Latin America: Is There Still Hope for a Recovery?

Last year, after surviving the worst recession since the crisis of the 1980s, Latin America began to experience a slow economic recovery. But the outbreak of war against Iraq has placed the region once again in the eye of a hurricane. One of the main obstacles to a Latin American economic upturn was uncertainty regarding a possible military conflict. Now that the uncertainty has ended, the region can only hope that the war’s impact on foreign investment, exports, and fluctuations in the price of oil will be minimal. That will depend on the length of the conflict and the behavior of the world economy, in particular, the U.S. economy.

In a global marketplace, no region is indifferent to what happens beyond its borders. Latin America is no exception. As a result, even before the war, generalized uncertainty around the world had a negative effect on the economy of the region. According to a report for the month of March from Dresdner Bank Lateinamerika AG, “the drop in global demand brought down exports and investment” in those countries.

“There had been hope that the Latin American economy would recover towards June 2002 because of the recovery in the United States. But that didn’t take place,” notes Rafael Arce, professor of applied economics at the Autonomous University of Madrid. “You have to remember that the past fiscal year was an unfortunate one. Argentina suffered from the devaluation of the peso, and in the Brazil of [president Luiz Inacio] ‘Lula’ [da Silva] there was a significant flight of foreign capital. There was even talk of a risk of default, which then did not take place.

“Growth in the region was very limited,” Arce adds. “It was thought that the region would grow as much as 3%, but that didn’t happen. In order to say that an emerging country is doing well, you need growth of between 7% and 8%, because that leads to significant economic wellbeing.”

The outbreak of war has acted like a pitcher of cold water on these countries, which can only expect that the situation will worsen – although the magnitude of the impact will depend, in large measure, on the length of the conflict. If it is short, the impact will be limited. According to analysts at Dresdner Bank, GDP growth in the region would be 1.5% in the “short” [war] scenario and would mean volatility in financial markets. Yet, individual economies “would not suffer distortions in the long term.”

“These economies are very dependent on the North American economy, and react with a delay of three months,” says Arce. “The American war … has at least broken the rhythm of expectations, and it has permitted uncertainty to disappear. If the war lasts only a short time, say 10 days, the economic recovery of Latin America will begin to arrive, in a modest way, after the summer – or in 2004 …” Under the most optimistic scenario, he adds, “this fiscal year can wind up better than the previous one, but below the levels that these countries need.”

If, on the contrary, the war turns into a long confrontation, that would have a harmful effect on Latin America’s anticipated economic recovery and, according to the German bank, “it would be necessary to completely revise the development projections for the zone for this year and for 2004.” Analysts at Dresdner Bank, as well as at the Inter-American Development Bank, agree in estimating that GDP growth for the region will amount to between 1% and 2% in 2003.

“Assuming a long war, growth for this fiscal year will stay on the same level as in 2002; in 2004 there will be a backward movement in the economy of the region,” Arce emphasizes, harking back to the first Gulf War to warn of a possible “misleading economic improvement. On that occasion, as a result of the increase in public spending on arms, uniforms, and so forth, there was a positive economic reaction to the war but it was followed by a global recession.”

Pre-war Optimism

Before the tanks began making their way toward Iraq, economists were looking at 2003 with a certain optimism. In part, that was a result of the devaluations of 2001 and 2002, which helped increase regional competitiveness and might possibly have boosted Latin American exports this year. Also, political uncertainty was expected to disappear with the conclusion of the election process in most Latin American countries. Argentina will have a new president in May. In Ecuador, Lucio Gutiérrez became president in January. In Brazil, the recently-named team headed by ‘Lula’ has already begun to take its first steps.

Nevertheless, the war has raised doubts about overcoming the crisis. In this time of uncertainty, oil provides the most positive piece of economic data for the region. Before the war, its price was sky-high, but since the beginning of the conflict there has been a downward trend that has benefited, in general, every Latin American country.

In the short term, a rise in the price of crude oil would be positive for countries that export oil, such as Argentina and Venezuela. But it could be damaging for them in the long term, since it implies a slower global economic recovery, and Latin America depends a great deal on other economies, especially the United States, for its growth.

Analysts have indicated that the behavior of oil prices depends also on the length of the conflict and on the condition of the Iraqi oil infrastructure after the war is over. It’s important to remember that Saddam Hussein’s army, before its retreat in 1991, burned 90% of the oil wells. If this happens, and if the combat lasts longer than expected, only those countries that are oil exporters will gain any advantage from the situation.

Venezuela would be among the countries that benefit most from an increase in the price of petroleum. Its balance of payments would improve substantially, since black gold represents 50% of that country’s public revenues. However, these positive results would be minimized by the effects of the strike in the country’s oil sector, where production dropped by 65% during the same period. Dresdner Bank analysts note that “recession in the country will continue, however long the war lasts.”

Another country that could benefit from an increase in oil prices is Mexico. Dresdner Bank analysts believe that “although it is possible that income from crude oil exports will rise,” Mexico could become significantly affected by a weakening of global economic activity – in particular, by the economy of the United States. In such a situation, exports to its northern neighbor would suffer significantly from any loss of economic strength. If the war winds up being brief, the German bank expects the Mexican economy to grow by 2.7%.

Tourism is another risky sector. “In the very short term, North American tourism could decline as a result of fear of air travel, as well as fear of possible [terrorism] attacks. But if the news is good, the [Latin American] region will become a favorite, since many Americans who travel to Europe prefer not to cross the Atlantic Ocean and will choose closer destinations, such as those in Latin America,” explains professor Félix López Iturriaga of the University of Valladolid.

“In any case, the main conflict that economies of the region are going through is an internal one. These countries’ own crises are, for them, more relevant than the war,” continues López Iturriaga. “But that doesn’t mean that the military confrontation does not affect their economies. They will see themselves affected because we all live in a globalized world.”

Argentina, Chile, Brazil

Other countries that could be hurt by the war in Iraq are Argentina, Chile and Brazil. Argentina, after its devaluation, found itself in a delicate economic situation in 2002. Analysts predicted a slow way out of its recession during 2003. Indeed, before the war, the biggest optimists were predicting that the best growth rate in the region would be Argentina’s where the Inter-American Development Bank was estimating an economic growth rate of between 4% and 5% this year, following a drop of 10.2% in 2002. According to Dresdner, in the event of a short war, the growth rate of exports would be affected by a weakening in the global economy, and would have a direct impact on GDP growth, which the bank put at 3.5%.

Brazil is one of the countries that would suffer the most from any economic instability resulting from the Iraq war. Foreign investors could withdraw from Brazil “because of the higher foreign debt and the poor condition of public sector accounts,” according to Dresdner.

 “Brazil has a more diversified economy than the rest of the region,” adds Arce. “Its foreign trade is divided – 25% with the European Union, 25% with the U.S., 18% with Argentina and Mercosur, and the rest [32%] with other countries. The recovery of its economy depends, therefore, on the European and American situation. A great obstacle has been the loss of its growth market toward the south, through Argentina.”

In addition, Dresdner Bank predicts strong growth in [Brazilian] interest rates, both external as well as internal, which would negatively affect investment and consumption. As a result, GDP growth is now estimated at 2%.

Chile appears immune to the crises of the Latin American economies. Nevertheless, a long military conflict would seriously shake the Chilean economy, since it depends enormously on imports of petroleum as well as on foreign commerce (exports have a 34% share.) According to the German bank, “the increase in copper prices could help stabilize exports” during the conflict.

If the war were short, GDP growth would not decline by much compared with the 3.3% rate estimated for 2003. Along the same lines, the president of the IDB affirms that “if [uncertainty over the price] of oil only lasts two or three months, it won’t have an impact, for example, on the Chilean economy. But if it goes on for a more prolonged period, it will end up affecting growth.”

Reprisals against Mexico?

Shortly after taking power, U.S. president George W. Bush affirmed that this was going to be “the century of the Americas,” referring to the will to tighten economic ties between the United States and Latin America. This objective must culminate in the signing of the FTAA (Free Trade Area of the Americas) treaty in 2005. Nevertheless, in accordance with the weak support most Latin American countries have given to the American attack on Iraq, it could be that this phrase remains nothing more than words.

Specifically, Chile and Mexico, both non-permanent members of the Security Council of the United Nations, are afraid that their overt opposition to the conflict will bring with it some economic costs that can tarnish bilateral economic relations, even though it is unlikely they will lead to concrete and specific actions. José Maria Peredo, professor of international relations at the Universidad Europa de Madrid, suggests that “these fears have a basis, since in bilateral relations there is always a set of interests that are constantly being exchanged. For example, you speed up an international treaty or you don’t.”

In this sense, Chile could be hurt in the commercial arena, since it already has a free trade treaty with the United States, pending ratification by the American congress. Chile’s failure to support the Iraq conflict could result in a decision by the U.S. to slow down approval of that treaty.

Chile’s attitude with respect to the war is hardly surprising because, according to Peredo, “that country always stays outside processes of economic integration (i.e., Mercosur, the Andes Pact) and is quite unilateral and independent. Chile’s position has been appropriate considering the country’s idiosyncrasies.”

The case of Mexico is different. Even though Peredo does not discard the possibility of concrete economic reprisals [against Mexico] he thinks that would be unlikely because “the country spent a long time fitting itself into the great free trade treaty with the United States.” In his opinion, the Fox government’s refusal to support the attack was surprising – precisely because that country, along with Canada, is constructing a “greater North America.” In that sense, continues Peredo, “the posture adopted by Mexico can be interpreted as an attitude of counterweight to the United States, to reaffirm its own sovereignty.”

Whether or not there are any reprisals, this much is clear: The countries of Latin America feel that they have gotten little support from the United States and the European Union at a time when they are facing the most serious crisis they have gone through in recent times.

Moreover, it is possible that their general opposition to the war against Iraq could make the region fall into oblivion. And that would have repercussions for the economic recovery that is so eagerly awaited.