Alsowhile significantly below south asia lacs ratio

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Unformatted text preview: sses. In several past episodes, such desperate measures were unable to prevent financial meltdowns. Fortunately, the pains from past crises have led to significant institutional and policy improvements in LAC’s macroeconomic and financial areas. More specifically, LAC’s vulnerability to shocks has fallen in tandem with the emergence of: (i) sounder and more flexible currencies; (ii) more resilient financial systems; (iii) better fiscal and public debt management; and (iv) stronger external positions. These 14 improvements are perhaps most noticeable in countries that have been able to build credible inflation targeting regimes. Regarding local currencies, an increased number of countries in the region have moved to flexible exchange rate arrangements (Figure 3). The effectiveness of these regimes has risen in line with a reduction in the pass‐through —implying that exchange rate movements now coexist with low and stable inflation—and the deepening of local currency debt markets—implying that exchange rate movements now generate much less adverse balance sheet effects. Similarly, the resiliency of LAC’s financial systems has increased, reflecting significant reforms in financial legislation, regulation, and infrastructure that were introduced following the crises of the late‐1990s. These reforms have led, among other things, to a virtuous combination of financial deepening and a rising share of loans funded by local currency deposits (Figure 4). LAC’s fiscal and external conditions have also registered improvements. To be sure, much of the good fiscal and external outcomes were driven by good luck. That is, LAC countries benefited from the benign external environment of the recent past, characterized by abundant liquidity, booming commodity prices, and vigorous global growth. Nevertheless, better policy frameworks are part of the story too. In the area of public finances, enhanced debt management systems and greater discipline in fiscal policy contributed to reductions in government debt burdens and improvements in the currency and term structure of such debts (Figures 5 and 6). The result was greater fiscal sustainability, even if, with the notable exception of Chile, LAC governments did not save sufficiently during the good times. Finally, in the external front, there was a substantial accumulation of international reserves across LAC countries, which was due not just to terms‐of‐trade windfall gains but also to efforts to self‐insure against capital flow reversals (Figure 7). In sum, improved policy frameworks in LAC have contributed to reducing the weaknesses that used to be incubated in the monetary, financial, fiscal, and external fronts. These vulnerabilities tended to greatly magnify the adverse effects of external shocks. In the current crisis, such vulnerabilities are tamed and are, thus, not an independent source of shock amplification. As a result, many LAC countries are likely to avert a systemic financial crisis at home. However, this reduced vulnerability is insufficient to prevent bad consequences—the storm spreading from the center to the periphery is of such a formidable m...
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