Is the Caribbean still in need of economic reform?
Output in Latin America and the Caribbean is estimated to have contracted 1.4 per cent in 2016, the second consecutive year of negative growth. This weakness was due to the combined effects of low commodity prices and domestic economic challenges in large economies.
In South America, where a large share of countries are commodity exporters, GDP growth contracted 2.8 per cent. Growth in Mexico and Central America slowed to 2.3 per cent, while growth in the Caribbean decelerated to 3.2 per cent. Regional growth is projected to recover, reaching 2.6 per cent in 2019, as domestic constraints loosen and fiscal consolidation is completed.
Global headwinds, such as policy uncertainty in the United States and subdued growth among other major trading partners, will weigh on economies across the region, at least in the near term. However, commodity prices are projected to stabilize and to gradually recover, providing modest relief for regional commodity exporters with improved terms of trade and increased fiscal and export revenues.
Within the region, several countries are implementing fiscal consolidation and reforms. As these are completed, economies will be on a better fiscal footing, with space for urgently needed public investment projects to promote growth in the medium term. Economic activity will be supported by exports, which are still benefiting from a competitive edge derived from prior depreciations. These competitiveness effects will be partially offset by weak growth in advanced economies.
Latin America and Caribbean is on the verge of recovery after two years of recession. Given low growth among the region’s major trading partners, and with commodity prices stabilizing around current lows, supporting a cyclical recovery is an immediate high-priority challenge. For the medium term, economies must focus on structural reforms to rebuild policy buffers, to reduce dependence on primary commodities, and to increase investment. Such reforms will harness advances in productivity as the engine of growth.
The regional outlook assumes a bottoming out and recovery of the South American economy by the first half of 2017. While it will be important for governments to nurture and support the nascent recovery, most governments in South America have limited policy space for counter-cyclical policies. Revenues have deteriorated sharply over the past couple of years, due to weak economic growth and depressed commodity prices.
Monetary policy continues to be constrained by a combination of weak growth, elevated inflation, and volatile currencies, despite some recent easing of inflationary and exchange rate depreciation pressures. A carefully crafted fiscal-monetary policy mix will be necessary to provide a conducive environment for stronger domestic demand, especially in light of larger downside risks to global growth.
Fiscal adjustment often entails slashing investment to key areas such as infrastructure. While this policy path quickly eases fiscal pressures, it fails to address the structural weaknesses hindering governments’ ability to decrease current spending or increase revenue.
Decreased infrastructure investment may also inflict further harm to long term growth. Given that investment levels in Latin America and the Caribbean are already low compared to other regions, and have been contracting since 2014, it is critical for governments and the private sector to increase capital investment to expand potential growth.
To narrow fiscal deficits, governments will need to engage in deeper reforms to achieve better-quality revenue and spending, while maintaining investments that increase long-term growth. Measures to improve tax revenue collection – such as broadening the tax base, reducing tax evasion, and diversifying away from commodity-based taxes – will help improve fiscal positions and instill confidence.
