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Don’t Expect Miracles From the Multilaterals

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First appeared at Americas QuarterlyWith Latin America and the Caribbean potentially facing years of difficulties due to the pandemic and related economic crises, attention has shifted to what multilateral institutions like the International Monetary Fund (IMF) might do to help. There’s no doubt they can play a crucial role in preventing another lost decade in the region. But these institutions will also face limitations because of capital constraints and other factors. The need is clearly acute. Latin America and the Caribbean remains the epicenter of the global pandemic, currently accounting for more than 43% of global deaths after a surge in COVID-19 fatalities in Brazil, Mexico and several other countries in the region. And GDP declines in the second quarter of 2020 have revealed how

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Don’t Expect Miracles From the Multilaterals

First appeared at Americas Quarterly

With Latin America and the Caribbean potentially facing years of difficulties due to the pandemic and related economic crises, attention has shifted to what multilateral institutions like the International Monetary Fund (IMF) might do to help. There’s no doubt they can play a crucial role in preventing another lost decade in the region. But these institutions will also face limitations because of capital constraints and other factors.

The need is clearly acute. Latin America and the Caribbean remains the epicenter of the global pandemic, currently accounting for more than 43% of global deaths after a surge in COVID-19 fatalities in Brazil, Mexico and several other countries in the region. And GDP declines in the second quarter of 2020 have revealed how strong the impact of COVID-19 has been on the region’s economies.

As the last-resort liquidity provider, the IMF has so far doubled access to emergency funding, and provided more than $5 billion of total financing to 17 countries in the Caribbean, Central and South America mainly through its Rapid Financing Instrument (RFI).

But when it comes to full-fledged financing deals, one must distinguish between three country categories.

A first tier includes countries that display strong balance sheets both on fiscal and balance-of-payment dimensions and have access to the Flexible Credit Line facility — designed not to be withdrawn except in extreme circumstances — that serves as positive stamp and a low-cost insurance. Mexico, Colombia and now Chile and Peru are in this category. This precautionary lending line was expanded to $107 billion.

A second category includes countries that were already facing external finance difficulties prior to COVID-19, like Argentina, Ecuador, Honduras and Jamaica. Argentina just restructured $65 billion in debt held by private creditors. Now it faces renegotiation of its $70 billion debt with multilateral institutions, including $44 billion to the IMF. The only possibility is a new roll-over program, which Argentina has already requested.

Ecuador has also returned to the IMF after its own debt restructuring with private creditors, while Honduras and Jamaica have recently reached agreements with the Fund. It is noteworthy that the IMF agreement with Jamaica accepted a reduction in its primary surplus as a counterpart to higher public social spending. Those are clear changes from past practices.

Then there is a third cohort of countries with some that are already trying package negotiations, and others that have not so far needed IMF support. As the pandemic and the economic crisis are still unfolding, we are likely to see some of the members of this cohort joining the second tier.

Multilateral and regional development banks, in turn, have all sped up their assistance and disbursements for countries to spend on health and social protection systems, making money arrive faster, among other ways, by approving immediate disbursement projects. For some countries that did not have access to the IMF’s emergency facilities because of lack of a minimum agreement, the banks were the only resource immediately available.

However, while the IMF has some remaining additional lending space, development banks must deal with limitations because of capital constraints. Already reflecting such limitations, the IDB prioritized the poorest countries in the region. A capital increase of the World Bank was agreed in 2018 but not implemented yet. In turn, a campaign for an increase of the IDB’s capital is expected after its presidential election this Saturday.

For the next year, however, it will get harder for multilateral banks to maintain or expand the disbursement volume. That is unfortunate given their relevance as both a source of long-term finance to support the economic recovery in Latin America and the Caribbean and as a cross-country pollinizer of knowledge through their operations.

No one-size-fits-all

COVID-19 has been a tragedy for the region, and not only for the human loss. Income concentration and higher public debts will be part of its legacy. And it left naked the region’s shortcomings on public health expenditures, degrees of formalization of labor occupation, lack of digitalization of government functions and others.

The overall gloomy picture contains a diversity of country conditions — which means the support from multilateral institutions must vary accordingly.

Latin America as a whole is expected to suffer a GDP downfall of something above 8.5% in 2020, only partially recovered by a positive 4% average growth rate next year. It is worth recalling that the shrinking of the per capita income in the region follows a period of lackluster growth. The IMF’s World Economic Outlook update in June showed Latin America as the worst economic performer of all developing countries’ regions and that is not expected to change in the forecasts to be released in October.

Among the largest economies, Argentina, Mexico and Peru are poised to exhibit two-digit GDP declines this year, followed closely by Ecuador, while projections for Brazil, Chile and Colombia show negative growth rates in the range of minus 5% to minus 7.5%. Uruguay is the only country in this group expected to recover its 2019-level GDP by the end of 2021. Venezuela is a tragedy apart.

Such differences reflect a range of factors, from domestic conditions prior to the virus to how the COVID-19 global shock affected them, and the different policy responses. Countries have taken different approaches to the pandemic, from “let it follow its course” (Mexico, Nicaragua) to stringent mobility restrictions (Colombia, Chile and Peru), and the half-hearted and uncoordinated local shutdowns in Brazil. And many are already planning or executing re-openings, while infections and deaths are declining but still at a slow pace.

Economic shocks from abroad also affected countries differently. Oil exporters felt the impact of the barrel’s price downfall, while Brazil and Argentina have benefited from China’s resilient demand for agricultural goods. While falling tourism arrivals hit the Caribbean, remittances were less disappointing for Central America and others, helped by the U.S. government income transfer to its residents.

Policies of “flattening the recession curve” – including income transfers to citizens, credit to companies, etc. – have played a role, mitigating local shocks at the cost of raising public debt. Brazil and Peru had the largest schemes of income transfers to citizens, while Chile prioritized credit to firms and Mexico opted for neither.

In Brazil, the resources transferred to 67 million citizens as an “emergency aid” in the first half of the year outweighed in value the whole decline in wages, a major factor behind the less-than-expected economic recession in the period. But debt to GDP is forecast to reach levels close to 95% at the end of the year. While the federal government managed to cross the storm by resorting to short-term funding, fiscal challenges will be taller at the end of the crisis period.

Despite such a variety of country situations, they all face the possibility of a new lost growth decade ahead. Tackling chronic problems in infrastructure, education, inequality, governance and security will be of the essence, while coping with the immediate COVID-19 legacy. Re-strengthening multilateral banks’ capital structures would be of great help.

ABOUT THE AUTHOR

Don’t Expect Miracles From the Multilaterals

Otaviano Canuto is a senior fellow at the Policy Center for the New South, a nonresident senior fellow at the Brookings Institution, and principal of the Center for Macroeconomics and Development. He is a former vice-president and a former executive director at the World Bank, a former executive director at the International Monetary Fund and a former vice-president at the Inter-American Development Bank. Contact: [email protected]

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