Fiscal adjustments for productivity and social inclusion foreseen for Latin America and the Caribbean

Busan, March 30, 2015.- Many Latin American and Caribbean countries need to make budget adjustments in the face of rising fiscal imbalances and higher financial risks, according to the Inter-American Development Bank’s annual macroeconomic report.

The 2015 report addresses the question of how budgets should be adjusted and how fast, and projects a baseline annual growth scenario for 2016-2019 of 3 percent, on par with the 1990s but below the 4.7 percent registered during the pre-crisis 2003-2008 period. Additional negative external shocks in China, Japan and Europe could further erode economic growth.

On the bright side, stronger U.S. growth and lower commodity prices, including oil, may give a boost to countries that import energy and have strong trade ties with the United States.

“Latin America and the Caribbean has performed well in the years that followed the global financial crisis, increasing fiscal spending to fuel economic growth,” said IDB Chief Economist José Juan Ruiz. “But lower commodity prices and higher inflexible spending are threatening to erode many of the gains. Countries will need to find ways to enhance revenues and the efficiency of spending while they protect social gains”.

The report – The Labyrinth, How Can Latin America and the Caribbean Navigate the Global Economy – points to common trends affecting the entire region but also provides analysis for the specific situations faced by individual nations, and provides policy suggestions going forward. It was issued during the IDB’s Annual Meeting held in Busan, Korea.

The slowdown in growth comes amid rising inflation in some countries, which will constrain their ability to use exchange depreciations to respond to negative shocks.

At the same time, corporate bond amortizations are expected to rise annually to $64 billion in 2020, the majority in dollars. Dollar issuance soared in recent years but is now falling and may fall below the level of required payments.

Commodity winners and losers

From 2011 to date, metal prices have fallen 44 percent, food prices have declined 20 percent and oil has plunged 59 percent. While commodity prices are subject to volatility, the report does not foresee prices bouncing back to their previous highs anytime soon.

For nine commodity-dependent countries, the average decline in fiscal revenue is 9 percent in the baseline scenario, ranging from a 2 percent drop for Peru to over 10 percent for Trinidad and Tobago, Ecuador, and Venezuela.

Impacts vary on the trade balance. The winners are 11 countries in Central America and the Caribbean that will enjoy net positive effects larger than 1.5 percent of GDP from commodity price declines. Countries such as Brazil and Mexico will see mild negative effects while Bolivia, Trinidad and Tobago, Colombia, Venezuela and Ecuador will be harder hit.

Fiscal Adjustments

For the fourth year in a row, the structural primary fiscal budget was in negative territory, -1.1 percent of GDP in 2014. Since 2010 the structural primary fiscal balance has improved in only 6 of 20 countries. Eleven countries – accounting for 58.5 percent of the region’s GDP – should make fiscal adjustments to avoid higher debt levels.

The right fiscal adjustment will vary across countries. Dialing back spending may be difficult for many in the region. Over seven years, primary public spending has grown 3.7 percent of GDP, of which 2.7 percentage points are on inflexible items such as wages, subsidies and transfers.

Those with high tax intakes may be better off reducing spending, while those with low fiscal revenues as a proportion of GDP will be better served by widening the tax base, removing tax subsidies and exceptions, and improving tax administration. Low energy prices offer an opportunity to consider green taxes that also bring environmental benefits.

Countries can also put their resources to better use. In health, the region is between 12 and 44 percentage points below the most efficient country in generating healthy life expectancy with given resources. In education, spending has risen from 4.2 percent to 5.6 percent of GDP in 13 years, with little evidence of better effectiveness.

Almost one in four of the region’s inhabitants benefit from conditional cash transfers, but many programs can better target the extreme poor.

“Many countries are facing difficult tradeoffs. On the one hand higher productivity is required to boost potential growth but on the other, given lackluster world prospects, the arithmetic of debt sustainability must be carefully monitored,” said Andrew Powell, the coordinator of the report for the IDB. “Consolidation efforts must be carefully calibrated in terms of both composition and timing to navigate the months and years ahead”.