Towards a Sustainable FTAA: Does Latin America Meet the Necessary Financial Preconditions

1
Towards a Sustainable FTAA Does Latin America
Meet the Necessary Financial Preconditions?

• Liliana Rojas-Suarez
• November, 2002

2
Recent Developments Are Providing Renewed
Interest in LAC towards a Trade Agreements Model

• NAFTA has proved successful and has produced
  significant benefits to Mexico
• Forecasts for capital flows to the region are
  discouraging. The model of growth financed solely
  by private inflows no longer seems viable for LAC
• The approval of TPA was seen as a signal of US
  commitment towards free trade. However, recent
  protectionist measures have clouded this
  achievement and these concerns were reflected in
  the Quito meetings.
• The agreement in Doha is supportive of new trade
  arrangements

3
What Does Current Research Conclude about the
Preparedness of LAC Countries to Join a Free
Trade Area?
4
What Does Current Research Conclude about the
Preparedness of LAC Countries to Join a Free
Trade Area?

• There is a coincidence in the Schott and WEF
  studies regarding the best performers in terms
  of readiness to compete internationally Chile,
  Costa Rica, Mexico, TT and Uruguay
• There is also agreement that Nicaragua and
  Ecuador are the worst performers i.e., the least
  ready to join FTAA
• However, there are significant discrepancies in
  the ranking of some major countries in the
  region, such as Brazil and Venezuela, as well as
  several of the smaller countries
• As of 2001, none of these studies classified
  Argentina as a bad performer

5
Further Financial Conditions Necessary to Ensure
the Sustainability of a Free Trade Area

• While the macro, micro, and political variables
  identified by recent research are necessary to
  assess a countrys capacity to join a free trade
  area, I argue that those variables are not
  sufficient to ensure the sustainability of the
  integration effort.
• Two additional financial policy requirements are
  needed
• Sustainable public debts as determined by the
  achievement of sustainable structural fiscal
  balances
• Compatible exchange rate systems across trading
  partners
• Both requirements aim at containing incentives to
  break the rules of a free trade area in the
  presence of an adverse shock.

6
Sustainable Public Debts Ensure Sustainable Free
Trade Agreements

• If a country faces severe difficulties in
  servicing its debt, pressures for obtaining
  additional resources through tariff increases and
  relaxation of trade agreements will develop. The
  impasse in MERCOSUR during 2000-2001 exemplifies
  this point
• Ratios such as Debt to Exports or Debt to GDP do
  not appropriately indicate whether a country is
  on a sustainable debt path
• Public Debt sustainability has two components
• Capacity to pay A country has a sustainable
  public debt if it is able to generate permanent
  primary fiscal balances that stabilizes the ratio
  of debt to GDP
• Willingness to pay This relates to market
  perceptions about a governments commitment to
  service external debt

7
Compatible Exchange Rate Regimes Across Trading
Partners Are Essential for a Sustainable Free
Trade Area

• Compatible exchange rate systems between trading
  partners do not necessarily mean equal regimes or
  a common currency
• Exchange rate systems between trading partners
  are not compatible if an adverse shock in one
  partner severely affects the other because of the
  exchange rate arrangement
• Incompatible exchange rate regimes create
  incentives to abandon a free trade agreement
  between the member states

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Are Public Debts Sustainable in Latin America?
What About Capacity to Pay?

• Based on assumptions about long term rates of
  growth and interest rates, at the end of 2001,
  Brazil, Mexico, and Peru were on sustainable
  paths.
• While the Colombian and the Peruvian cases were
  unclear, the cases of Ecuador and Venezuela were
  worrisome.
• For Brazil, the projected primary surpluses of
  3.5 of GDP from 2001 onwards appeared to be
  sufficient to maintain the fiscal stand in order.

9
Are Public Debts Sustainable in Latin America?

• Based on markets expectations about fiscal
  surpluses during 2002, the sharp increase in
  spreads cannot be blamed on the fiscal stance.
  Indeed, the changes in the forecast signaled an
  improvement of the fiscal stance during the
  Cardoso government
• Instead, the high spreads for Brazil since
  mid-2002 were driven by fears about a change of
  course by the potential (and now confirmed)
  government of Mr. da Silva. With sources of
  finance curtailed, the necessary fiscal
  adjustment was increased.
• Thus, analyses of debt sustainability cannot be
  based solely on a countrys capacity to pay.
  Perceptions about a countrys willingness to pay
  might determine whether a country has a debt
  problem.

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Are Exchange Rate Arrangements in LAC Compatible
with Free Trade Areas?

• Given the importance of trade between Brazil and
  Argentina, the convertibility law in Argentina
  and the flexible exchange rate system in Brazil
  were not compatible. The recent change in regime
  in Argentina is a step in the right direction for
  a sustainable Mercosur

11
Are Exchange Rate Arrangements in LAC Compatible
with Free Trade Areas?

• In the Andean Community (AC), dollarization in
  Ecuador does not create problems for the
  sustainability of the AC because
• Share of commodities in exports is extremely high
  (90 in Ecuador). Thus, a depreciated currency of
  a partner country within the AC will not have a
  significant effect on Ecuadors revenues from
  exports.
• Trade between partners in AC is very small. Small
  trade links reduce the contagion effect from
  one country to another

12
Are Exchange Rate Arrangements in LAC Compatible
with Free Trade Areas?

• In CACM and Caricom, very diversified exchange
  rate arrangements (including dollarization) can
  be compatible with a stable trade area. This is
  due to the small size of these economies and the
  small intra-regional trade in both trade areas.
  None of the countries in those groups can gain
  much by raising tariffs on imports from trade
  area partners.
• NAFTA teaches an important lesson As the share
  of Mexicos trade with the US is very large, the
  flexibility of the Mexican exchange rate system
  allows Mexico to deal with an adverse shock
  arising from the US. Allowing the exchange rate
  to adjust is a more efficient and more effective
  tool to improve Mexicos trade balance with the
  US than increasing tariffs since Mexicos motor
  of growth trade integration does not need to
  be disturbed by temporary fluctuations in the US
  business cycle.