By Taimur Ahmad
When running for the top job at the IMF in 2011, Mexico’s central bank governor Agustín Carstens campaigned as “the emerging markets candidate”.
A former deputy managing director of the Washington-based multilateral, Carstens was always the underdog to French finance minister Christine Lagarde, who ended up getting the job of managing director.
But as a self-styled champion of the developing world, Carstens sought to hammer home the point that the global emerging markets he proposed to represent were no longer the crisis-prone basket cases of decades past; moreover, that any institution of global economic governance must give credence to the collective voice of the developing world. On the campaign trail he argued passionately that the emerging markets, having been through so many years of financial turmoil, were better equipped than ever to face the vicissitudes of the global economy – and also to chart a way through them.
Previously at the Bank of Mexico, Carstens himself gained first-hand experience of dealing with financial crises, including Mexico’s debt problems in the 1980s and the peso crash in 1994. Emerging markets, he said, had learned the hard way – and they have come out the better for it.
Nothing bears this out like the 2008 global financial crisis itself, Carstens says, where the emerging markets – and Latin America in particular – bounced back with unprecedented vigor.
Storm clouds are again gathering over the region, as growth slows and financial volatility rises. But in an interview with LatinFinance, Carstens explains why he thinks the emerging markets of Latin America are in strong position to withstand the next global shock.
LF: Latin America proved especially resilient during the 2008/2009 global financial crisis. What accounted for that strength relative to past episodes?
AC: Latin America was a crisis-prone region and that pretty much lasted until the early 1990s. This weakness that Latin America showed for a couple of decades was a manifestation of poor macroeconomic management and even poor institutional development, in the way policy was designed and implemented.
Latin America reacted to much better policy management after the 1990s and this reflects two things: one, the general recognition, not only among technicians but also among politicians and society in general, that to have disorderly macroeconomic policymaking was not good for the country and was bad for society in general.
That allowed some steps to be undertaken and structural reforms to be implemented. Among them: to have a far more professional fiscal process; to have, in some cases, strict rules on fiscal policy; to have enhanced regulations, reform of financial markets; and, in for most countries, some sooner than others, to adopt the autonomy of the central bank.
So as a reaction to the economic problems that permeated all the way through society, there was support, political support, to establish arrangements to facilitate good policy-making.
Many Latin American countries during the first years of this century have benefitted a lot from the openness of China. China has participated more in international markets and has become a very important player in some commodities.
Given that Latin America is commodity-rich that has benefitted the region a lot.
Latin America experienced a very important terms-of-trade shock over the last decade. Obviously it has benefitted some countries more than others. Mexico in general was one with fewer benefits of this. But for the region as a whole, this was a very positive development.
You mention the more sophisticated macro-policy response. But to what extent were measures by G7 central banks, including Fed swap lines for systemically important economies, responsible for that apparent resilience?
My view is that Latin America had a solidly-founded macro-framework and that solidity was the anchor of the strength of the economy throughout this turbulent period.
These other aspects, such as liquidity provided by central banks, Fed swap lines and so on, were at particular moments an important complement to the fundamental aspects of strong macro-policies.
But without the external support, would strong macro-policies alone have been sufficient to safeguard the region?
Well, that is mostly what has happened. For example, ample liquidity in the world economy has helped from the point of view that in the absence of it probably the collapse of the world economy would have been worse. Financial instability would have been worse and that probably would have enhanced the severity of the storm we are facing.
But all in all the liquidity that was provided has also led to some important concerns for Latin American countries, namely the rapid capital inflows; it has generated challenges we didn’t necessarily want.
In a way it has been a mixed blessing. Yes, it has, in a way, helped the world economy. The strength of the recovery, especially in the US, is due to the monetary policy actions the Fed has taken. But at the same time, these actions have had spill-over effects that we have been forced to deal with.
Overall, the policies that the Fed and other central banks have implemented are beneficial for the region, but I certainly wouldn’t go as far as saying that we have sailed through this period with resiliency due to the liquidity injection by the central banks.
The picture has changed again as the global liquidity cycle looks set to turn. What do you see as the principal risks here for Latin America?
Certainly this will create some volatility in the markets. But most Latin American countries have strong fundamentals to weather this enhanced volatility. Obviously we could have some turbulence in the markets but would that create major damage to the economic strength of the region? I don’t think so.
What is the main difference for Latin America today facing this volatility as compared to 2008?
In 2008 a lot of the volatility in Mexico and Brazil and other places was due to some major corporates that had turned to very perilous types of derivatives trades that exposed them, and our financial markets, to more volatility.
All the authorities, and also the corporates, learned that that was not adequate and not part of a responsible way of running business. Today the corporate sector and the banking sector is not exposed to those types of positions. So an aspect that very clearly magnified the external shock, the crisis abroad, is not present today.
The Fed and the other monetary authorities will be extremely careful in how they unwind their policies. The Fed has bent over backwards to hold the markets’ hand, telling them what they’re thinking, so that most of the people are not caught by surprise. Also the unwinding of monetary policy will take place when there is evidence that the US economy, and other economies, are stronger. So the correction in the monetary policy stance should not be so dramatic for the world economy because the correction in policy will be a recognition that the reasons for such extraordinary policy measures are not present any longer.
But in most scenarios it would seem the rest of the world would probably struggle more rather than less when liquidity is withdrawn?
Well I don’t think it would be appropriate to draw such a clear distinction between advanced and emerging economies.
More than anything there are some particular markets that are more vulnerable than others, for example high yield bond markets might be more vulnerable – and that includes corporate high-yield bond markets in advanced economies. So I don’t think it’s fair to portray that emerging markets have more to suffer.
But there are some emerging markets that are stronger than others, there are some markets that are more liquid, that have more depth than others so there will be a distinction between advanced and emerging markets, but I certainly would not agree to characterize that all emerging markets in general are less well prepared to withstand a correction in policy.
Do you discount the possibility that US treasury yields could shoot up much faster than the market expects today?
You can always build catastrophe scenarios. But I think the probability of such a scenario is very low. Why? Traders can generate short-term turbulence and some inadequate dynamics in the short term but at some point, fundamentals kick in.
If you have strong fundamentals, you have strong anchors in the nominal variables in your economy and that eventually should bring order to the behavior of the main macro-variables.
If you have a strong anchor and there is a strong storm, the boat might move a lot, it will move around the ratio designed by the length of the anchor, but if you have weak anchor then it will just bash against the rocks. So if you have a strong anchor, the boat might still be rocked but that doesn’t mean that it will lead you to a catastrophic scenario.
Yes, we might have some volatility but at the end of the day, if you have strong fundamentals it is less of an issue. Take Mexico, we have a very low debt to GDP ratio, we don’t have any pressing funding needs neither in the private sector nor the public sector. We don’t have any structural imbalances. And we have embarked on a series of reforms.
There is concern also about a broader slowdown in the emerging markets. What is your take on this?
My take is that emerging markets have slowed down. There is a close correlation between world trade and industrial production. What we have seen is a sharp decrease in world trade. So what we are seeing is that emerging markets are being affected by the world business cycle.
We are not immune to it – probably we didn’t feel this as much before because expansionary fiscal and monetary policies of some economies, advanced economies, provided short-term relief for the world economy.
Now what we see is that most of the policy instruments that advanced economies had have run their course and we don’t have much space left. So the business cycle around the world has become more severe and that has affected emerging markets.
Emerging markets are still growing much faster than advanced economies but I would also take this as a call for emerging markets that they also have to mind the structure of their own economies and try to engineer additional structural reforms so that they can enhance their capacity to grow and counterbalance the effects of external weakness.
In Mexico, we are going through a reform process so we don’t have to depend so much on the performance of the world economy.
How much of a risk does currency volatility pose in Latin America, given that the headwinds are likely to increase?
In general, if you have strong fundamentals you shouldn’t worry too much about it. You should concentrate first in setting your fundamentals and at the same time, doing more to promote growth.
For Mexico, if you look at a chart of volatility, there has been a very slight dent recently. It’s still at very low levels. The Mexican peso is the most liquid market in Latin America, the 13th deepest market in the whole world. It’s a very complete market and we have good pricing. Yes, it has shown some turbulence, but it has not been extraordinary. Our expectation is that it will continue like that in the future.
Do you see any risks in the renewed market enthusiasm for Mexico?
I don’t see a bubble being created in the Mexican markets. All the parties in this reform effort are very serious about moving forward. There are already some important reforms that have materialized and are in the process of being implemented. Both the government and the legislature have been very open in discussing what they think. So in general, the expectations are realistic and they are being reflected in the market. I don’t see a bubble in any way.
You’ve cut your growth forecast for the Mexican economy by a full percentage point. Why?
One factor was precisely a slowdown in world growth, particularly in the US this year. That slowdown affected importantly our exports. Now we are seeing more solid performance in the US economy, especially starting in the second quarter, the second half should be better. The US economy was affected by the fiscal drag: measures that were implemented, but will no longer be present, so the expectations for next year are much better. Given its close ties to the US economy that should benefit Mexico in particular.
The other aspect was that during the change in administration we had some form of fiscal contraction as the outgoing administration wound down and the incoming administration took charge. This change always slows down the impulse of government spending in the economy. That was an important factor and has been addressed by the government. I don’t think it should be an issue in the second half. The second half of this year should be much better than the first half, but the poor performance in the first half is sufficient to anticipate lower growth for the year as a whole. But also for next year we expect growth should continue at a reasonable rate.
So these factors speak against the need for a rate cut in the second half of the year?
We feel that the monetary policy stance is adequate. We don’t have any additional factors to tell the market. LF