Regional Survey: Latin America

Figures valid as of April 26, 2009.

I recently spent two weeks in Buenos Aires and to the casual tourist, Argentina seems to be doing well. Condo construction proceeds apace in the brand new Puerto Madeiro district, luxury hotels charge well beyond the budget of all but the wealthiest traveler, busy streets are full of trendy shops, and there is a range of quality Argentine-produced goods in stores and supermarkets. The country is remarkably self-sufficient, growing most of its own food and manufacturing a wide range of its own goods, from cars to clothes to petrochemicals to heavy industry. The media paints a different picture, but I’ll get to that.

Argentina is but one country in Latin America, a vast region blessed with natural resources but not so blessed by history. Any survey of this area must zero in on the two regional giants: Brazil, trying to forge its own path, and Mexico, a bit too close for comfort to the economic giant to its North. To understand how these countries are coping with the current world economic crisis, one must first rewind a decade…

Latin America then …

The last time South America was in economic turmoil, it was a continent-wide contagion. The recession of 1998-2003 witnessed insolvent corporations, massive layoffs, and a deterioration in banking systems across the southern continent. Argentina’s currency collapse in late 2001 provoked major protests, wiped out savings accounts, and churned through five presidents in two weeks leading up to the government’s US$ 93 billion default on its public debt. Argentina’s problems spilled over its borders to Brazil, its huge neighbor to the north.
Meanwhile, Mexico went through its own currency crisis in 1994, when US President Clinton had to risk public ire to bail out his southern neighbor by assembling a $20 billion loan package with the help of the International Monetary Fund (IMF). The later 1990s witnessed solid gains in its economic stability as Mexico integrated ever tighter into the US economy.

For Latin Americans, the IMF was a prominent force during this tumultuous period. Argentina took on more and more IMF debt until it was denied funding in 2001, leading to its default. In 2002 Brazil was forced to borrow $30 billion, the largest rescue loan in the history of the IMF.
The IMF loans came with strings attached, including strict conditions relating to government policy. Governments could do little to address the bleak recessionary times except to introduce ever more painful measures (‘bitter medicine’, they promised). Many in Latin America blamed the IMF for their troubles at the time—troubles ranging from capital flight to massive unemployment to frayed social programs.

What a difference a decade makes

Today, Latin America continues to face more fiscal and policy hurdles than more developed countries. The 2009 OECD outlook for the region reports that the Latin American performance gap remains high, due to the tendency for Latin American governments to rely on volatile non-tax sources (such as resource royalties) and regressive indirect taxes (such as goods and services taxes). Limited tax income means there is less money available for public spending, social transfers, and development.

Putting aside OECD measures, we can still be impressed at how the Latin American countries have improved their situation over the last decade. The formation of the southern common market MERCOSUR is one example of how they have marshalled their vast resources and populations to sustain a robust internal market.
The political unrest that dominated the continent for most of the 20th century has largely dissipated (with a few exceptions of course), replaced by functioning left-of-center democracies. Through gritty determination (and some loans from Hugo Chavez), Brazil and Argentina have detached themselves from the IMF. Indeed, the Latin American reluctance to deal with the IMF and its laissez-faire supply-side economics has ironically put the region in a better position to ride the current storm than those more developed countries that put too much faith in their unregulated financial sectors.

Brazil and Mexico in particular ensured through fewer debts and higher reserves that they had the ammunition to use counter-cyclical monetary policies to prop up economic activity in economic crises such as the one they now find themselves in.

Brazil: Fading immunity

Brazil is a decade-long success story. Its government is stable and doing better at keeping the wild west mentality in check (presuming the successor to President Luiz Inácio Lula da Silva, whose term limit expires next year, can keep a steady hand on the tiller). Brazil has vast resources, including a rapidly expanding oil industry. Brazil’s banks, once thought hamstrung by government controls, have fared much better than their less regulated peers in the US or UK. Brazil’s macroeconomic policies, flexible central bank, higher reserves, diversified exports and relatively self-sufficient economy means it is not as exposed to the economic structural problems now being faced by some other more developed countries.

Going into the current crisis, Brazil had US$200 billion in its war chest.
In January, Brazil slashed its benchmark overnight interest rate (the Selic), injected some US$100 billion into the banking system and currency markets, reduced taxes, and offered new credit lines to the agriculture and industrial sectors.

As the crisis wears on, Brazil is starting to show the strains. As recently as this January, Brazil had an impressive rate of net growth in formal employment of 200,000 jobs/month (with the unemployment rate down to 6.8%, the lowest point in seven years). Since January, however, Brazil has lost jobs at a breakneck pace, with big layoffs at Embraer, Vale, and other national standbys. Unemployment has shot up to 9%, with job loss counts rising each month (141,000 in March alone). Brazil’s exports have fallen 20% and industrial production has dropped by 17% from a year earlier in February.
This is down from December’s figure of 12%, which was then the largest drop in 17 years of record keeping.

Whereas recent indications were for continued healthy growth through 2009, Brazil’s economy is actually shrinking (down 3.6% last quarter). The jury is now out on whether Brazil can leverage its large market and copious resources to wait out the storm.

Mexico: NAFTA Hangover

Although it may have done many of the same things right as Brazil (and has a manufacturing base that is now lean and efficient), Mexico is way too integrated with the US economy to receive an immunity badge from the current economic crisis.
Many of its standard sources of income are down: exports (of which the USA buys 80%), crude production, remittances from Mexicans living in the USA (down 6% in January). Even before this week’s swine flu epidemic, foreigners were not investing in the country, perhaps scared off by a nasty battle with the drug warlords, or perhaps generally joining the ‘flight to safety’ of US investments. FDI is down 32%, and the risk premium on Mexican bonds at 1000 basis points is now five times that of the USA. As a result of all of this, Mexican companies are losing out and the peso was down the most of any major currency as of early March, despite vociferous complaints from the Mexican government. The peso gained against the US dollar since then, but started falling again this week because of the growing health epidemic.

Going into the crisis, Mexico had $120 billion in reserves, and started to use these funds for counter-cyclical policies. In January, it lowered its benchmark interest rate and dispensed upwards of 3% of its GDP in fiscal stimulus.
On March 31, Mexico signalled that it was ready to take out a precautionary flexible credit line of $47 billion from the International Monetary Fund to support the reserves of its central bank. The credit line criteria required sound public finances, low inflation and a stable banking system, so in a way it was a compliment to Mexico’s fundamental stability.

Now Mexico must focus on getting its economy back on track. One avenue would be to look to other markets. Mexico has the largest number of privileged export-import deals of any country on earth, but up until now has depended almost exclusively on NAFTA.

And then there’s Argentina…

Despite my sunny impressions of Argentina, the media paints a far gloomier picture: a population not able to keep up with heightened rates of inflation, a government teetering on the brink of default (again), drought-stressed farmers resisting their government’s efforts to make them pay even more export taxes, a flight of US dollars out of the country, and foreign investors scared off (yet again) by the recent nationalization of US$24 billion of private pension assets by the government of Christina Fernandez de Kirchner. So perilous is the government’s situation that Fernandez has decided to move up the national elections from October to July before things go from bad to worse (in contravention of electoral term laws put in place by the former president, her husband Néstor Kirchner). Because of the various restrictions on capital, MSCI Barra, a global research firm, has recently downgraded Argentina from ’emerging market’ to ‘frontier’ status.

I may be suffering from gloom fatigue, but I’m not sure the media has quite captured the entire picture. Argentines have grown to expect economic crisis every decade and have become skilled at being self-reliant and squirreling their funds away. The lack of foreign investment over the years has necessitated home-grown solutions. Indeed, the country has become such a cauldron of startups and think tanks (PDF) that one expects the country will continue to succeed despite, or perhaps because of, its decennial crises.

Now that the entire world seems to be in the same Sargasso Sea of economic stagnation, maybe there’s something to learn from a society, and region, that has learned prudence from previous economic crises, and a certain pluck to succeed despite it all.

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