articulated strong policy programs aimed at restoring stability through fiscal discipline and other reforms. International support was effective because it reinforced these policies. In Colombia, President Uribe’s reforms helped the country re-access international capital markets within months after its sovereign spreads rose to over 1,100 basis points over U.S. Treasuries. In Brazil, this combination allowed the country to overcome pre-election market jitters and facilitate a smooth transition to President Lula’s administration. With Brazil’s continued strong policy performance, the United States supported a 12-month extension of Brazil’s IMF program that is allowing the country to graduate from reliance on official financing in a market confidence-enhancing way.
Let me say a few words in this context about Argentina. The United States supported Argentina’s transitional IMF program and the launch of Argentina’s three-year IMF program in September 2003 to strengthen the current economic recovery and lay the basis for sustained economic growth. The program is designed to address Argentina’s chronic fiscal problems, restore the health of the banking sector, and resolve the country’s defaulted debt. We have emphasized that debt negotiations between Argentina and its private creditors must be transparent and have the give-and-take needed to encourage creditors to participate in the debt exchange.
The IMF program was designed specifically to give Argentina the flexibility it needs to negotiate a debt restructuring with its creditors. The program leaves Argentina’s primary surplus targets for 2005 and beyond unspecified above a 3 percent of GDP floor, so that the increment to this floor can be decided upon as Argentina determines the level that will be needed to achieve a debt exchange that achieves broad creditor support. Once the amount of resources from the international financial institutions is determined, specification of a primary surplus path in the IMF program would have largely determined the amount that private creditors got paid. It would not be appropriate for the IMF to be in the middle of negotiations between Argentina and its creditors in this way. The amount of IMF exposure is to be held constant during the current three year program and should then decline significantly. There is no need for exposure to the World Bank and Inter-American Development Bank to decline in this way if viable projects and programs continue to merit new lending.
The difference between Argentina and Brazil regarding the manner in which the primary surplus is set in the IMF program reflects that Brazil’s debt is not the subject of an ongoing negotiation. Moreover, in Brazil, where debt is not in default and payments to private creditors are clearly defined, one can calculate a primary surplus target needed for debt sustainability. The Lula Administration’s 4.25 percent of GDP primary surplus policy has enabled Brazil to honor its debt obligations, retain access to the international capital markets, and avoid a deep output contraction.
We have also stressed the importance of understanding and dealing appropriately with contagion. Early on in the Bush administration we talked a lot about the dangers of overemphasizing contagion as a phenomenon, since it could lead to support for countries that may not be following good policies. We have sought to concentrate support on countries hit by external shocks that have a direct impact on their economies, but which are also pursuing strong adjustment efforts. So for example, when Uruguay’s banking system was hit by deposit withdrawals associated with the Argentine crisis, the United States extended a very short-term $1.5 billion loan to help Uruguay end the deposit run until additional assistance from the IMF, World Bank, and Inter-American Development Bank could be mobilized.
The emphasis on accountability and ownership is guiding our approach to U.S. development assistance, as evidenced in President Bush’s Millennium Challenge Account (MCA), targeted at countries that invest in people, pursue good governance and rule of law, and promote economic freedom. For fiscal year 2004, Congress appropriated $1 billion to the MCA. In 2005 the Bush administration is requesting $2.5 billion as the program ramps up to the $5 billion target in 2006. The poorest countries in the Western Hemisphere will be eligible to compete for MCA funds this year. Within a few weeks, the Board of the Millennium Challenge Corporation will determine which countries may apply to be beneficiaries of the MCA funds for FY2004.
We are emphasizing initiatives aimed at increasing economic growth, promoting job creation, and raising standards of living in Latin America. The most obvious is the Bush Administration’s ambitious trade agenda for the region. The U.S.-Chile Free Trade Agreement has already been completed, and an agreement with five Central American countries and the Dominican Republic has been negotiated (CAFTA). We have also announced our intent to negotiate an agreement with the Andean countries, aimed at eventually including Colombia, Peru, Ecuador, and Bolivia, and to launch negotiations with Panama. A successful trade capacity-building exercise will continue under CAFTA and be replicated in negotiations for the Andean FTA. Our efforts also continue toward a Free Trade Area of the Americas that would encompass all countries in the Hemisphere in an integrated market.
A growing focus is encouraging entrepreneurs and promoting access to credit for small businesses. Small businesses are the engine of job creation in Latin America and throughout the world. At the Summit of the Americas, the United States led the effort to establish the goals of cutting the time and expense to start a new business and tripling bank lending to small and medium enterprises, with the help of the IDB, by 2007.
Finally, the United States is working to facilitate access to a powerful and largely untapped source of funds for economic development: remittances from workers in the United States to their families back home. Annual remittance flows to the region are more than five times the annual flow of official development assistance from all sources and account for a substantial portion of GDP for many countries in the region. The United States is committed to working with the countries of the region to achieve the Summit of the America’s goal of halving the average cost of remittance transfers in the region by 2008.
In sum, I am optimistic about the region’s prospects. Perhaps cautiously optimistic is the best way to put it. To be sure there are risks. Sustaining the positive trends that I have discussed today will take political will and persuasion. Microeconomic reforms of the kind mentioned earlier are central to increasing rates of growth that have been historically disappointing. The United States stands ready to work with the countries of the region on these continuing challenges.
Thank you and I am happy to take questions.
REPORTS
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