1. Latin America Outlook with special reference to Argentina and Chile Guillermo A. Calvo Research Department Inter-American Development Bank Washington, April 11, 2001

2. 1 Outline of the Presentation â The Big Picture â Forecasts â Understanding Argentina in the light of Chile

3. The Big Picture

4. â Slowdown in output and investment â Linked to rising interest rate spreads â Spreads have increased by more than 350 basis points since September 1997 â Impact of US recession on capital flows: Õ lower Foreign Direct Investment Õ higher portfolio flows Õ but impact is not serious

5. 4 *Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela Deceleration Stalling? RecoveryRecession ? Seasonally Adj. GDP, Annualized Quarterly Growth Rate -6% -4% -2% 0% 2% 4% 6% 8% 10% 1996.I 1996.II 1996.III 1996.IV 1997.I 1997.II 1997.III 1997.IV 1998.I 1998.II 1998.III 1998.IV 1999.I 1999.II 1999.III 1999.IV 2000.I 2000.II 2000.III Growth Rate LAC’s output recovery

6. 5 *Includes Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela DecelerationRecoveryRecession s.a. Investment, Annualized Quarterly Growth Rate -30% -20% -10% 0% 10% 20% 30% 1996.I 1996.II 1996.III 1996.IV 1997.I 1997.II 1997.III 1997.IV 1998.I 1998.II 1998.III 1998.IV 1999.I 1999.II 1999.III 1999.IV 2000.I 2000.II 2000.III Growth Rate LAC’s investment recovery ?

7. 6 Deceleration LA Eurobond Index Spread, Quarterly Averages 200 300 400 500 600 700 800 900 1997-I 1997-II 1997-III 1997-IV 1998-I 1998-II 1998-III 1998-IV 1999-I 1999-II 1999-III 1999-IV 2000-I 2000-II 2000-III 2000-IV LAC’s business cycle is closely linked to interest rate spreads RecoveryRecession?

8. 7 LAC Spreads have consistently ratcheted up 0 100 200 300 400 500 600 700 30 Sep.9731 Jul. 9810-Apr-01 284 186 470 650 180 366 Average includes Argentina, Brazil, Colombia, Mexico, Uruguay y Venezuela

9. 8 Impact on capital flows to LAC of a 1% expansion in US growth and a 1% reduction in US interest rates 1.69 0.90 0.03 2.60 0.0 0.5 1.0 1.5 2.0 2.5 3.0 US GrowthUS Interest Rates US and LAC FDI Portfolio Flows

10. 9 In a “typical” US recession â Output falls 3.3% â Real interest rates fall 1.4%

11. 10 Net impact on emerging markets growth rate of a “typical” US recession -0.25% -0.38% -1.60% -1.80% -1.60% -1.40% -1.20% -1.00% -0.80% -0.60% -0.40% -0.20% 0.00% LACDeveloping CountriesIndustrialized Asia Thus, if the US catches a cold LAC will just sneeze!

12. Market Forecast

16. Understanding Argentina in the Light of Chile

17. 16 Equals in Bust, Unequals in Recovery â Similar recession Õ Both countries suffered from similar Sudden stop, and sharp growth slowdown in 1999. â However, recovery in 2000/1 has been much faster in Chile.

18. 17 Why did Argentina Perform Worse than Chile in the Recovery? Alternative Hypothesis: Political Factors? Terms of Trade? External Financial Constraints? Exchange Rate Regime? Degree of Openness? Fiscal Performance and Level of Public Debt?

19. The Anatomy of the Recession/Recovery Cycle: GDP (s.a. GDP, 1998.II=100) Chile Argentina

20. The Anatomy of the Recession/Recovery Cycle: the Full Picture (s.a. components of demand, 1998.II=100) exports rest of domestic demand investment Chile exports consumption Argentina investment

21. Terms of Trade (1997-II = 100) Chile Argentina

22. Private Capital Flows (4 quarters, millions of US dollars) Chile Argentina

23. Chile Argentina Real Exchange Rate (vis a vis the U.S. dollar, jan 97 = 100)

24. Chile Argentina Inflation (CPI, 12 month rate)

25. Degree of Openness

26. The Track Record on Fiscal Discipline (Fiscal Surplus, % of GDP) Chile Argentina BoomRecessionPost-recession

27. Public Debt Levels at the Start of the Recession Chile Argentina

28. 27 Why did Argentina Perform Worse than Chile in the Recovery? Tentative Conclusions: Exchange Rate Regime and Public Sector Nominal Stickiness. Degree of Openness Fiscal Performance and Level of Public Debt

29. 28 Aggravating Factor for Argentina: Mercosur â Brazil has the option of devaluing its currency â thus, FDI aimed at Mercosur is more likely to go to Brazil, making it more unlikely for investment to recover in Argentina.

30. The Cavallo Plan

31. Short Run Leadership and political consensus Higher taxes (on checks) to promptly correct fiscal imbalances and meet IMF targets Expansive monetary policy (lower liquidity requirements). Higher tariffs and tax exemptions to reactivate selective sectors Long Run Deregulation Expenditure rationalization and tax reductions for all sectors Open up the economy to trade beyond Mercosur

32. 31 Possible Trouble Spot: Loose Money â Expanding domestic credit may result in lower international reserves, â which increases the vulnerability of the financial sector, â results in higher interest rate spreads, â lower investment and growth.

33. 32 Currency Basket â It may be good for trade, â but it increases financial vulnerability if the financial sector continues being highly dollarized. â Moreover, it may generate excessively high dollar/peso exchange rate volatility. â Raising the issue at present may cause confusion, and suspicion that it might result in devaluation vis-a-vis the dollar, â which may result in a greater loss of bank deposits.

34. 33 Argentina: Bank Deposits

35. 34 Argentina: International Reserves

36. Latin America Outlook with special reference to Argentina and Chile Guillermo A. Calvo Research Department Inter-American Development Bank Washington, April 11, 2001