international analysis and commentary

New and old economic troubles in Latin America


In Brazil, around a million people took to the streets in mid-March to protest the government of President Dilma Rousseff, tarnished by the corruption scandal surrounding state-run oil company Petrobras and by mounting economic difficulties across the country. Argentina is suffering the consequence of long-running economic mismanagement and contending with extremely low foreign reserves and a sky-high inflation rate among other problems. Venezuela has been in the thick of a political and economic crisis for months. All in all, 2015 did not begin as a particularly promising year for Latin America and observers predict that the next few months will not get any better. In fact, the regional economy is going to experience widespread turbulence for a while, though the extent and depth of it will vary from country to country. “There are some external factors at play, like China’s slowdown, lower oil prices, a less supportive liquidity environment overall, which makes the cost of capital that much more expensive for emerging markets, and the US Federal Reserve poised to hike rates,” says Aryam Vazquez, Senior Economist for Latin America at the global advisory firm Oxford Economics. “But there are also self-inflicted, country-specific problems that are undermining growth at the local level.”

If the economic struggles of Argentina and Venezuela have been going on for a while and are well known, Brazil’s troubles are more recent and somewhat surprising for a country that, as part of the much-touted BRICS group, was seen as one of the engines of global growth during the worst years of the financial crisis. In particular, Brazil’s public finances deteriorated drastically in 2014, when the country registered a record high budget deficit of nearly 7%, up from 3.3% in 2013. At the time, President Rousseff justified the rapid increase in government spending as a way to stave off a looming recession. But some believe less noble calculations also played a role. “They wanted to win the elections, didn’t care for public finances,” says Rafael Amiel, Director for Latin America at the global research provider IHS. “And so a huge, humongous, fiscal deficit was piled up in a matter of months.” Since the end of December, Rousseff has launched an ambitious austerity program to close the budget hole and experts agree that current Finance Minister Joaquim Levy is the right person for the job. Nevertheless, the impact of cuts is already being felt by Brazilian citizens and is compounded by the fact that the national currency, the real, has been in a free fall vis-à-vis the US dollar. None of which bodes well for 2015. “We see two bad scenarios for Brazil,” says Amiel. “Either there is a full-blown political crisis and no reform and, as a result, a 3-4% GDP contraction this year and a protracted recession, with a huge depreciation of the real and very high inflation, or, if our baseline scenario holds and Brazil behaves as it should, we think it will experience a recession in 2015 but begin growing again next year.” A group of economists regularly polled by the Brazilian Central Bank recently predicted that the national economy would contract 0.83% in 2015, the worst performance in 20 years, and inflation would rise to 8.12%.

Brazil’s woes weigh heavily on the entire region because of the size of its economy. The same is true for Mexico, which has been doing much better overall but is also facing some headwinds. “We are among the pessimists when it comes to Mexico and we see growth at only around 2.7% in 2015,” says Amiel. “This is driven by two key factors: lower oil prices are hurting the economy, not so much in the sense of public finances, because the government has hedged against them, but because we are in the midst of a big energy reform and Mexico is about to auction around 100 oil fields and this is not the best time to do it.” The second cloud hanging over this country, adds Amiel, is that both corruption and insecurity appear to be on the rise again ever since the PRI (Partido Revolucionario Institucional) came back to power in 2012 with President Enrique Peña Nieto. Last year, he was personally involved in a controversy about how he and his wife had paid for their fancy new house right around the time his administration had to answer for the disappearance of 43 students, abducted and then massacred by local law enforcement in the southern state of Guerrero. Additionally, the two-speed national economy, with starkly different productivity levels in different parts of the country, remains an impediment to stronger growth, though the depreciation of the Mexican peso should help competitiveness.  

The more hopeful news in Latin America comes from smaller countries that have stood out, in recent years, for their prudent management of public finances and monetary policy, in particular Chile, Peru and Colombia, and even the Dominican Republic and Uruguay. Like their bigger neighbors in the region they too are being hit by external challenges: Colombia by the fall in oil prices; Chile, which is highly reliant on copper exports, because of the parallel decline in commodity prices; and Peru, probably more than anybody, by the slowdown in China. But, overall, they should be more resilient and better prepared to handle these shocks.

Finally, there is the question of when and how the US Federal Reserve may increase interest rates and what impact this might have on emerging markets. In March, the Federal Open Market Committee came one step closer to this decision when it removed the word “patient” from its policy statement. Now, analysts foresee that a rise in rates might come anywhere between June and the autumn. “Our view is that it will happen in September and it will be very gradual,” says Vazquez of Oxford Economics. “It is a huge change, leading to a lot of currency volatility in Latin America, lower equity markets. Which shows it is already fairly priced in, though the timing and depth of it continues to create some uncertainty.” According to Amiel of IHS, loose monetary policy in the European Union and Japan should help counterbalance, at least in part, a move in the opposite direction by the Fed and, with the international appetite for high yield instruments still big, Latin American governments should be able to continue to come to market somewhat successfully. “I don’t see capital flows shaken too much but the uncertainty that is in the foreign exchange market is going to hurt the natural development and economic activity of the region,” he says. “It is true that with the depreciation of local currencies, the tourism and export sectors will benefit, but others that rely on imports will struggle while governments will suffer from lower tax revenues.”

Though the picture for 2015 in Latin America is gloomy, short of any unforeseen development, the regional economy should not remain underwater for long. “We expect a correction, a level of stabilization with some currency appreciation, toward the end of the year, when all the current noise vanishes,” concludes Amiel. Even Argentina, certainly one of Latin America’s more troubled spots today, has something to look forward to in the presidential elections scheduled for October. With President Cristina Fernández de Kirchner constitutionally barred from running again, the vote opens up the possibility of real political change and, therefore, of a new era of much needed economic reform.