Latin America May See 'Deep And Persistent' Damage From Europe Crisis

03/18/2012 20:46

FOXNews: MONTEVIDEO –  While Latin American economies are expected to grow on average 3.6% this year despite the current European malaise, a more severe crisis in Europe will cause "deeper and more persistent" effects in the region, which is less prepared to deal with a downturn than during the 2008 crisis, the Interamerican Development Bank said Sunday.

The region as a whole has less monetary and fiscal room to fight the effects of a crisis in Europe, the IDB said in a report. The crisis would likely slow China output and cause a dip in commodity prices, and would inevitably hurt the U.S. as well, reversing recent signs of an improving economy.

Unlike the previous crisis, in which Central American and Caribbean countries more closely linked to the U.S. suffered the worst effects while South American countries passed through almost unscathed, this crisis would hurt the region as a whole, the bank said.

"The pattern of global demand and associated risks has once again changed," the IDB said in the report. "Uncertainty is high and the risk of another crisis, this time emanating from Europe, has risen."

Strong capital inflows in recent months create another problem, the bank noted. Looking at past occurrences of such strong inflows, the bank found that there is a 51% chance that the inflows will be followed by a recession, a banking crisis, or both. The likelihood of that happening, however, depends greatly on whether or not countries have a quality banking supervision system. The type of inflow also matters, the IDB said, with heavy portfolio and banking inflows often causing crises.

The region has also become overly dependent on commodity exports, the bank reported. A downturn in Europe would surely curb Chinese demand, taking its toll on prices of raw materials. But the bank added that grain prices would be less affected than metals prices.

In the face of an eventual downturn, countries are less able to respond with fiscal and monetary stimulus, according to the report. In the case of monetary stimulus, countries are starting with lower rates than ahead of the 2008 crisis--indeed, some central banks were raising rates after the 2008 crisis started to counter the effect of high commodity prices. In the case of fiscal policy, many countries put in place countercyclical measures, but then failed to remove them when conditions improved, the bank said. That has eroded their ability to put in place stronger fiscal stimulus this time around.

Finally, a crisis raises the risk of Latin American subsidiaries of European banks reining in lending, the bank said.

Though most of the banks are locally funded, "European banks are deleveraging, and capital is considered by home supervisors on a consolidated basis, suggesting that adjustments in capital levels may yet imply lending restrictions," the IDB wrote.

As a whole, Latin America has taken steps to reduce the risk of a crisis, improving financial supervision, building up currency reserves and putting in place macroprudential measures. Their fiscal health is also less skewed to overseas debt and with fewer liabilities.

But "if the situation in Europe worsens, it is difficult to see the region escaping so lightly" as it did in 2008, the bank wrote.

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