Annex III Adjustment and Recovery in Latin America and the Caribbean

International Monetary Fund. Research Dept.
Published Date:
February 1995
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The onset of the debt crisis in 1982, after a period of expansionary fiscal and monetary policies that resulted in significant domestic and external imbalances, made it clear that a major adjustment effort was necessary in many countries of Latin America and the Caribbean. The debt crisis was associated in the early 1980s with a steep increase in international interest rates, recession in the industrial countries, and a sharp drop in the prices of commodities exported by countries in the region.

The basic strategy to deal with the crisis and facilitate economic recovery involved strong adjustment efforts by debtor countries, cooperative action by lenders, and a strengthening of policies in industrial countries to improve the external environment. The multilateral financial institutions, including the IMF, provided financing; but in the case of the IMF, its support in designing and monitoring the adjustment programs and in helping to mobilize financing from other sources was perhaps more important.

The Initial Adjustment Phase

From 1983 to 1989, many of the countries in Latin America and the Caribbean achieved considerable progress in redressing external imbalances. There was less success in reducing inflation and restoring economic growth (Chart 27). Progress in this area was uneven, since varying circumstances affected countries’ ability to implement adjustment policies and structural reforms.

Chart 27.Western Hemisphere: Selected Economic Indicators

1 Real GDP, inflation, and fiscal positions art- weighted by GDP valued at purchasing power parity.

2 Money growth is weighted by GDP convened lo U.S. dollars at market exchange rates.

3 Debt service refers to actual payments of interest on total debt plus actual amoritization payments on long-term debt.

The external environment for countries in the region also became more favorable in 1983-89. Economic growth in industrial countries recovered to 3½ percent a year on average, from less than 1 percent a year in 1981-82, and international interest rates declined substantially from 1983 to 1987 before rising again somewhat in 1988-89. Although the terms of trade of countries in the region deteriorated by a cumulative 22 percent during 1983-89, this mainly reflected the reduction in oil prices in 1985 and 1986: when the major oil exporters are excluded, the region’s terms of trade improved by more than 3 percent.

The average rate of inflation in the region increased from 61 percent a year in 1981-82 to 113 percent a year in 1983-87, and to about 300 percent a year in 1988-89. The acceleration of inflation, particularly in 1988-89, can be attributed mainly to Argentina and Brazil, where the implementation of adjustment programs was uneven, and to Nicaragua and Peru, which pursued expansionary demand policies in combination with price controls and other controls on the economy. In contrast, Bolivia adopted a strong adjustment program in mid-1985 and moved from hyperinflation in 1984-85 to inflation of around 15 percent a year in 1987-89. Most of the countries in the Caribbean, as well as Honduras and Panama, recorded annual inflation rates below 10 percent during most of the 1980s.

To reduce inflation and improve their competitive position, most countries in Latin America and the Caribbean sought to strengthen their public finances and to curtail monetary expansion. For the region as a whole, public sector deficits were lowered from about 5 percent of GDP in 1982 to 1 percent of GDP in 1985. During this period, 17 countries achieved reductions in their deficits of more than 5 percentage points of GDP; only a few (Guyana, Nicaragua, Suriname) saw their deficits significantly widen. Fiscal adjustment was accompanied by credit restraint to slow the growth of money and to improve net international reserve positions. During 1986-89, by contrast, the fiscal deficit of the region rose by nearly 2 percentage points of GDP, with some countries suffering considerable deterioration in their public finances.

Exchange rate policies have varied widely among countries and over time in individual countries. Some countries (particularly those in the Caribbean) maintained currency pegs to the dollar, others sought to maintain the value of their currencies in real effective terms, and others allowed their currencies to float. In 1983-87 the real effective exchange rates of the region depreciated by a cumulative 25 percent on average, followed by an appreciation of 22 percent in 1988-89.

The dollar value of exports from Latin America and the Caribbean rose only slightly in 1983-87 because increases in volume were offset by falling prices. Import growth moderated as external financing to the region was curtailed in the wake of the debt crisis, and as currencies of most of the larger countries in Latin America depreciated. The external current account deficit narrowed from the equivalent of 5 percent of aggregate GDP in 1982 to an average of 1½ percent of GDP a year in 1983-87. In 1988-89, there was a recovery in world prices for most of the region’s exports, but because of strong import growth the external current account deficit narrowed only marginally, to about 1 percent of GDP in 1988-89.

Because of the narrowing of the region’s external current account deficit, the growth of external debt slowed from an average of $33 billion a year in 1980-82 to an average of $15 billion a year in 1983-87. Relative to GDP, external debt rose from 43 percent at the end of 1982 to 54 percent at the end of 1987, reflecting in part the real depreciation of the currencies of many of the debtor countries, which reduced the dollar value of their GDP. The stock of debt declined slightly in the following two years, and the ratio of outstanding debt to GDP fell again, to 43 percent. Relative to exports of goods and services, the region’s debt-service payments were reduced from over 40 percent in 1983 to 30 percent in 1989. However, except for minor bond placements by Mexico and Venezuela in 1989, there was little or no voluntary private lending to the region through the end of the 1980s.

In 1984-87, the region’s output rose at an annual rate of 3½ percent, compared with a decline of nearly 2 percent a year in 1982-83. This improvement was attributable mainly to real GDP growth of more than 5 percent a year in Brazil, Chile, Colombia, and Peru. In 1988-89, growth fell back to about 1 percent a year as output declined in some countries and increases in output slowed sharply in others. Belize, Chile, Colombia, Costa Rica, Guatemala, Honduras, Paraguay, and the East Caribbean countries continued to grow at rates well above the regional average.

The slowdown in growth toward the end of the decade was attributable, at least in part, to the reduction in domestic investment: after exceeding 23 percent of GDP over a period of several years through 1981, investment fell to less than 19 percent of GDP in 1983-86. In many countries, fiscal adjustment during this period was achieved initially through cutbacks in public investment rather than through increases in public saving. Investment also was affected adversely by the curtailment in foreign financing, and more generally by the effect of the debt crisis on investor confidence.

Further Adjustment and Consolidation

The region made substantial progress in reducing imbalances, lowering inflation, and improving growth performance during 1990-93. Much of the success came from the tightening of fiscal policies and the deepening of structural reforms. Many countries undertook a broad opening of their economies that, coupled with rising confidence, stimulated large inflows of private capital.

These positive developments took place against the background of a weakening external environment. The growth of output in industrial nations slowed from 3½ percent a year in 1983-89 to 1½ percent a year in 1990-93, and the growth in industrial countries’ import volumes declined from more than 7 percent a year to about 3 percent a year. Moreover, the terms of trade of Latin America and the Caribbean weakened, mainly because of lower export prices. At the same time, the region benefited substantially from the decline in international interest rates since 1989. On average, industrial countries’ short-term interest rates declined from just below 9 percent in 1989 to about 5 percent in 1993, and the six-month U.S. dollar LIBOR (London interbank offered rate) fell from more than 9 percent to about 3½ percent.

In addition, since the introduction of the Brady initiative in May 1989, nine countries in the region have reached debt-restructuring agreements with commercial bank creditors that incorporated important elements of debt reduction. These packages reduced the bank debt of developing countries in the region by about $37 billion (or about 8 percent of the region’s debt at the end of 1988).1 At the same lime, the official bilateral debts of a number of countries (including Bolivia, Haiti, Honduras, Jamaica, Nicaragua, and Paraguay) were reduced through various debt-forgiveness initiatives, and the official bilateral debts of Bolivia, Guyana, Honduras, and Nicaragua were rescheduled under enhanced concessions in 1991-93. Although the overall amount of debt relief may be viewed as limited compared with the total debt outstanding, the debt-reduction agreements with bank creditors and the concessional rescheduling of official bilateral debt helped countries to persevere with economic reforms and increased domestic and external confidence in many countries of the region.

Strengthening Public Finances

In 1990-93 fiscal consolidation proceeded in many countries of the region. On average, the region’s public sector balance shifted from a deficit of nearly 3 percent of GDP in 1989 to a surplus of 1 percent in 1993. Although the strengthening of public finances was particularly pronounced in Argentina, more than two-thirds of the countries improved their fiscal positions during this period. Only a few countries are currently running deficits that are larger than they were in the 1980s.

Public sector reforms were central elements in the fiscal consolidation process. These measures, intended to strengthen government finances and to improve operations of public entities not slated for privatization, focused mainly on tax policy, improved tax administration, better expenditure control, public pricing policy, management, and the quasi-fiscal operations of central banks. As regards the tax structure, considerable progress has been made in reducing the reliance on international trade taxes and in shifting the weight of taxes lo domestic transactions and income. Most countries in the region have introduced or extended the scope of value-added taxes or broadly based sales taxes to replace a multiplicity of indirect taxes, and the valuation base for excise taxes has been shifted from specific to ad valorem. In many cases, tax rates have been lowered, and tax administration has been strengthened.

On the expenditure side, the efforts have focused not only on the control of spending, but also on the establishment of new priorities for government programs. Typically, higher priority has been given to public investment and social spending, particularly on health and education. In this regard, countries have sought to improve the targeting of subsidies and other social outlays in order to improve the quality of social programs and to reduce the spending pressures that derive from generalized access to such programs. In line with the attempts to downsize the public sector and control the wage bill, in a number of cases governments have sought to reduce public employment, often through voluntary retirement programs.

There have been improvements in public pricing policies in recent years, resulting in efficiency gains and contributing to the strengthening of public finances. For example, public prices and user charges generally have been adjusted to cover costs, and long-run marginal cost considerations increasingly are being taken into account in the pricing of electricity, water, and telecommunications. Although some countries still price petroleum products below their opportunity cost, there has been a sharp increase in fuel prices in the region in recent years.

In keeping with the region’s new economic strategy, a large number of public enterprises and financial institutions have been divested to rid the slate of loss-making enterprises and to reduce government intervention. Privatization has also served to mobilize resources for debt-reduction operations and to facilitate debt-equity swaps with foreign creditors. Argentina, Chile, and Mexico have privatized most publicly owned companies and institutions, including airlines, telecommunications companies, and mining and steel companies. Privatization has also been undertaken in Peru and Venezuela. Chile privatized its social security system in the early 1980s, and the privatization of social security systems is under way in Argentina, and under consideration in Mexico and Peru.

Most public enterprises that have not been slated for divestment have undergone considerable restructuring to increase competitiveness while avoiding the need for government subsidies. Action has been taken to reduce excess employment and lower the cost of labor to levels comparable with the private sector. In some countries the authorities have introduced management contracts with private firms, competitive bidding, and efficiency audits to strengthen the operations of public enterprises.

In addition to privatizing public companies, the authorities in many countries have sought to increase the role of the private sector by contracting out services traditionally provided by the public sector, such as electricity and water service. In 1992, Bolivia began turning over most of its customs operations to private firms under the supervision of a reformed and downsized customs administration.

Financial Sector Developments

Traditionally, the financial sector in many countries of Latin America and the Caribbean has been regulated closely, with substantial use of directed credit, often at subsidized rates, to sectors favored under government development strategies. More recently, however, interest rates have been deregulated, and they are freely determined in all but a few countries. At the same time, compulsory credit allocation schemes have been largely abandoned, reserve requirements simplified, and market-based instruments introduced for purposes of monetary and credit control. Banking legislation has been modernized, prudential standards have been raised, and many countries have sought to increase the independence of their central banks.

Equity markets in the region surged in the early 1990s, reflecting the positive economic developments in many of the countries. There was a broadening of the investor base in most countries to include foreign investors. For example, market capitalization increased fourfold in dollar terms in Chile and Venezuela from 1988 to 1992 and tenfold in Mexico and Argentina; the growth in regional stock markets has continued, led by a surge in the Brazilian stock market. The growth of regional equity markets has also been evident in large increases in turnover ratios (total annual equity trading divided by year-end capitalization).

Exchange Rate Policies and Commercial Reforms

With a strengthening of fiscal and credit policies in a number of countries, the authorities were able to slow the rate of currency depreciation and, in some cases, to use exchange rate policy as an element of comprehensive and aggressive anti-inflationary programs. In March 1991, Argentina adopted strong adjustment and structural measures and pegged its currency to the dollar under the Convertibility Law, which also established the backing of the monetary base with the central bank’s gross international reserves and prohibited indexation of contracts denominated in domestic currency. The Peruvian currency was floated in a situation of hyperinflation in 1990, and concomitant strong fiscal and credit policies sharply lowered the rate of currency depreciation. At the same time, strong inflows of private sector capital into many countries of the region contributed to the appreciation of currencies in real terms.2 For the region as a whole, currencies appreciated in real effective terms by a cumulative 30 percent in 1990-93; excluding Brazil, the appreciation was 58 percent.

There have been several structural reforms in the external sector, including the gradual opening of the economies to external competition. An early round of trade liberalization was initiated in the mid-1970s in Chile, and Bolivia and Mexico began liberalizing in the mid-1980s. Subsequently, the momentum spread through most of the region as import tariffs were reduced, the tariff structure was simplified, and quantitative restrictions were lifted. Tariff rates, which averaged over 50 percent in the mid-1980s, have been cut to less than 20 percent in most countries, and tariff dispersion has been reduced. The trade reforms often were accompanied by steps to liberalize payments for invisibles and to introduce capital account convertibility.

In the 1990s there has been a push for further economic integration in the region. Existing arrangements such as the Andean Pact, the Caribbean Community (CARICOM), and the Central American Common Market are becoming more outward-looking through reductions of tariff rates vis-à-vis the rest of the world. New arrangements such as the Southern Cone Common Market (MERCOSUR), which involves Argentina, Brazil, Paraguay, and Uruguay in a free trade area that is to take effect at the end of 1994, and the North American Free Trade Agreement (NAFTA, between Canada, Mexico, and the United States) are expected to create trade and foster economic growth.

In line with the trend toward liberalization, domestic price controls have been reduced or lifted in most countries, and business activity has been deregulated in a number of sectors. For example, within the transportation sector, substantial deregulation has been extended to port operations (Argentina, Brazil, Colombia, Mexico, and Uruguay), the trucking industry (Argentina and Mexico), and maritime transportation (Argentina, Colombia, and Venezuela). Attempts also have been made to create a more flexible labor market; although progress has been made in increasing labor mobility in some countries, wage indexation, high payroll taxes, and distortionary severance-payment schemes remain problems in several countries.

Improvements in Macroeconomic Performance

As a result of stronger fiscal and monetary policies and structural reforms, inflation was brought down from 360 percent in 1989 to about 220 percent in 1993; excluding Brazil, inflation in the region was reduced from around 130 percent in 1989 to an average of 18 percent in 1993. Inflation was reduced sharply from hyperinflationary levels in Argentina, Nicaragua, and Peru following the adoption of adjustment programs. Three countries (Dominican Republic, Bolivia, and Mexico) lowered inflation to single digits, bringing the number of countries in the region with single-digit inflation rates to 14.3 Nevertheless, inflation remains a major concern in Brazil, and there are ten countries in the region with annual inflation rates in excess of 20 percent (in some cases, including corrective price adjustments). For some countries where substantial progress has been made to curtail inflation, the reduction of price increases to industrial country levels has been complicated by indexation practices that were established during the period of prolonged inflation. In an effort to reduce the inertial element of inflation, Mexico introduced incomes policies centered on a tripartite agreement between government, business, and labor lo limit increases in prices and wages with the support of an exchange rate policy to lower inflation.

The region’s real GDP rose by 2½ percent a year on average during 1990-93, slightly higher than in the period 1983-89. Excluding Brazil, the region’s output rose by about 3½ percent a year in 1990-93, compared with an average rate of about 1 percent in 1983-89. During the 1990-93 period, annual output growth for the region as a whole exceeded the average for the 1980s in all but eight of the countries (The Bahamas, Barbados. Brazil, Haiti, Nicaragua, Peru, Suriname, and Trinidad and Tobago). Some countries have been particularly successful in reducing urban unemployment (Bolivia, Chile, Guatemala, Honduras, and Mexico), and only two had higher average unemployment than in the 1980s.

After a sharp improvement in 1989-90, the external current account deficit of the Latin American and Caribbean countries widened markedly, owing to a drop in export prices and rising imports induced by higher investment and the economic recovery. The combined current account deficit increased from around 1 percent of aggregate GDP a year in 1989-90 to about 2½ percent of GDP in 1991-93. However, the overall external balance of payments turned strongly positive because of the large inflows of private capital. As a result, the region’s net international reserves have tripled since the end of 1989m to nearly $110 billion at the end of 1993. After declining in 1988-89, the external debt rose by $60 billion in 1990-93. Relative to GDP, however, the debt was reduced from 43 percent at the end of 1989 to 35 percent in 1993.

Achievements and Remaining Challenges

In recent years there has been a marked improvement in the economic performance of most countries in Latin America and the Caribbean, notwithstanding the recession in industrial countries. Growth has been restored in most countries, inflation has sub-sided, the overall balance of payments of the region has improved, the debt burden has been reduced, and there has been a return of domestic and external confidence in the economic prospects of most of these countries. The economic recovery was helped by lower international interest rates, particularly dollar rates. Debt-reduction agreements with commercial bank creditors and reschedulings on concessional terms with bilateral creditors also have played an important part in reducing the debt burden.

More important, however, the improvement in economic performance reflects a major strengthening of economic policies in the region. Fiscal imbalances have been reduced considerably in most countries, with the support of reforms to broaden the revenue base and lo reduce the size and scope of the public sector, including through privatization. The improvement in fiscal performance has facilitated better monetary and exchange rate management and has allowed governments to focus increased attention on the social sectors. At the same lime, market-oriented structural reforms encompassing most economic sectors have led to improved efficiency and better resource allocation.

Considerable economic progress has been achieved in the region, but many challenges remain. Several countries that have initiated adjustment programs continue lo face problems of high inflation and external debt, and others have yet to begin the task or need to restart programs that have faltered. There is also a need for countries that are well advanced in their economic transformation to persevere in their efforts and to consolidate the progress already achieved.

Output growth has increased in most countries of the region since the 1980s, but there are only a few in which per capita incomes are rising at rates higher than 2 percent a year. Although there has been a significant improvement in public sector saving in the region as a whole, gross national saving declined to an average of about 18 percent of GDP in 1990-93, compared with 20 percent in 1987-89. Notwithstanding the improvements in efficiency, stronger economic growth requires an increase in domestic saving and investment.

Despite a reduced debt burden for the region as a whole, external debt remains high in many countries, and difficulties in debt management could return if interest rates in the industrial countries rise from their current low levels. A sustained recovery of economic activity in the industrial countries, however, would have a favorable effect on the region’s exports.

The strengthening of confidence in the economic policies of the countries in the region has helped to attract large inflows of private capital, but this has complicated economic policy management in many countries. Some countries have allowed their currencies to appreciate somewhat in response to these inflows; others have attempted to control a buildup of liquidity by monetary means, including open market operations. However, such actions could result in reduced competitiveness or higher interest rates, which could stifle exports and private investment. Fiscal adjustment would be an appropriate alternative to help to offset the effects of capital inflows that might not be available in the medium to longer run.

Finally, notwithstanding the progress that has been made in addressing problems of the poor in many of the countries of Latin America and the Caribbean, a large number of people in the region continue to live in extreme poverty. Further progress in strengthening the basis for the sustained growth of output and employment will help to reduce poverty. In addition, countries need to continue their efforts to improve the targeting of social spending programs and to give priority to expenditure on social infrastructure such as education and preventive health care.

This annex was prepared by the IMF’s Western Hemisphere Department.


Including the present value of debt-service reduction and net of the cost of enhancements. See Charles Collyns, George Anayiotos, and others, Private Market Financing for Developing Countries (IMF, December 1993).


See Susan Schadler, Maria Carkovic, Adam Bennett, and Robert Kahn, Recent Experience with Surges in Capital Inflows, IMF Occasional Paper 108 (December 1993).


For a case study of Mexico, see Mexico: The Strategy to Achieve Sustained Economic Growth, edited by Claudio Loser and Eliot Kalter, IMF Occasional Paper 99 (September 1992).

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