Since 2020, the economies of the world have been hit by a series of severe shocks, most dramatically the COVID-19 pandemic and the Russian invasion of Ukraine. As a result, after growing around 3.9% last year, Latin America and the Caribbean region now faces considerably lower growth projections for 2023, with private forecasters predicting growth at around 1%. It also confronts a host of problems, including fiscal deficits, excessive levels of debt, and soaring inflation. Add to that elevated domestic and global interest rates, increased global financial risks, as well as depressed global demand, and the challenges for this and subsequent years are substantial.
The challenges include the nearly 18% of the population living on less than around $3 a day, with poverty levels greater than a decade ago and inequality climbing. Fiscal deficits and debt should be reduced. And there is the need to spur long-term growth beyond its estimated 2%—too low to meet the development goals of most countries in the region.
A New Macroeconomic Report
To help the region address these issues, the IDB recently released its 2023 Latin American and the Caribbean Macroeconomic Report with an in-depth look at monetary, fiscal, labor market and financial areas. The report includes proposals for policy actions to mitigate the impact of current shocks and set up conditions for greater economic growth and social equity. One goal of fundamental importance is fiscal consolidation: the process of bringing down fiscal deficits. This can be achieved in part through the strengthening of fiscal institutions and the use of fiscal rules, which seek to curb expenditure and anchor debt. Governments made considerable efforts towards fiscal consolidation in 2022 after the ballooning deficits created by record pandemic spending, and the primary deficit in 2022 is estimated at only 0.4% of GDP. With slow growth expected in 2023, however, fiscal situations could deteriorate.
Preventing that from happening is essential. It is key to bringing gross debt below the 64% of GDP where it stood at the end of 2022 to prudent levels (estimated at 54% of GDP). It is fundamental to reducing sovereign credit risk, cutting financing costs, lowering sovereign interest rates, and creating more space for monetary policy. And it will help ensure the fiscal space to support much needed policies that can advance economic and social development.
To that end, expenditure efficiency must improve. There should be better targeting of transfers and subsidies and a higher quality of public investment, including in the essential area of infrastructure. Such policies can be progressive, helping to provide a safety net for the poor, and boosting productivity for stronger long-term growth. Wage adjustments must also be done carefully. They should be targeted to expected, rather than current, inflation, so as to reduce the risk of future increases in inflexible spending.
On the revenue side, several countries are planning tax reforms over the next two or three years. These should aim to expand the tax base and cut back on tax evasion and tax avoidance. They should also make the tax structure as progressive as possible, potentially through measures like a negative income tax.
The Problem of Inflation
Inflation, particularly food inflation, reached its highest level in more than 20 years in 2022, spurred by both stronger aggregate demand from the post-pandemic recovery and global commodity price hikes caused by Russia’s invasion of Ukraine. As a result of aggressive monetary policy responses, international and domestic rates rose, and inflation in most countries of the region has started to show signs of slowing. But it will remain above target until at least 2024. This creates serious challenges for central banks which must try to keep inflation expectations anchored and maintain a tight monetary stance until expectations align with targets. In this pursuit, monetary policy needs to rely on consistent fiscal and economic policies, with the independence of central banks continuing to be crucial.
Most countries have enjoyed good access to external financing from private and multilateral sources since the darkest days of the pandemic. But financing costs have risen in the second half of 2022, affected by higher inflation, higher international and domestic interest rates, higher debt ratios and more volatile financial markets. As the region’s economies decelerate, their financing needs may diminish, reducing their exposure to sudden stops in capital markets. Nonetheless, governments must consolidate their fiscal positions and tackle liability dollarization to minimize vulnerabilities. Financial supervisors should also enhance the use of stress tests to address weaknesses in financial institutions and produce detailed plans to manage them.
Setting the Stage for Renewed Growth
The year 2023 will be a difficult one of adjustment, both regionally and globally. We hope that these policies taken together—aimed at containing inflation, avoiding economic contraction, and creating the conditions for productivity growth in the medium and long term—will prove effective in reducing poverty and improving the wellbeing of all the region’s citizens. There are undoubtedly big risks: inflation continues to be elevated; it is difficult to know what will happen with the war in Ukraine; and lower-than-expected global growth and higher-than-expected financing costs could prove troublesome for the region. If policies are implemented to contain global shocks, however, the stage could be set for a faster and better recovery when global conditions normalize.