The world of forking paths – report by InterAmerican Development Bank (IADB) March 2012

" The world of forking paths – Latin America and the Caribbean facing global economic risks " is the title of the report IADB released during its annual meeting in Montevideo this month. The report has projected different global scenarios and their possible impact on Latin America. They have also given some policy recommendations to the Latin American governments.

The major factors which will impact the region are: commodity prices, Chinese growth, European crisis, inflow of capital, the role of foreign and particularly European banks in the region and US recovery. A deceleration of Chinese growth is likely to affect producers of metals more than producers of grains.

The report concludes, " while the world is one of forking paths and it is impossible to know which alternative will become a reality, Latin America has good reason to be optimistic thanks to the new set of tools it has developed and the experience it has gained deploying them effectively". This is based on their following assessment:

-The region has made substantial economic progress both in terms of growth and in the ability to respond to external shocks.

-Many of the region's economies have achieved reduction in external public debt and increase in a greater proportion of public sector debt issued in local currency, have been able to use effective countercyclical fiscal policies, have greater possibilities of employing the exchange rate as a shock absorber while maintaining stable prices and have deployed several macro-prudential tools.

On the other hand vulnerabilities remain due to excessive commodity dependence of most South American countries, capital inflow and credit boom and the role of the European banks.

I must compliment the IADB for choosing the most appropriate and interesting title for their report. The inspiration for the title is " The garden of forking paths " a story written by the famous Argentine author Jorge Luis Borges. The story is about the revelation of a labyrinth that had many paths that forked once and then forked again and again providing many alternative realities. The main characters in the story is a Chinese professor acting as a German spy in England and his ancestor who wanted to construct a vast and intricate labyrinth in which all men would lose their way.

Fiction is becoming a reality...In the real Latin American economic story, the Chinese are playing a similar important role, opening many labyrinths, as in the Borges fiction. The Latin Americans should not get lost in the labyrinth. They should play their part smartly and find their best way forward...

Latin America prepared for the Changing Global Economic Landscape

" Negative global economic trends will affect Latin American countries, but much of the region has more capacity than before to shape its own destiny, potentially maintaining GDP growth and stability during the coming years. Indeed, we project that Latin America could grow at an average rate of 3.5%-4% in 2012, about two percentage points faster than developed countries". This is the conclusion of a report of Standard and Poors with the title " The Changing Global Economic Landscape And Its Impact On Latin America" dated 14 march.

Excerpts from the report:

- The Latin American region as a whole enjoys higher average sovereign ratings today than before the recent global recession. Standard & Poor's has investment-grade ('BBB-' or higher) ratings on 6 Latin American sovereigns (accounting for more than 80% of the region's GDP). By contrast, only 35% of the region's sovereigns (as measured by GDP) had investment-grade ratings in 2007. Many countries now enjoy more capacity to respond to adverse shocks than before.

- On the whole, Latin America has acquired greater economic resilience in recent years, with lower inflation, less dependence on external funding, and greater policy flexibility to respond to an external shock. The strengthening of creditworthiness in many countries has paralleled encouraging social trends that augur well for political stability in coming years.

- The ability to control inflation—along with steps to gain more exchange rate flexibility—has set the stage for developing domestic capital markets in many countries. As a result, sovereigns throughout the region have been able to reduce their dependence on external funding, shifting a greater share of their debt into the local market.

- New laws and regulations have also encouraged the growth of domestic financial institutions, especially pension funds, which provide an alternative source of funding for both sovereign and nonsovereign borrowers. The banking systems in much of the region are funded locally, with deposits exceeding loans in most countries.

- The improving net external position of many Latin American countries stems in large part from the growth of domestic capital markets as well as fiscal reforms that have contained the growth of public-sector debt. According to the IMF, the average maturity on outstanding domestic debt in Latin America exceeded eight years (in 2010) compared with about four years in 2003. Maturities on new sovereign bond issuances are now averaging 14 years. The growing capacity of sovereigns to issue debt in their local currency for longer maturities and increasingly at fixed nominal interest rates has reduced their vulnerability to a sudden loss of external liquidity or to a sharp spike in interest rates. That, along with flexible exchange rates, has strengthened sovereign creditworthiness.

- The level of income inequality has declined in Latin America, though it remains the most unequal region in the world. Much of Latin America is becoming middle class, at least when using a very broad definition of that group. This encouraging social trend has potentially positive political implications, likely reducing the appeal of populism and boosting public support for policies that favor stability and moderation. Lower political risk augurs well for long-term stability and growth by reducing the likelihood of a sudden reversal of recent economic policies.

- The U.S. has become less involved in local politics and less inclined to actively support or oppose particular governments and their economic policies. In sum, the international context gives Latin America more political space to pursue its own policies. Increasingly, Latin America's fate lies in its own hands.

While highlighting these positive and optimistic points, the report has also pointed out the challenges and problems faced by the region such as vulnerability to the global uncertainties, pressures on currencies arising from the low interest rates in developed markets, FDI inflows, changes in price and demand of commodities and lower productivity levels in the region.