Last year there was good news for the Latin American economies. The region’s recovery is stronger than expected and the growth forecasts of the World Bank and IMF have improved since six months ago. Vaccination campaigns and fiscal support have led to an economic recovery since the second half of last year, despite a marked loss of momentum in the third quarter of this year.
But the future looks uncertain. Latin America is caught between two major global forces that threaten the region’s growth: a potential decline in US capital flows as pandemic stimulus fades; and declining growth in China, where an energy crisis hits as the country’s depleted real estate markets turn. To weather the storm, countries in the region will have to focus their fiscal support and signal that medium-term frameworks will be followed, while doing what it takes to ensure that a private sector recovery can slow down the contraction. of the policy can compensate.
Even so far, the region’s recovery has been uneven and partial. This is largely due to differences in vaccination coverage – 75% of the population fully vaccinated in Uruguay, 5% in Nicaragua – and in the ability and willingness to provide fiscal support. By the end of this year, the GDP of most countries in the region will remain below 2019 levels, and no country is likely to reach GDP levels predicted for 2022 before the pandemic.
The recovery is partly due to the strength of GDP growth in the region’s largest trading partners – the US, China and Europe – as global financial conditions remained positive despite occasional hiccups. A rebound in commodities has cooled recently, as prices of some commodity groups have dropped or detained, but the terms of trade have generally improved for the resource-dependent countries of the region. According to the tracking by the Institute of International Finance (IIF), capital flows to Latin America recovered this year and slowed in the second half.
But the global landscape looks set to become more hostile, as trends in both the US and China are set to wreak havoc on Latin American economies. A global rise in inflation, driven by supply and labor constraints that are unlikely to disappear for the foreseeable future, makes interest rate hikes and an end to monetary stimulus likely for next year. Since late September, investors have been concerned about inflationary pressures in the US boosted revenues, thereby reversing a fall in market interest rates.
Some fear that changing monetary policy in the US could lead to a repeat of the 2013 Taper Tantrum as capital fled emerging markets. But capital flows to the region are not equally intense during the past years. For most countries, favorable terms of trade and reduced domestic demand have resulted in fairly comfortable external accounts. A repeat of 2013 seems unlikely, but domestic investment could fall if financial conditions deteriorate.
Meanwhile, China, the main buyer for much of Latin America’s exports, faces a slowdown in growth as GDP-stimulating activity in real estate markets stagnates, in a repeat of its economic rebalancing after the 2008 financial crisis. The immediate effects of the collapse of Evergrande, a heavily indebted Chinese real estate company, and other real estate companies may remain largely contained domestically, but the resulting macroeconomic slowdown is already visible in the latest figures . China’s new growth rate could take its toll on both exports and commodity trading conditions for the region.
Latin American countries can do little to change these global trends. How can they best navigate through it? The best option may be to just focus on the domestic front. The legacy of the pandemic of higher government debt means that fiscal and financial support must become more selective, targeting the most vulnerable companies and workers. Countries in the region that typically face tight fiscal space (Brazil, Colombia and to some extent Mexico) will shy away from new spending. Those still in more favorable territory, such as Chile and Peru, still have to anticipate tighter external financial conditions.
Limited policy space and social pressure amplify political risks, but spending cuts mean heavy reliance on the private sector to fuel the recovery. The recent experiences of Mexico and Peru have shown how policy uncertainty can hold back private investment. The region will have to rely on greater efficiency, spending less and ensuring that money is spent helping the populations hardest hit by the pandemic crisis.
In the longer term, attention should be paid to the fact that an incomplete economic recovery has led to weak labor markets, scars and “shadow” unemployment. Hence the relevance of implementing policies for retraining and reskilling workers. Like Carlos Felipe Jaramillo, Pepe Zhang and I have recently discussed, Latin America has already partially achieved high-income status, but a significant proportion of the population is highly vulnerable to economic shocks and natural disasters. The pandemic has made it painfully clear that the region urgently needs a vulnerability-based approach to understanding and tackling poverty.
All opinions expressed in this piece do not necessarily reflect those of Americas Quarterly or its publishers.