In late April, CGD’s senior fellow Liliana Rojas-Suarez and distinguished non-resident fellow Mauricio Cárdenas participated in an event organized by Columbia University to discuss the economic prospects in Latin America. They were joined by the director of sovereign ratings at Fitch, Richard Francis, and the director of the Western Hemisphere department at the IMF, Alejandro Werner.
The conversation, moderated by adjunct professor Gray Newman, included diverse views on the state of affairs in Latin America. Here are some of the key insights from the event.
What are the risks and challenges for Latin America?
Presenters discussed the risks and challenges that Latin America faces amidst COVID-19, which are numerous and multidimensional:
- Significant uncertainty about the size and duration of the recession. The World Bank and the IMF forecast that GDP growth in 2020 will drop 4.6 percent and 5.2 respectively. A recent study by the Bank of Spain estimates that the GDP contraction could be between 6.5 percent and 11.5 percent, in a more adverse scenario. Moreover, Latin American countries do not seem to have reached their peak of confirmed cases yet, and the crisis is very much ongoing.
- Three key sources of income will drain this year: tourism, remittances, and commodity exports. Practically all countries in the region depend on one or more of the three.
- Substantial capital outflows. By mid-April, emerging markets had experienced outflows of 100 billion dollars–four times those of the Global Financial Crisis.
- Significant fiscal pressures, which are particularly harmful for some countries due to preexistent fiscal deficits and exorbitant debt obligations. Countries like Argentina or Ecuador are on the brink of default. Others, like Chile, Paraguay, or Peru—despite better initial conditions—are implementing important fiscal stimulus packages. Brazil, Chile, and Peru, for instance, have announced fiscal measures between five and seven percent of their GDP. Further deficits are impending for all the countries in the region.
- Decreasing commodities prices. This decline will hurt most countries in the region, particularly Bolivia, Chile, Ecuador, Paraguay, and Peru. The oil price shock will particularly harm countries like Mexico, that had pre-existing problems with PEMEX.
- Weak external financial positions (due to current account deficits and high short-term debt). These financial difficulties will make accessing credit more complicated in countries like Argentina, El Salvador, or Costa Rica.
- Vulnerability to US dollar appreciation, which, given the large share of public and corporate debt denominated in dollars, limits monetary policy response.
- Inevitable increases in poverty and inequality, issues that were already pervasive in Latin America.
- Finally, the social and political environment, generally challenging for most countries in the region, might worsen. Social unrest erupted earlier in 2019 in many countries. There are upcoming elections in Bolivia (postponed), Dominican Republic, and Suriname, and many governments face polarization and congressional fragmentation instability (most notably in Brazil and Nicaragua). Moreover, there already was uncertainty about policy changes and reforms (i.e., pensions system in Brazil and government change in Argentina). Increases in populism and authoritarianism in the region, as a result, are concerning.
To read more about the structural economic fragilities of Latin America check the latest CLAAF statement.
So… What should countries do?
Presenters agreed that countries need to continue acting rapidly and decisively. Concretely, fiscal stimulus is imperative on three fronts:
- Health sector
- Support for the most vulnerable individuals
- Credit to SMEs (and in some cases, direct subsidies for payrolls, although many countries will not be able to do this)
The cost of these measures would amount to more than 5 percent of GDP. As a reference, in 2008 the fiscal response meant 3 percent of the region’s GDP, but the initial conditions were better then, when there was more room to increase debt. Today, significant external financial needs constrain the response capacity in Latin American countries.
Most countries in the region have increased their external debt since 2008, which is also largely denominated in US dollars, and only a few countries have real capacity to increase and fund fiscal deficits through pre-existing savings or using domestic capital markets. (i.e., Chile and Peru).
On the monetary side, central banks have been proactive in the provision of liquidity, using numerous tools, but they are constrained by the need of both dollar and domestic currency liquidity. Although controlled inflation allows for monetary policy easing, issuing local currency to assist domestic needs harms currencies that have already depreciated more than 20 percent (Colombia, Mexico, and Brazil among others).
With decreasing domestic resources, pressing financial needs, and limited monetary policy capacity, Latin America needs hard currency funding, and this is where the IMF and credit agencies play an essential role.
How can the IMF help?
At the event, Werner stated that the IMF was working on emergency lending, short-term liquidity, and debt relief. As of May 11, the IMF had offered a strong response by:
However, countries in the region have been slow to ask for support. Of the total emergency financing that the IMF is providing worldwide (almost US$16 billion), Latin America amounts for less than a quarter of it (3.5 billion). Only Colombia and Mexico are currently using the precautionary credit lines, and Peru has recently applied.
Presenters agreed that countries need to also put in place plans to return to economic stability once the crisis has passed. Having viable medium-term fiscal frameworks will be crucial; it would increase confidence in the markets and ensure that debt does not become an additional problem in the near future.
As Werner said: “Come to us and spend as much as you need, but keep the receipts”
In addition, they demanded more from the IMF, and Cardenas floated a bold idea: can the IMF serve as a bridge between the hard currency liquidity that advanced economies have been injecting and the need for such liquidity that emerging markets have? The short-term liquidity line is a step in this direction, but given the dimension of this crisis, innovative measures should not stop there.
And what is the role of credit agencies?
Credit agencies argue that their role is limited to overseeing and evaluating the capacity of countries and firms to repay their debt. To that end, Francis said that Fitch already matched its record of downgrades for a year (24) and has seven of the 19 economies in the region on negative outlooks, more than any other region in the world.
Nevertheless, on how credit agencies should perform their role under the current circumstances, participants did not agree as much as they did on other topics. Cardenas and Rojas-Suarez raised two relevant points:
- Credit agencies should consider accommodating their models and evaluations to the exceptional circumstances.
- Building on the previous point, a popular question from the late 90s and early 2000s remerged: are credit agencies procyclical? Are the ratings done at the right time or are they done too late? This is a controversial and complex topic, yet an important one.
In all, most guests agreed, the rating agencies are an integral part of the international financial system and in the current crisis they should re-evaluate their methods and approaches, adapting them to these exceptional circumstances.
For many more insights and details, check out the full video and Liliana Rojas-Suarez’s presentation.