Latin America's economic boom could end in a "full-blown" crisis unless the region's governments properly manage the situation, the International Monetary Fund's top regional official said in an unusually stark warning to both policy makers and investors on Thursday.
Nicolas Eyzaguirre, the IMF's director for the western hemisphere, said that Latin America's economic fundamentals appear to be in good shape. Yet he urged policy makers to take steps to keep their economies from overheating by trimming public spending, maintaining sound monetary policy and setting aside as much of the windfall from the current boom as possible.
Otherwise, he told a conference of central bankers in Rio de Janeiro, the region could see its currencies dramatically weaken as a result of a sudden external shock - such as a fall in global commodities prices or an unexpectedly fast increase in interest rates in the United States.
Mr. Eyzaguirre honed in on Brazil, saying that the government of President Dilma Rousseff should continue to "rein in the economy through an array of measures to avoid excessive exuberance, or it could end in tears."
"If a big correction comes into the fore ... capital could stop coming into the country all of a sudden and you could have a big financial crisis," he added.
The remarks by Mr. Eyzaguirre, a former Chilean finance minister, were some of the strongest warnings to date by a senior official of the near-term dangers posed by Latin America's recent run of prosperity.
Much of the region's strong economic growth and the run-up in its currencies has been fuelled by rises in global commodity prices, which have also fed a growing inflation problem in several countries.
Brazil's government has been struggling to keep a lid on inflation this year, despite three interest rate hikes and the announcement of about $30-billion in spending cuts. Annual inflation in April breached the top of the central bank's target range of 4.5 per cent with a two percentage point tolerance, although the central bank expects the rate to gradually fall back toward target.
Mr. Eyzaguirre said that the region had been shielded from the 2008 financial crisis partly due to steady commodity prices, but it could not take that for granted during future crises.
"Don't take that for granted. Let's prepare for a potential shock in the future that may include commodity prices ... in good times, everybody looks very handsome," he said.
A moderate correction in global commodities prices could particularly affect appetite for the Brazilian real, he said, warning investors to not overexpose themselves to the carry trade in the currency.
With interest rates near zero in many developed economies, investors have been borrowing money cheaply abroad to pour into higher-yielding assets in Brazil, where interest rates remain among the world's highest at 12 per cent.
While he tempered his speech with praise for policymakers' efforts so far, Mr. Eyzaguirre also criticized Latin America's record of overspending during good economic times.
"We are much more prone to overspend in good times than other parts of the world," he said. "We have to watch carefully that this won't be the case any more."
If countries cannot slow exchange rate appreciation through financial regulation and fiscal and monetary policy, the region should also consider adding capital controls to reduce its vulnerability to heavy inflows of capital, he said.
Mr. Eyzaguirre's comments accompany a weakening of the real and some other regional currencies in recent days in tandem with global commodities prices. Concerns over demand in China, a major buyer of Latin America's commodities, have prompted some to ask whether regional growth will shift into a slower phase.
"There is a very good chance that prices could change quickly and abruptly," said Jorge Knauer, treasurer of Banco Prosper in Rio de Janeiro.
"The drop in commodities prices has the same impact as a reduction in liquidity through interest rates. When commodities fall, the region's currencies will fall with them."
Others saw longer-term reasons for concern.
"It sounds like he's asking whether the region is doing enough to prepare for the proverbial rainy day," said Mr. Gray Newman, head Latin America economist for Morgan Stanley.
"The risk is that policy makers get too comfortable [with growth]and don't feel the kind of urgency to really prepare for what might be ahead."