1. All That Glitters May Not Be Gold: Debating Key Issues May 8 th, 2008 Prepared for Presentation at the XXVII Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC. This Presentation is based on the IADB Research Department report “All That Glitters May Not Be Gold: Assessing Latin America’s Recent Macroeconomic Performance”, coordinated by Alejandro Izquierdo and Ernesto Talvi

2. OBJECTIVES  To present a regional macroeconomic perspective

3. -15% -10% -5% 0% 5% 10% 15% Dic-91Dic-92Dic-93Dic-94Dic-95Dic-96Dic-97Dic-98Dic-99Dic-00Dic-01Dic-02Dic-03Dic-04Dic-05Dic-06 Argentina Brazil Chile Colombia Mexico Peru Venezuela Beginning of Current Boom Tequila Crisis Russian Crisis Cumulative R 2 1st PC 2nd PC PC= Principal Component 0.42 0.64 Synchronization of Economic Fluctuations in Latin America (Real GDP, average annual growth)

4. OBJECTIVES  To evaluate macroeconomic performance and fundamentals internalizing the impact of external factors  To present a regional macroeconomic perspective

5. External Conditions for Latin America *World-7 includes G-3 (EU-15, Japan and USA) and EM-4 (China, India, Korea and Russia) 4.8% World Production (World-7 GDP Index, Annual Variation, Weighted by PPP adjusted GDP * ) 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06 Mar-07 Jul-07 Average 91-97 299 264 External Financial Conditions (EMBI spread, basis points) 100 200 300 400 500 600 700 800 900 1000 Oct-02 Mar-03 Ago-03 Ene-04 Jun-04 Nov-04 Abr-05 Sep-05 Feb-06 Jul-06 Dic-06 May-07 Oct-07 Mar-08 984 548 EMBI+ Non-Latin EMBI Average 91-97 200 364 Average 91-97 Oi l Non-Oil Commodity Prices (Index of Oil and Non-Oil Commodities, Oct-02=100) 65 115 165 215 265 315 365 Oct-02 Abr-03 Oct-03 Abr-04 Oct-04 Abr-05 Oct-05 Abr-06 Oct-06 Abr-07 Oct-07

6. OBJECTIVES  To stimulate a constructive policy debate  To evaluate macroeconomic performance and fundamentals internalizing the impact of external factors  To present a regional macroeconomic perspective

7. Growth Performance

8. LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. 03-07 Average: 5.8% 74-06 Average: 3.2% Observed GDP Growth (LAC-7, GDP Annual Growth) 90s BoomCurrent Boom Russian Crisis 91-97 Average: 4.6% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 199119931995199719992001200320052007 *Izquierdo, Romero and Talvi (2007) Forecast for GDP: 2003 – 2006 * (LAC-7, Values in logs) 4.55 4.60 4.65 4.70 4.75 4.80 4.85 Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 GDP at long run average growth Observed GDP 90% confidence interval Predicted GDP with Observed External Factors Growth Performance in Latin America ‘This Time Is Different’‘All That Glitters May Not Be Gold’

9. 03-07 Average: 5.8% 74-06 Average: 3.2% Growth Performance in Latin America ‘All That Glitters May Not Be Gold’ World: 5.0% 2%3%4%5%6%7%8% 9% Latin America Africa Emerging Europe Middle East Ex USSR Emerging Asia Growth in EMs: A Comparative Perspective (Real GDP, 2003-2007 annual growth) LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. ‘This Time Is Different’ 03-07 Average: 5.8% 74-06 Average: 3.2% Observed GDP Growth (LAC-7, GDP Annual Growth) 90s BoomCurrent Boom Russian Crisis 91-97 Average: 4.6% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 199119931995199719992001200320052007

10. 90s Boom Russian Crisis Current Boom LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. 0,11 0,12 0,13 0,14 0,15 0,16 0,17 0,18 199019921994199619982000 2002 20042006 Investment to GDP Ratio (Private investment, constant prices, in %) Investment in Latin America Investment: 90’s vs. 00’s Expansion (Private investment, LAC-7, Year 0 = 100) * Deflated by capital price indexes. The current expansion year 0 is 2002 and the 90s expansion year 0 is 1990. 95 105 115 125 135 145 155 165 175 01234 Current Expansion 90s Expansion 16.5% 17.0% ‘This Time Is Different’‘All That Glitters May Not Be Gold’

11. 90s Expansion Current Expansion Productivity in Latin America ‘This Time Is Different’‘All That Glitters May Not Be Gold’ 90’s BoomRussian CrisisCurrent Boom Productivity: 90’s vs. 00’s Expansion (Total Factor Productivity, LAC-7, Year 0 = 100*) 99 101 103 105 107 109 111 113 01234 *The current expansion year 0 is 2002 and the 90s expansion year 0 is 1990. Annual Variation LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Total Factor Productivity Index Total Factor Productivity (1990=100 and annual variation in %) -3% -2% -1% 0% 1% 2% 3% 4% 5% 1990 19921994199619982000 200220042006 98 102 106 110 114 118 122 126 Productivity Growth Productivity Index 90-06 Average Growth: 1.0%

12. Productivity in Latin America ‘This Time Is Different’‘All That Glitters May Not Be Gold’ LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Productivity Growth by Region (Total Factor Productivity, 1990-2006; annual rate) 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% Emerging AsiaEmerging Regions* Advanced Economies LAC-7 * Excluding LAC and China 3.0% 1.8% 1.0% 90’s BoomRussian CrisisCurrent Boom Annual Variation LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Total Factor Productivity Index Total Factor Productivity (1990=100 and annual variation in %) -3% -2% -1% 0% 1% 2% 3% 4% 5% 1990 19921994199619982000 200220042006 98 102 106 110 114 118 122 126 Productivity Growth Productivity Index 90-06 Average Growth: 1.0%

13. QUESTIONS FOR DISCUSSION: GROWTH PERFORMANCE  From your country’s perspective, do you consider that external factors play an important role in explaining current growth performance?  Our evidence suggest that even if the favorable external environment persists, the effect on growth will probably dissipate. Do you think that external conditions have a level or growth effect on economic activity?  Has the trend growth rate in your country increased above its historical average? If so, can the dynamics of investment and productivity during the current expansion support higher trend growth rates in your country?  From a growth perspective, does your country fit the regional pattern? Why yes or why not?

14. Fiscal Policy

15. Observed and Structural Fiscal Balances * -4% Chile (% of GDP) -2% 0% 2% 4% 6% 8% 10% 19911993 1995 1997 1999200120032005 Beginning of Current Boom Russian Crisis (Structural balances computed by applying the “Chilean Fiscal Rule” to other LAC-7 countries) Structural Observed LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). Latin America (LAC-7, % of GDP) Beginning of Current Boom Russian Crisis -5% -4% -3% -2% -1% 0% 1% 2% 3% 19911993199519971999200120032005 *Izquierdo, Ottonello and Talvi (forthcoming). -4.1% ‘All That Glitters May Not Be Gold’ (Structural) 1.0% (Observed) ‘This Time Is Different’

16. Structural Fiscal Balance 0,0%0,0% Fiscal Balances by Country (Dec-06, in % of GDP) LAC-7 Observed 1,1% 0,6%0,6%Argentina1,8%-2,2%-2,2% -3,3%Brazil-3,0%-4,9%-4,9% 6,1%6,1%Chile7,7%1,0%1,0% -1,2%-1,2%Colombia-0,5%-0,1%-0,1% -0,5%-0,5%Mexico0,1%-4,5% 0,6%0,6%Peru2,1%2,1%-1,8% -2,0%Venezuela-0,2%-16,0% Traditional HP Filter* “Chilean” Fiscal Rule** Fiscal Balance -4,1% LAC-6 is the simple average of Argentina, Brazil, Colombia, Mexico, Peru and Venezuela. LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *HP = Hodrick Prescott; lambda = 1600 (quarterly data). **Izquierdo, Ottonello and Talvi (forthcoming). -1,0%LAC-60,0%0,0%-4,9%

17. Fiscal Revenues and Expenditures * Beginning of Current Boom Russian Crisis Beginning of Current Boom Russian Crisis Fiscal Expenditures Fiscal Revenues Adjusted Revenues Fiscal Expenditures Fiscal Revenues Chile 85 135 185 235 285 335 19911993199519971999200120032005 ( Fiscal Revenues, Mar-91 = 100) Latin America ( LAC-7, Fiscal Revenues, Mar-91 = 100) 85 135 185 235 285 335 19911993199519971999200120032005 LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *Izquierdo, Ottonello and Talvi (forthcoming). (Adjusted revenues computed by applying the “Chilean Fiscal Rule” to other LAC-7 countries)

18. Beginning of Current Boom Russian Crisis 85 135 185 235 285 335 19911993199519971999200120032005 Fiscal Expenditures Fiscal Revenues Adjusted Revenues LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *Izquierdo, Ottonello and Talvi (forthcoming). Increase in Public Expenditures (in % of increase in fiscal revenues, 2003-2006) 0%20%40%60%80%100% Chile Argentina Peru Colombia Mexico Brazil Venezuela LAC-7: 77% (LAC-7, Fiscal Revenues, Mar-91 = 100; Adjusted Revenues following the “Chilean Fiscal Rule”) Fiscal Revenues and Expenditures* Revenue Bonanza and Government Expenditure in Latin America

19. Public Investment Expenditure 17.2% 13.1% 14.0% 10% 11% 12% 13% 14% 15% 16% 17% 18% 199820022007 ( LAC-7, in % of Primary Expenditure) Beginning of Current Boom Russian Crisis 85 135 185 235 285 335 19911993199519971999200120032005 Fiscal Expenditures Fiscal Revenues Adjusted Revenues LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. *Fiscal balances include: Public Sector (Mexico), Non-Financial Public Sector (Argentina, Colombia, Peru), General Government (Brazil), Central Government (Chile, Venezuela). *Izquierdo, Ottonello and Talvi (forthcoming). (LAC-7, Fiscal Revenues, Mar-91 = 100; Adjusted Revenues following the “Chilean Fiscal Rule”) Fiscal Revenues and Expenditures*

20. Observed and Structural Public Debt * (LAC-7, in % of GDP) 30% 35% 40% 45% 50% 55% 19901991199219931994199519961997199819992000200120022003200420052006 Current Boom90s Boom Russian Crisis LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. 52% 37% 33% 50% (Observed Debt) ‘This Time Is Different’ *Izquierdo, Ottonello and Talvi (forthcoming). 47% 44% (Structural Debt) ‘All That Glitters May Not Be Gold’

21. QUESTIONS FOR DISCUSSION: FISCAL POLICY (I)  Do you think having explicit structural fiscal balance targets à la Chile could be useful for your country? If so, what are the difficulties in implementing such a rule?  From a fiscal policy perspective, does your country fit the regional pattern? Why yes or why not?  Do you consider the structural fiscal balance a relevant concept for evaluating the stance of fiscal policy? If so, is a ‘Chilean-Style’ smoothing (i.e. saving the boom to a large extent) relevant for your own country?

22. QUESTIONS FOR DISCUSSION: FISCAL POLICY (II)  Should structural fiscal balance targets be established taking into account the target levels of structural public debt? How should these target levels be determined? Is the 20% of GDP rule of thumb a valid one for your country?  Assuming that we are in the presence of a permanent improvement in the external environment, which is the optimal way of assigning the increase in fiscal revenues in your country: increase current expenditure, increase capital expenditure, debt reduction or reduction in tax rates?

23. Public Debt Management

24. LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Debt Riskiness (LAC-7, Risky Debt in % of Total Domestic Debt*) 50 55 60 65 70 75 80 19911993199519971999200120032005 Mutation in Debt Riskiness: Two Revealing Examples (Risky Debt in % of Total Domestic Debt**) **For Mexico, risky debt is computed by taking the ratio of Tesobonos (denominated in US dollars) to total domestic public debt. The latter includes Cetes, Bondes Ajusta Bonos and Tesobonos. For Brazil, risky debt is constructed by taking the ratio of the sum of domestic public debt indexed to the Selic plus exchange-rate-indexed debt over total domestic public debt. 5% 28% 67% 90% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Dec-93 Nov-94 Mexico Aug-97 Dec-98 Brazil *Risky debt includes foreign-currency debt, short-term debt and variable interest rate debt. LAC-7 excludes Peru. Debt Composition in Latin America ‘This Time Is Different’‘All That Glitters May Not Be Gold’

25. QUESTIONS FOR DISCUSSION: PUBLIC DEBT MANAGEMENT  From a risk perspective, do you believe that changes in debt composition are a reasonable substitute for the reduction in debt levels?  Form a public debt management perspective, does your country fit the regional pattern? Why yes or why not?  How much of the change in debt composition is structural and how much due to favorable international conditions?  If so, how should debt composition targets be determined?

26. External Position

27. Capital Flows to Latin America* Russian Crisis -20 0 20 40 60 80 100 19911992199319941995199619971998199920002001200220032004200520062007 (LAC-7, Billions of US Dollars) Net Capital Flows LAC-7 is the sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. * Calvo and Talvi (2007). Russian Crisis Capital Inflows and Outflows (LAC-7, Billions of US Dollars) -20 0 20 40 60 80 100 120 140 19911992199319941995199619971998199920002001200220032004200520062007 Outflows Inflows ‘This Time Is Different’‘All That Glitters May Not Be Gold’

28. Russian Crisis Jan.91-Jun.98 Variation: 271% Jun.98-Dec.02 Variation: -15% Dec.02-Dec.07 Variation: 175% International Reserves in Latin America 174 404 *LAC-7 is is computed as the sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. International Reserves 15 65 115 165 215 265 315 365 415 19911992199319941995199619971998199920002001200220032004200520062007 (LAC-7, Billions of US Dollars*) LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. International Reserves to M2 Ratios (LAC-7, in %) Dic-93Dic-94Dic-95Dic-96 Dic-97 Dic-98 Dic-99 Dic-00 Dic-01 Dic-02 Dic-03Dic-04 Dic-05 Dic-06 Beginning of Current Boom Russian Crisis 0.30 0.35 0.40 0.45 0.50 0.55 ‘This Time Is Different’‘All That Glitters May Not Be Gold’

29. International Reserves in Latin America EA-5 is the simple average of Indonesia, Korea, Malaysia, Philippines and Thailand. 13.0 EA-5 22.1 *LAC-7 is is computed as the sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. Russian Crisis 174 404 15 65 115 165 215 265 315 365 415 19911992199319941995199619971998199920002001200220032004200520062007 Jan.91-Jun.98 Variation: 271% Jun.98-Dec.02 Variation: -15% Dec.02-Dec.07 Variation: 175% (LAC-7, Billions of US Dollars*) International Reserves ‘This Time Is Different’‘All That Glitters May Not Be Gold’

30. QUESTIONS FOR DISCUSSION: EXTERNAL POSITION (I)  Is there information available at the country level to make a sectoral analysis of the capital account?  Do you think that a sectoral perspective of the capital account offers a relevant angle for vulnerability analysis?  From a capital account perspective, does your country fit the regional pattern? Why yes or why not?

31. QUESTIONS FOR DISCUSSION: EXTERNAL POSITION (II)  Which are the effective ways of financial insurance in the absence of international risk sharing arrangements? Should reserves be acquired with genuine resources, i.e. fiscal surpluses that take into account an optimal pattern of reserve accumulation?  Do international reserves obtained by issuing monetary liabilities (including sterilization bonds) really constitute an effective insurance, available in times of sudden stops? Is reserves-to-M2 ratio a relevant indicator in a context of flexible exchange rates?

32. Latin America and the US Subprime Crisis

33. Bond Prices by Region (US High Yield and Latin EMBI Bond Price Equivalent, 23-Jul-07 = 100) 88 90 92 94 96 98 100 102 104 Jul-07 Aug-07 Oct-07 Nov-07Dec-07 Jan-08 Latin America Sep-07 Feb-08 Latin America0% US High Yield-10.8% Variation* Bond Price (in %) Spread (in bps) *23 Jul-19 Feb 105 305 Latin America’s Reaction to US Subprime Crisis

34. Bond Prices by Region (US High Yield, Latin EMBI, Asia EMBI and Europe EMBI, Bond Price Equivalent, 23-Jul-07 = 100) 88 90 92 94 96 98 100 102 104 Jul-07 Aug-07 Oct-07 Nov-07Dec-07 Jan-08 Latin America US High Yield Sep-07 Feb-08 Latin America0% US High Yield-10.8% Variation* 1.3%Asia 2.8%Emerging Europe Bond Price (in %) Spread (in bps) *23 Jul-19 Feb 105 305 90 81 Emerging Markets’ Reaction to US Subprime Crisis

35. Speculative Grade-0.3% US High Yield-10.8% Variation** 3.2%Investment Grade Bond Price (in %) Spread (in bps) **23 Jul-19 Feb 127 298 108 * Standard & Poor’s Credit Ratings prior to US subprime crisis. Speculative Grade AAA AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC SD Credit Ratings * Investment Grade Investment Grade Speculative Grade * A country with strong fundamentals is defined as a country that displays both a current account and a fiscal surplus and a country with weak fundamentals is a country that displays both a current account and a fiscal deficit. Strong Fundamentals * Weak Fundamentals * Weak Fundamentals-1.3% US High Yield-10.8% Variation** -0.2%Strong Fundamentals Bond Price (in %) Spread (in bps) **23 Jul-19 Feb 140 298 76 Bond Prices in Emerging Countries and Fundamentals (US High Yield and EMBI Bond Price Equivalent, 23-Jul-07 = 100) 87 90 93 96 99 102 105 108 Jul-07 Aug-07Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 US High Yield Emerging Markets’ Reaction to US Subprime Crisis

36. US High Yield and EMBI Bond Price Equivalent (23-Jul-07 = 100) 87 89 91 93 95 97 99 101 103 105 Jul-07 Aug-07Sep-07 Oct-07 Nov-07Dec-07 Jan-08 US High Yield Investment Grade FED Funds target rate, in % 2.5 3 3.5 4 4.5 5 5.5 Fed Funds Rate Speculative Grade Bond Prices in Emerging Countries and the Fed Funds Rate Emerging Markets’ Reaction to US Subprime Crisis and the Fed

37. QUESTIONS FOR DISCUSSION: THE US SUBPRIME CRISIS AND LATIN AMERICA  What is your interpretation of the apparently limited reaction of Latin America to the US Subprime Crisis?  Could the US Subprime Crisis create an ‘Indian Summer’ in the region? If so, what should be the policy response? Should monetary and fiscal policy be tightened?  Should we expect a Volcker-jump in interest rates once the financial crisis in the US subsides? If so, what should our countries be doing to protect themselves from that eventuality?

38. All That Glitters May Not Be Gold: Debating Key Issues May 8 th, 2008 Prepared for Presentation at the XXVII Meeting of the Latin American Network of Central Banks and Finance Ministries, IADB, Washington DC. This Presentation is based on the IADB Research Department report “All That Glitters May Not Be Gold: Assessing Latin America’s Recent Macroeconomic Performance”, coordinated by Alejandro Izquierdo and Ernesto Talvi