The crisis lands down south

Monday, October 6

Latin American countries will differ in their resilience to the current international crisis, depending partly on the quality of their macroeconomic policies in recent years. Since 2003, Latin America has enjoyed sustained economic growth due mainly to three factors -- high commodity prices, strong international growth and low interest rates -- all of which now appear set to change.

Rising resilience?

Although recognising the depth of the international crisis, governments in some of the region's main countries believe that their economies are better prepared to withstand this crisis than any other in the past 30 years. They point to the results of improvements in macroeconomic management, reducing foreign debt and boosting reserves. Moreover, the crisis comes at a 'good' time for the region in that its main economic challenge this year has been to contain the second-order effects of a surge in inflation.

Latin America's banking systems, too, appear to be on a relatively strong footing to resist the crisis. As far as is known, they have not invested significantly in US mortgage-backed securities, nor do domestic financial markets have the complex instruments that were at the root of crisis. Overseas credit represents a relatively low percentage of bank funding, and the main international banks operating in the region, such as Santander and HSBC, are generally considered sound.

However, because overseas bank borrowing tends to be short-term and is used mainly to finance foreign trade, a credit crunch is identified as the main immediate risk to the region. In addition, since the region's financial markets -- apart from Brazil -- are small and generally still shallow, large companies look to international equity, bond and bank markets to finance new projects. This factor alone, independently of the impact on regional growth, suggests a significant reduction in domestic investment next year.

Commodity prices.

According to ECLAC, primary products, including oil -- LAC's single most important export -- accounted for 52.4% of the region's exports in 2006. As well as affecting the region's external accounts, a drop in commodity prices would have two other important effects:

• Fiscal accounts. These are considered the region's most important vulnerability to the international crisis, after the immediate threat to liquidity. This is most acute in countries which have not used strong growth to improve their fiscal situation.
• Foreign investment. Mining and hydrocarbons projects have played a key role in the recent growth of foreign direct investment (FDI) in LAC, which reached a record 106 billion dollars last year, according to ECLAC. Moreover, the United States is the region's largest source of FDI.

In line with international concern about the impact of the crisis on progress towards the Millennium Development Goals, slower growth in Latin America, combined with weaker fiscal finances, could rapidly undo much of the reduction in poverty achieved over recent years.

Despite sustained economic growth, support for free-market economic policies in Latin America dropped from 52% in 2007, down from 59% in 2002 (and 66% in 1998), according to Latinobarometro, a Santiago-based research organisation. At the same time, approval of the United States also declined. An economic downturn would accentuate these negative attitudes even in countries with a long-standing commitment to free-market policies. However, governments such as Venezuela’s will not necessarily be able to capitalise, facing problems of their own as oil revenues decline.