Herd-mentality investors piled into Carib assets

The World Bank said on Apr. 18 that short-term investors piled into Latin American and Caribbean assets in early 2012, threatening, instead of helping, with financial stability.

“The problem is that this type of market-based, as opposed to bank-based, capital flows has not added to financial stability, as many had initially hoped,” said Augusto de la Torre, the World Bank’s chief economist for the region, in a statement.

“To the contrary, portfolio flows into and out of emerging economies tend to be pro-cyclical and seem to increasingly respond to global factors, rather than country-specific ones,” he added.

De la Torre said the region’s capital markets changed in the 1990s, as asset managers overtook commercial banks as the main arbiters of financial relations.

He described this as the “dark side” of global capital movements, stating that many of these funds are “gigantic” and act in a very different way from banks, adding that they are often short term and used to a “herd mentality.”

“International financial intermediation has tilted towards a herd behavior that is focused on short-term horizons and where being able to exit rapidly dominates over patient analysis of long-term prospects,” de la Torre said.

He, therefore, urged the region to learn to cope with volatility that originates elsewhere, “especially if they hope to secure and further [the region’s] recent gains,”

The World Bank’s chief economist, however, said current growth forecasts for the region stand between 3.5 percent and 4 percent for 2012 and 2013, higher than those of Eastern Europe and Central Asia, and similar to those of East Asia.

He said inflation rates are expected to remain, on average, around 6.25 percent this year.

The World Bank also said the region’s record growth in recent years slowed in 2011.

“The region began to decelerate in 2011 because it was already encountering bottlenecks and because it was operating at maximum production capacity, and it was necessary to apply the brakes a bit to avoid overheating” de la Torre said.

He, however, said many regional countries have taken advantage of the benefits of growth to reduce their vulnerability to external circumstances.

“In that context, the region is much better prepared. Perhaps not as much so as in 2008, but there are still many countries in the region that have a lot of room to lower the interest rate to stimulate their domestic economies, if necessary,” de la Torre said.

Nevertheless, he warned that all countries of the region are not equally prepared, identifying three groups: countries that are highly exposed to risk but have low vulnerability; countries with high exposure to risk that need to better prepare themselves; and countries with low vulnerability but also a low response capacity.

“This was one of the most interesting findings of our report: there is a group of countries which are highly exposed to external shocks but which are not vulnerable,” de la Torre said.

“This is because they have the capacity to absorb external shocks, thanks to some more robust macroeconomic policy frameworks,” he added, stating that the report was prepared for the Spring Meetings of the World Bank and the International Monetary Fund (IMF) in Washington.

On Apr. 17, the IMF said prospects for Latin America and the Caribbean remain promising, with economic growth expected to increase next year after “a slight slowdown in 2012.

In its World Economic Outlook, the IMF said it expects economic growth for the region as a whole to slow to 3.7 percent this year from 4.5 percent in 2011, and to increase again in 2013 to 4.1 percent.

The Washington-based financial institution said a “cooling of domestic demand, a weaker external environment, and a slowdown in capital flows” have helped to reduce the “risks of overheating” in the region.

It said the region faces limited downside risk from Europe, and remains vulnerable to portfolio investment flows, which put upward pressure on currencies.

The IMF said increased risk aversion from developments in Europe resulted in a temporary reduction in capital flows, but not a reversal of flows, which “has been a net positive for the region.

“Nevertheless, the region has had difficulty absorbing hot money in the past, and this remains an ongoing source of vulnerability,” it warned.

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