IMF: LATIN AMERICAN ECONS' GROWTH CREATES RISK OF OVERHEATING

Mexico City, May 4 (MNI)- Latin American economies are experiencing risks of overheating due to excessively strong expansion, the International Monetary Fund said in a report Tuesday.

Early signs of overheating include: rising demand-driven inflation compounded by food and energy price hikes that will require additional rate hikes; current account deficits widening with import growth exceeding export growth and borrowing in foreign currency rapidly expanding, the report says.

"We have as a base scenario for 2011 and 2012 very high exchange rates for those who export commodities, very low interest rates, and therefore all of the conditions to keep overheating," said Nicolas Eyzaguirre, the IMF's director for the western Hemisphere.

In fact, South America is already somewhat overheated this year, Eyzaguirre said, speaking in Mexico City at the presentation of the IMFs regional economic outlook for the Americas.

With a projected 4.75% regional growth this year, countries need to roll back policy stimulus put in place during the financial crisis, which they are not doing, the report says. Latam nations must also keep raising policy rates to contain demand pressures and limit spillover from higher food and fuel prices into core inflation, the report says. Eyzaguirre specified that monetary policy should be moved back at least to neutral.

Eyzaguirre also strongly warned against Latam countries, banks and corporations borrowing heavily from foreign sources with low interest rates, saying that economies could collapse once capital flows reverse.

"If capital flows reverse we can have strong devaluations in our countries, the balance sheets of corporations would become vulnerable and fragile with big solvency problems hitting the bank and eventually generating a systemic crisis," Eyzaguirre said. He pointed to similar conditions during the Lehman Brothers collapse, where foreign credits were the banks most volatile funding source.

Eyzaguirre added that while South Americas current account deficit only averages about 2% of GDP in 2011, that number could be at 4.5% if record exchange rates were rolled back to 2005 prices.

"We are slowly and imperceptibly, as a smoker would say, growing addicted to external financing and this is dangerous and must be stopped," Eyzaguirre said, recommending IMF work jointly with countries on the matter.

The report says an adjustment to fiscal policy could prevent excessive deterioration of external balances, and that countries should strengthen their financial systems using macro-prudential policies.

Eyzaguirre also pointed to exchange rate concerns in Brazil, Chile and Colombia, calling Brazil's overvalued real "worrying," and saying the country may be the most sensitive to a "shock" due to its size, strong growth and enormous capital inflows.

The IMF report says challenges differ across the region. Argentina, whose core inflation is "precarious," needs to decelerate demand, Eyzaguirre says. Central Americas growth is weakened by high reliance on remittances, the IMF says. The most volatile region, the Caribbean, is being held back by high public debt, according to the report. Latam economies are still in their adolescence, Eyzaguirre added.

Oil prices are another concern:

"We cannot discard an alternative scenario where oil reaches between $150 and $200 [per barrel]," Eyzaguirre said. "This would be very catastrophic for South America because metals and food would fall precipitously”.

Mexico may have largely avoided overheating its economy as inflation and currency remain far from danger areas, and oil concerns may not have as great an impact, Eyzaguirre said. Even U.S. construction troubles are offset by strong industrial growth, giving Mexico a stronger outlook than many other countries in the region, he said. However, he added, the nation needs to improve education and pass structural reforms or it wont sustain current levels of economic growth.

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