By Judith Ugwumadu From Public Finance International

Latin America and the Caribbean governments need to shore up their fiscal reserves to guard against risks from other parts of the world, the Inter-American Development Bank has warned.

Its 2014 Latin American and Caribbean macroeconomic report said growth in the region is expected to reach 3% this year and 3.3% in 2015, driven by improving economic conditions in the US and Europe.

But while the projections were in line with the region’s baseline potential, the absence of economic reforms exposed the region to international risks, the IDB said.

The reported highlighted two main potential risks: financial shocks if interest rates in the US rise more quickly than expected; and slower economic growth in China, which could drag on growth in Latin America and Caribbean. South American economies are especially vulnerable to a Chinese slowdown because they are an increasingly important trade partner with China.

Santiago Levy, IDB vice president for knowledge and sectors, said a stronger fiscal position could help the region offset some of these international threats.

‘Fiscal balances have deteriorated and rebuilding fiscal buffers should be a priority especially given current uncertainties,’ he said.

Latin America and the Caribbean region may also be at an increased risk of a so-called Sudden Stop situation in capital flows, the bank warned. Such a ‘dramatic event’ depended on a country’s fiscal deficit, on the current account deficit and the level of dollarisation and reserves, among other variables.

While most countries in the region had seen these indicators deteriorate in recent years, the IDB noted that reserve levels in many countries were below optimum levels given the risks of a Sudden Stop situation.

IDB economist Andrew Powell, who coordinated the study, said: ‘We need to take a closer look at reserve levels in this environment of heightened risks and higher fiscal deficits. And we need to monitor private sector currency mismatches and liquidity risks. We cannot be complacent.’

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