IDB: Fiscal reform key to boost growth in Latin America and Caribbean

NASSAU, Bahamas – The Latin America and the Caribbean region faces mediocre future growth unless tough fiscal measures are enacted, the Inter-American Development Bank (IDB) has warned.
In its annual macroeconomic report released in the Bahamas yesterday, the Bank said that weak global growth, a fading demographic boom, lower commodity prices and deteriorating fiscal positions underscore the urgent need for major reformulations in fiscal policies.
Most countries need to trim fiscal spending. However, the report argues against cutting capital investments but rather undertake more fundamental reforms.
“Fiscal adjustments are never easy,” said IDB Vice President Santiago Levy. “Many countries are in the difficult position of having to act now or face more painful adjustments later on. The good news is that there is room to increase spending efficiency and rebalance fiscal policy to improve growth and protect the many social gains that have been achieved over the past decade.”
Titled ‘Time to Act: Latin America and the Caribbean Facing Strong Challenges’, the report notes that commodity prices have returned to their levels of the 1990s and are unlikely to bounce back anytime soon.
The region will experience flat to slightly negative growth in 2016.
Besides lower commodity prices, Latin America and the Caribbean region faces a demographic shock, too. An ageing population and other demographic trends mean that in 2011-2020 the increase in the employment share may only contribute 0.6 per cent to growth rather than 2 per cent in the 2000s – a potential loss of 1.4 per cent.
The upshot is that in the post-commodity boom period of 2014-2020, average annual growth is expected to be 1.7 per cent, far below the 4 per cent registered during the exceptional commodity boom of 2003-2013.
“Most forecasts predict only moderate increases for commodity prices” said Andrew Powell, IDB’s Principal Economic Advisor and the lead author of the report, “but we should note that commodity prices are virtually impossible to predict. Countries need to find better ways to manage commodity price uncertainty”.
There are additional downside risks. According to IDB calculations, for every 1 per cent in slower growth in China reduces growth in Latin America and the Caribbean by 0.6 per cent. Every one per cent reduction in the growth of the US economy trims additional 1.5 per cent off growth in Latin America and the Caribbean. “Adding China and the US shocks together will delay the region’s recovery by one year,” said Ruiz.
Some countries saved and can now smooth the transition to lower-commodity prices. However, several countries increased fiscal spending in response to the 2009 recession and then failed to reverse the increases as the recession receded.
Central America and the Caribbean countries are benefitting from lower oil prices and the US economic recovery but several countries still require fiscal adjustment to keep debt from rising.
The report analyzes announced fiscal budgets of 15 countries. Revenue is expected to increase 1.1 per cent while cuts amounted to 1.7 per cent, of which one percentage point comes from reductions in capital expenditures, which will impact future growth.
There is an opportunity to rebalance spending in favor of public investment such as maintenance and infrastructure repair programs, according to the IDB. It said developing nations should invest at least 5 per cent of GDP in infrastructure to boost growth. Over 2008-2013, the average for 16 countries in the region was 3.7 per cent of GDP.
According to the Bank, better infrastructure will also help improve the region’s export performance, something that can be further helped by deepening regional integration to increase scale and allow firms to compete in global markets.
The report details fiscal reforms in four countries – Jamaica, Honduras, Mexico and Chile – that promote sustainability over the longer term.
The report also recommends trimming current spending by better targeting subsidies on gasoline, electricity and public transportation, which tend to leak to higher-income households. Targeting in conditional cash transfer programs can also be improved. Low international oil prices are an opportunity to levy more taxes on gasoline.
The IDB said there is also considerable space to improve efficiency, particularly in education and health, which tend to account for a large proportion of expenditure.

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