In the heat of the global recession, Latin American policymakers took unprecedented actions to break the downward spiral in aggregate demand. Beyond aggressively supporting financial markets, including interest-rate cuts and liquidity injection measures in some cases, many governments also pursued significant fiscal stimulus packages. Success in mitigating the crisis reflected a country’s overall fiscal preparedness. But now may be the time to tighten fiscal belts.
Together with the deterioration of public-sector finances, discretionary stimulus policies in 2008 pushed the overall fiscal balance of governments worldwide from an average deficit of 2.6 percent of GDP to a gap of almost 7 percent last year. Latin America was not an exception. One third of the region’s fiscal deficit increase—which widened from 0.6 percent of GDP in 2008 to 2.9 percent in 2009—can be attributed to the fiscal cost of discretionary measures.
But the degree to which countries could use fiscal policy to cushion the impact of the crisis varied. In general, commodity exporters like Brazil, Chile, Colombia, Mexico, and Peru pursued prudent policies in advance of the crisis, either saving part of the windfall from high commodity prices during the boom years or using it to reduce net external liabilities. This opened the door for either the adoption of counter-cyclical fiscal measures in Brazil, Chile, Mexico, and Peru, or, as in Colombia, the avoidance of big fiscal spending cuts to help contain the decline in aggregate demand.
Even so, there was a wide variety in the type and scale of measures. They included increases in public infrastructure spending (Mexico and Peru), transfers to vulnerable groups (Brazil, Chile, Mexico, and Peru), tax breaks for auto purchases (Brazil), and freezes on government-controlled prices (Mexico). The fiscal cost ranged from 1 percent to 3 percent of GDP, well below that of developed and other emerging economies. But off-budget initiatives—including the massive loans granted by Brazil’s state development bank that added up to 6 percent of GDP—did not represent an immediate fiscal cost.
The story was quite the opposite for those Latin American countries where high revenues during the preceding boom years were matched by even higher expenditure growth. At a time of collapsing commodity prices and shrinking external demand for goods and services, these policymakers could not pursue aggressive counter-cyclical policies and were forced to push the brakes on public spending. Many such countries—including commodity exporters like Argentina, Ecuador and Venezuela, and importers (including most of the Caribbean)—either experienced a deeper recession or are recovering at a slower pace.
It is fair to say that regional stimulus spending—in countries that could afford it—was quite effective in cushioning the effects of the global crisis. The Brazilian, Chilean and Peruvian economies, which deployed the largest stimulus packages, will grow at the fastest pace in 2010, above 5 percent.
How long can these countries maintain fiscal largesse? Strictly judging by the fiscal room to spend, the countries positioned to pursue aggressive counter-cyclical fiscal policies last year can keep spending and let their fiscal stance turn pro-cyclical. Brazil should be able to nearly double its primary fiscal surplus and meet this year’s 3.3-percent-of-GDP target without many expenditure cuts. Chile still has around $14 billion in its offshore copper fund after spending $8 billion last year, part of which will likely be used for reconstruction after February’s earthquake.
Peru’s central and regional governments have savings equivalent to 10 percent of GDP, which will facilitate its strategy of supporting growth by accelerating public investment. Overall, much short-term fiscal retrenchment is unlikely in these countries.
A more appropriate question is whether countries that can afford to maintain expansionary fiscal policies should keep doing so even after their economies emerge from recession. Pressure from markets and rating downgrades already prompted Mexico to tighten its fiscal stance, forcing it to approve tax hikes—implemented this year—in the middle of last year’s recession.
But markets may not put similar pressure on Brazil, Chile and Peru due to ample global liquidity and the fact that their fiscal accounts still look much better than those of many developed countries. Instead, the pressure to start removing fiscal stimuli may come from inflation, which is already starting to accelerate in Latin America—up 5.1 percent from December 2008 to December 2009 and up 6.3 percent year-on-year in March 2010. While increases in taxes and/or administered prices have been a key driver of higher headline inflation in most countries this year, inflation risks are rising due to the broadening recovery in domestic demand, the normalization in still-low food prices and the rebound in commodity prices.
Pressure to reduce public spending may also come from currency appreciation. This is already happening across Latin America due to higher commodity prices and is being exacerbated by governments forced to cover fiscal gaps with external financing. Currency appreciation also limits the policy options of central banks, which are forced to implement interest-rate hikes that seek to fight inflation and intervene in currency markets in order to prevent further appreciation.
Policymakers may eventually realize that if fiscal policy is not tightened, central banks would be forced to aggressively hike interest rates and do the dirty job of fighting inflation alone, which could trigger more currency appreciation and hurt export competitiveness and growth. In the end, something’s got to give.
