Latin America and the Caribbean should rebuild policy space and be watchful for downside risks before economic circumstances become unfavourable, according to the International Monetary Fund (IMF).

Supportive external conditions facing some countries — abundant and cheap external financing, and favorrable commodity prices — may persist for a while, but are likely to dissipate over time, the IMF’s latest Regional Economic Outlook for the Western Hemisphere states.

“Conditions remain favourable. The double tailwinds of easy external financial and high commodity prices are likely to persist for a while but not forever,” said Nicolas Eyzaguirre, director of the IMF’s Western Hemisphere Department. “Now, the challenge for many countries is to take advantage of this environment to rebuild buffers, to enhance the resilience and flexibility that has served them so well the last few years.”

Growth in Latin America and the Caribbean (LAC) continues to be firm despite a slowdown in the second half of 2011 due to tightened policies following the post-crisis rebound and the effect of global uncertainties. The Fund projects that the region will grow at 3.7 per cent in 2012, and 4.1 per cent in 2013, up modestly from forecasts published in January.

The regional outlook report indicates that near-term risks are still tilted to the downside, and revolve most notably around possible renewed tensions in European markets and an oil price shock.

But the report also notes different conditions with the region that imply differing policy challenges.

Caribbean countries continue to face sluggish growth in tourism-intensive countries and stubborn fiscal imbalances.

The near-term focus should thus remain on working off fiscal overhangs and addressing financial fragilities.

Looking further ahead, greater efforts are needed to tackle structural weaknesses to boost competitiveness and growth.

South America’s financially integrated economies (Brazil, Chile, Colombia, Peru and Uruguay) grew at an average rate of 5.5 per cent in 2011, down from over 6.5 per cent in 2010.

With these countries performing near or above potential, but global risks elevated, their central banks face a challenging balancing act.

They will need to stand ready to support liquidity conditions if adverse global shocks materialise, while on the other they need to ensure that monetary policy settings continue to anchor inflation expectations.

At the same time, macro-prudential measures can help avoid financial excesses in the face of robust credit growth and volatile capital flows. In addition, efforts at fiscal consolidation should step up to grant monetary policy the needed flexibility and to rebuild buffers utilised during the 2009 crisis.

Meanwhile, South America’s less integrated commodity exporters (like Argentina and Bolivia), which have for the most part have been operating above potential, the priority should be to shift away from procyclical policies, to avoid further exacerbating overheating pressures and weakening the balance of payments, the report highlights.

Countries in Central America, which are near potential and have debt-to-GDP ratios above pre-crisis levels, should redouble their efforts to consolidate fiscal positions, while strengthening monetary and prudential frameworks.