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Oranjestad, 10 January, 2012 - What does the New Year hold for Latin American region's economies, especially with Europe still under stress?

For sure, a dimmer economic environment, here and abroad. Growth has softened in the larger countries of the region. The United States is growing a bit more, but elsewhere activity is softening, including in China.

Perhaps more importantly, global financial markets are still strained, because many questions about advanced economies remain unanswered:
• The future course of the European crisis remains the biggest risk.
• The United States has yet to strike the right fiscal policy balance, with both near-term support for growth and long-term sustainability.

Reasons for caution
While IMF’s official forecasts won't be public for a few weeks, it can be said that the IMF doesn't see a recession coming in Latin America if the European crisis remains contained, but weaker growth is clearly in the cards.

Financial risks continue to dominate the outlook, with all eyes on Europe. While deteriorating conditions there have not yet spilled over to Latin America, it will not be immune if the risks move to the foreground since Eurozone banks account for one-quarter of banking assets in the larger Latin American countries. But if the simmering crisis in Europe comes to a boil, that process could speed up, especially if euro zone banks are starved for short-term dollar funds.

Maintaining stability
What should countries do in the face of this risky outlook? A lot depends on their current macroeconomic situation.

On the monetary policy front, some countries are already taking preemptive steps, moving to neutral or easing, because they have inflation under control and activity is ebbing. (Easing may not be an option in countries with higher inflation or heavy dollarization.)

On the fiscal front, the major lesson from Europe today -- and from Latin America's past -- is that sound public finances are crucial. Meanwhile, financial systems should be under extra scrutiny for signs of stress, with a particularly watchful eye for liquidity strains.

The good news is that many countries in the region are entering 2012 from a position of strength. These countries have managed their economies and markets skillfully since the 2008 crisis, where Latin America was taught the importance of maintaining healthy liquidity conditions to avoid a credit crunch, which is very difficult to combat with macroeconomic policies.

Moreover, for the most part, banks are sound, monetary policy frameworks are increasingly credible, international reserve coverage is adequate, and public finances are strong. The key will be to hold that position.

Overall, as 2012 kicks off, IMF’s advice is to hope for good news, but prepare for the bad.