US financial volatility could slow down remittances in 2008 -Regional Economic Outlook

The outlook for Latin America and the Caribbean region remains robust but external shocks especially from the United States due to financial turbulence there could impact remittances in 2008.

Officials from the International Monetary Fund (IMF) on Wednesday morning at Le Meridien Pegasus Hotel presented the Regional Economic Outlook published in November to a gathering of public and private officials.

Deputy Director Jose’ Fajgenbaum of the Western Hemisphere Department of the IMF said that the Caribbean economic outlook remains robust, with expansion driven by consumption and investment.

The fiscal and current surpluses reflect reforms from the 1990s along with improved policy frameworks and continuing financial sector reforms and improved corporate fundamentals. But the external environment is subject to downside risk, he said, with weak external growth, possible and further tightening of the US and global credit market, volatile commodity prices and a slow down in remittances which may be more sensitive to the US cycles.

Shift to biofuels

Inflation was said to have crept up in the region, partly reflecting food price pressures and increasing oil prices which on average has increased by 20%, said the IMF. The increasing demand in India and China for food and the shift to biofuels has taken lands used to grow food, pushing prices up. The deputy director also said that imports are catching up rapidly with current account surpluses and some countries with surpluses will see this turn into deficits next year.

The IMF had projected inflation of 8% for Guyana in 2007, but the Finance Ministry has already revised this to over 9%, after inflation reached 13.3% in July; but the remaining monthly reports for 2007 have not been issued.

The IMF is projecting a growth of 4% for the Caribbean in 2007 and in 2008, and for Guyana, 2007 growth is projected at 5.5% and at 4.5% in 2008. In a perspective on the global and US economy, Fajgenbaum explained that the recent financial volatility (as a result of the meltdown in the US sub-prime mortgage market) has shaken the global economy and even though central banks have injected monies into the financial sector, liquidity remains tight and interest rates are “going up and up.” Latin America has been little affected, according to Fajgenbaum, by the financial turbulence in the US and in the international market and this was said to reflect some separation from the high yield markets in the US. The exposure to the US sub-prime market was said to be small or non-existent as compared to industrialized countries and Latin America has not faced the liquidity squeeze as in the US. The US mortgage market is worth 13% of that country’s GDP at US$2.2 trillion. Recession in the US economy was not forecast by the IMF since the labour market is strong and there is growth in wages which is sustaining consumption so far, according to the Deputy Director. “Hopefully (the) economy can withstand (the) sub-prime,” said Fajgenbaum, adding that the outlook is still difficult.

The US current account deficit is 6% – 7% of the Gross Domestic Product (GDP) and 1.5% of the global economy and is financed by debt securities. The deputy director noted that if the world economy raised doubts and did not want to finance these debt assets, this can have serious consequences on macro-economic policies around the world.

But all this turbulence has come at a time when the global economy is “quite strong,” he said, adding that world growth is expected to be 5.2% for 2007 and slowing to 4.8% in 2008.

The emerging markets of Brazil, Russia, India and China (BRICs) with growth close to 8% are contributing 49.2% of total growth, up from 34.2%, while industrialized countries have dropped from 33.8% to 18.3% in their contribution.

Financial integration

Mission Chief for the IMF in Guyana, Ana Lucia Coronel in her remarks on financial integration in the Caribbean explained that the financial sector is large but shallow and the assets of financial institutions are 150% of the regional Gross Domestic Product. The financial institutions of Guyana were also said to be 150% of GDP. There is “still some sign that calls for developing this sector,” noted Coronel. She said that very few corporate bonds are issued and traded and there is still a low stock market turnover. She reiterated that “this calls for some improvement.” The Caribbean financial market was said to be still segmented – for example, there are significant differences in prices of identical stocks in the region. The benefits of financial integration were identified as a reduction in the cost of capital and improved access to finance. Such a market, it was cautioned, will need strong oversight and regulation, since among the risks is that integration allows shocks to spread easily across borders.

Tax incentives and trade preferences

According to the mission chief, tax incentives to attract Foreign Direct Investment (FDI) are costly and it has meant foregoing 10% of GDP a year on average for the Caribbean. It was explained that tax incentives increase the administrative burden and erodes the tax base. On the other hand, the IMF is plugging sound and credible policies, infrastructure like roads and ports, strengthening institutional technical capacity, a credible judiciary and political stability.

“While globally efficient, the erosion of preferential trading arrangements will lower the income of the countries that had been enjoying special access,” according to the report. IMF staff calculations suggest, for example, that the value of implicit assistance provided by the EU banana regime averaged about 8% of GDP annually for the Windward Islands of the Caribbean (except Grenada) and close to 3% of GDP for Belize and Suriname during 1977-2007.

Similarly, implicit assistance from the EU sugar regime has averaged nearly 10% of GDP annually for Guyana and 2%-4.5% of GDP for Belize. “For these reasons, the erosion of EU trade preferences has been, and will continue to be, very costly for some Caribbean countries, with significant adverse effects on the trade balance, output, and the overall fiscal balance,” said the report. Meanwhile Finance Minister Dr. Ashni Singh in his brief observations before the presentations admitted that the US sub-prime market has implications for the re-pricing of risk and access to financial markets. This, Singh said, has implications for a number of large investment initiatives on the horizon. The volatility on the commodities market had opportunities for the agriculture sector and it was important, he said, that the policy makers and the private sector reflect on these opportunities.

Small states, the minister noted, face peculiar challenges and in addition to the analytical work that the IMF conducts, adequate attention and due regard should be given to the peculiarities of small states. (Nicosia Smith)