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WASHINGTON — It was short-lived, the decoupling. For a few months — from August 2007 to mid-2008 — Latin America thought it might emerge from the global financial crisis relatively unscathed. Even as the subprime cancer spread through the industrialized world, in Latin America things didn’t look bad.

The decoupling oasis was the result of an accelerated increase in commodity prices. A surge of inflation, triggered by high and increasing international prices of grains and fuels and exacerbated by economic overheating in several countries was the main problem in the decoupling phase.

By mid-2008, commodity prices plummeted as the financial crisis spread globally and the world economy entered an acute slowdown. Latin America was no exception, and was hit by this “perfect storm.” The region’s stock markets joined the global selloff; currencies depreciated dramatically; households, companies, and governments began feeling the credit crunch; remittances weakened; and a process of downward revisions to 2009 growth prospects was set in motion. All of this is happening amid great uncertainty about the future of global economic and financial dynamics.

The region is better prepared to prevent the inevitable problem of flows (falling fiscal revenue, lower GDP growth, reduced credit) from turning into a devastating run on Latin American assets, thanks to sound policies developed during the past decade that reduced macroeconomic vulnerability to external shocks. Managing the flow problem, however, will be difficult. It will severely test economic policies, particularly monetary and fiscal policy.

The central challenge for monetary policy will be whether, when and how much to ease. Theoretically, countries with exchange rate flexibility and mature local currency debt markets should be able to more easily use countercyclical monetary policy. In practice, however, the room for monetary policy maneuvering will depend not only on inflation pressures but also on how much stress the domestic currencies and financial systems are facing. Overall, countries with autonomous central banks and solid fiscal processes are better positioned to face this challenge.

The main challenge for fiscal policy in Latin America will be to manage the inevitable fall in tax revenues so as to protect expenditures (in education, social security, and infrastructure) that are necessary to prevent a rise in poverty and lay the foundations for future growth.

Fortunately, Latin American governments have some capacity to provide support to the economy via fiscal interventions. Maneuvering room for fiscal policy varies considerably, however, among countries and will depend on such factors as the existence of savings accumulated during good times (Chile is an indisputable leader in this regard), the degree of expenditure rigidity, and the scope for prudent borrowing.

Latin American countries were not responsible for this crisis, however they are suffering the consequences of it. They — as agreed during the G20 Summit — should be part of the solution.

As part of this global solution to the crisis, the World Bank announced that it has the capacity to provide financial support to developing nations, including Latin America with $100 billion over the next three years, with lending tripling to more than $35 billion annually. We are also working to speed up grants and long-term, interest-free loans to the world’s 78 poorest countries. Donors last year pledged $42 billion for the International Development Association (IDA), which is the bank’s window for the neediest countries.

In addition, new facilities via the International Finance Corporation are expected to total around $30 billion over the next three years. Japan announced a $2 billion contribution to support a new fund for bank recapitalization in small emerging markets.

As one of the main contributors to the IDA, Japan is showing leadership in making sure that the financial crisis does not deteriorate into a human crisis.

Augusto de la Torre is chief economist for Latin America and the Caribbean, World Bank.

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