Latin America and the Global Economic Crisis | Recession | Government Budget Balance

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An overview of the region up to 30 January 2009 by the UN Economic Commission for Latin America and the Caribbean (cepal) argues that the larger economies have been more directly affected by the global economic crisis (because in general they are more integrated with the global markets, especially finance), but are also better equipped to respond to it. In particular, Cepal sees South America as diverging from Central America and the Caribbean, which seem to be both less resilient in terms of their economies, and more exposed to the slump in the USA. They are being driven back to aid as the last/only resort. Mexico is in a category of its own, the most exposed to the US downturn, but as a large economy and an oil exporter, better placed to withstand the downturn than its Caribbean basin neighbours. Cepal highlights: A marked reduction in both international demand and the terms of trade for the region's goods and services, increasing difficulties in accessing international finance, strong pressure on exchange rates due to capital flight, a deterioration in labour markets, investment, and consumption.
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    Latin America and the Global Economic Crisis Duncan Green, Oxfam GB, March 2009 Introduction  An overview of the region up to 30 January 2009 by the UN Economic Commission for Latin  America and the Caribbean (cepal) 1  argues that the larger economies have been more directly affected by the global economic crisis (because in general they are more integrated with the global markets, especially finance), but are also better equipped to respond to it. In particular, Cepal sees South America as diverging from Central America and the Caribbean, which seem to be both less resilient in terms of their economies, and more exposed to the slump in the USA. They are being driven back to aid as the last/only resort. Mexico is in a category of its own, the most exposed to the US downturn, but as a large economy and an oil exporter, better placed to withstand the downturn than its Caribbean basin neighbours. Cepal highlights: ã  A marked reduction in both international demand and the terms of trade for the region’s goods and services. ã Increasing difficulties in accessing international finance. ã Strong pressure on exchange rates due to capital flight. ã  A deterioration in labour markets, investment, and consumption. Growth  By March 2009, growth projections for 2009 were still heading downwards, to 0.3 per cent (World Bank), 0.5 per cent (Cepal), or 1.1 per cent (International Monetary Fund). All three projections show a f all in per capita terms, compared to figures of 5.7 per cent in 2007 and 4.6 per cent in 2008 2 . Cepal’s Executive Secretary, Alicia Bárcena, likens the economy to flying a plane in which one by one, the motors are stopping. It is likely that future revisions will be downwards (e.g. in March, it became clear that Brazil’s economy had contracted by 3.6 per cent and industrial production by 20 per cent in the last quarter of 2008 3 , much higher than expected). Trade and finance Over 90 per cent of the region’s gross domestic product (GDP) and population reside in net commodity exporting countries 4 , so the slump in commodity prices has had a marked impact. Regional exports fell by 17.5 per cent between December 2007 and December 2008. Those economies that are most tightly linked to the USA, such as Mexico, Central America, and the Caribbean, have seen a rapid fall off in demand for manufactured exports, principally autos and maquila (garments and electr onics). Mexico’s exports fell by 31.5 per cent in 2008, according to government figures. 5  This, along with falling remittances, has undermined the benefits of falling oil and food prices for net commodity importers in the Caribbean basin. Tourism has also been hard hit. In the Caribbean, visitor numbers are expected to fall by up to a third in 2009, according to the Caribbean Tourism Organisation. This has halted some ambitious construction projects, with a knock-on effect on construction jobs. 6  In terms of financial flows, risk perceptions have risen rapidly, increasing the cost of borrowing for Latin American governments, and as in all developing countries, foreign direct investment (FDI) has contracted. Latin America and the Global Economic Crisis, March 2009 1  Financial sector There is considerable variation in the level of vulnerability of countries’ financial sectors. In Brazil, the government controls Banco do Brasil, a huge retail bank, and Caixa Econômica, the largest mortgage lender, plus the BNDES, a large development bank that funds companies. These banks are less vulnerable to capital flight and turbulence in US and in European financial markets, and provide the government with ready-made channels for directing the fiscal stimulus into the economy. Mexico’s financial sector, in contrast, is dominated by foreign banks that largely stopped lending once the crisis hit. In general, however, the region’s banking systems seem reasonably solid, at least compared to those of Europe or the USA, and the impact of the slowdown is felt more through the ‘real economy’ eg collapsing trade, than through financial contagion. Remittances Remittances offer a crucial safety net to poor or near-poor families in many Latin American communities and have become an increasingly important contributor to the national accounts (see chart). As a per cent of GDP, Central America and the Caribbean are by far the most vulnerable, with Honduras top – remittances amount to 26 per cent of GDP. The recession in the USA and Europe has meant a sharp deceleration in remittance flows, especially moving into 2009. Mexico’s remittances (the largest in value, though not as a per cent % of GDP) fell by 12 per cent in January 2009 compared to the previous year. 7  Jamaica’s remittances fell by 14 per cent in November and December 2008, just as the price of bauxite, its other big earner, halved. 8  Guatemalan remittances were down 8 per cent in January, according to Inforpress. Social impact Employment  Although any numbers at this point are highly speculative, Cepal foresees two main impacts on employment, both reversing previous trends (unemployment fell from 11 per cent in 2003 to 7.5 per cent in 2008). Firstly, rising formal sector unemployment; secondly, a shift towards the informal sector as a de facto safety net/source of jobs in a downturn. 9  Inter-American Latin America and the Global Economic Crisis, March 2009 2  Development Bank (IDB) fears that most of the job losses will occur in Small and Medium Enterprises (SMEs). 10  In January 2009, Mexico lost 128,000 formal sector jobs in a single month. 11  In Peru 50,000 jobs were lost in the last quarter of 2008, mainly in textiles and mining. Oxford Analytica reports that Brazil lost 700,000 jobs in December and January 12 , as key exporters such as Embraer and Vale have cut thousands of jobs in recent weeks as industrial production fell 12 per cent in December 2008, the biggest fall since the government started to keep records. 13  In countries such as Mexico and Bolivia, the return of migrants from the USA and Europe could further increase pressure on the labour market. The impact of the slowdown on inequality, which had been falling in most Latin American countries, will depend in part on government responses – for example, whether they concentrate on cushioning the impact of job losses in the formal sector, or on wider social protection mechanisms, and on the number of jobs created as part of fiscal stimuli programmes. Government responses to the crisis The larger economies in particular enter the crisis better able to cope than during previous economic shocks. In the words of one World Bank official, the region is ‘a better-built boat facing a nastier storm.’  14  The grounds for limited optimism include: ã  A major reduction in debt, especially denominated in foreign currencies (which reduces the dangers posed by depreciation). ã Some commodity-exporting countries (Chile, Peru, Mexico, Brazil) have built up ‘rainy day’ stabilization funds during the commodity boom years. Brazil’s $207bn of reserves, for example, are enough to cover 14 months of imports. 15   ã Governments have reduced their deficits, or run surpluses. However, Latin America is paying for its failure to deal with some of its other long term economic weak spots, notably neglecting to put in place good systems to raise domestic resources. The region’s low level of taxation (an average of just 18 per cent of GDP) and regressive taxation systems (the region has the lowest level of direct taxation of any world region) has left it particular ly dependent on foreign capital flows, a major source of economic vulnerability in a downturn. 16 Healthy finances, even allowing for falling tax revenues, provide governments with the ‘fiscal space’ to fund counter-cyclical policies (i.e. increase spending in a downturn). That breathing space is likely to be temporary, however, with commodity exporters seeing falls in revenues from mining royalties, and the general slowdown hitting government tax takes. Peru’s tax take was down 9 per cent in January 2009. Indeed most countries in the region were already moving from surplus into deficit on both fiscal balance and current account in 2008, with a further slide predicted for 2009. While this is what a counter-cyclical response would dictate, the ability to maintain this position is limited by access to finance. Moreover, some commodity importers, particularly in Central America, were already running large current account deficits before the crisis, led by Nicaragua with a substantial 16 per cent deficit in 2007. Although their commodity import bills will have eased, falling exports and remittances mean that they will have little fiscal space to respond to the crisis in anything other than the traditional countercyclical (and counterproductive) fashion. In January 2009, Nicaragua announced a 20 per cent cut in current spending. These countries will be highly dependent on enhanced aid flows to cushion the shock. Virtually all governments in the region have responded to the crisis by cutting interest rates, but as elsewhere, mere monetary measures of this kind have not been sufficient to rekindle demand and other measures, such as fiscal stimuli, are being actively considered.  A Cepal 17  overview of government reactions to the crisis suggests that governments have initially chosen to rapidly reduce interest rates and direct fiscal stimuli through the simplest channels – tax breaks and spending on big ‘shovel-ready’ infrastructure and housing projects. While speed is essential, Cepal points out that, as in the USA, tax breaks are less effective in stimulating demand, because people tend to save, rather than spend, the money. The social Latin America and the Global Economic Crisis, March 2009 3  impact of infrastructure investment varies enormously, depending on how many jobs they create and how many local inputs they use. The Mexican government has given explicit priority to stimulating SMEs, for example earmarking a minimum of 20 per cent of government procurement for them, but in general Cepal is concerned at the lack of attention to SMEs in most anti-crisis plans. 18  Chile has been by some distance best placed to run counter-cyclical policies. In January,  André Velasco, Chile’s finance minister, announced that Government spending would rise in 2009 by 10.7%. On 12 February 2009 the independent Central Bank cut its benchmark interest rate by a massive two-and-a-half percentage points, to 4.75 per cent. These measures mean the economy may suffer only a mild downturn. Much of the money will go on houses for poor people and on road maintenance. The government can afford this because not only is public debt minimal (4 per cent of GDP in December 2008), but the government has also piled up $20.3 billion (about 12 per cent of GDP) in a sovereign wealth fund which it can now spend. 19  That stands in contrast with Colombia, where the government has responded in more traditional countercyclical fashion, or with neighbouring Argentina, whose government has financed an increase in spending by nationalising private pension funds.  Social spending and social protection  Most governments have introduced some kind of countercyclical policies to cushion the impact on poor people and maintain social spending levels. Nicaragua is an exception, opting to cut the budgets for health and education by 12 and 7 per cent, respectively. 20  However, Cepal’s overview suggests that the level of increased spending on social programmes is considerably less than that on infrastructure. This may reflect either political preference, or the difficulty of rapidly scaling up social protection programmes. It is much easier to expand prior social protection networks than to set up new ones from scratch, so El Salvador for example, has doubled to $300 the monthly payments in its Bolsa Familia-style cash transfer programme. In Chile, the government has agreed a one-off ‘reactivation bond’ to 400,000 poor families. Where social protection systems are more rudimentary, or where trade unions have argued more strongly for jobs, spending has been directed more towards infrastructure and bailouts for ailing companies. Elsewhere however, social protection has become a casualty of the crisis. In Peru, according to Anamper, a national coalition of local organizations of older people, the government was on the cusp of agreeing a means-tested non-contributory pension, a major victory for the poorest older people. Legislation has been drafted, media work was positive. In February, however, the Ministry of the Economy and Finance told Anamper that a social pension was ‘out of the question’ and that this ‘was not the time for increased social spending of the magnitude required for a social pension’. 21   Crystal ball For the last year, every revision of predictions for 2009 and beyond has been downward. The likelihood is that the recession will hit Latin America with a degree of lag – because the region has not shared the US and European banking crisis, the impact is transmitted through the real economy (falling trade and remittances). However, as the real economy slows, and bad loans mount some countries may face a second round banking crisis of their own. Moreover, governments’ ‘fiscal space’ to run counter-cyclical policies is finite. At some point, if the economy does not pick up, they may have to start cutting, rather than increasing, spending. There have been a number of attempts to identify vulnerable countries according to various criteria (see table): Most at risk countries in LAC World Bank (decelerating growth) IMF (Low Income Countries only) Economist (larger emerging markets only)  Argentina Haiti Mexico (12 th  out of 17) Brazil Honduras Brazil (10 th ) Chile St Vincent Argentina (8 th ) Latin America and the Global Economic Crisis, March 2009 4
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