August 4, 2011, was a day that will be hard for Latin America to forget. On that Thursday, the principal stock markets in the region and the rest of the world succumbed to fears of a possible new U.S.economic crisissimilar to the one that broke out in 2008.
Amid the desperate efforts of market operators to calm investors, the Brazilian stock market index Bovespa in São Paulofell by 5.72%, the IPSA (Selective Index of Share Price) in Chile posted a decline of 3.94%, and Mexico’s index (the Bolsa Mexicana de Valores) experienced a decline of 3.37%.
The discouraging episode began 24 hours earlier, when the U.S. Congress was debating against the clock over Republican and Democratic plans which would each raise the debt ceiling and simultaneously reduce the country’s large deficit. Last May, when the U.S. reached its debt ceiling of $14.29 trillion, the White House made it clear that Congress needed to raise the ceiling to reduce itsliabilities before August 2, or the government would run out of funds to pay its bills.
After intense debates that plunged economies around the world into deadly suspense, Democrats and Republicans finally reached an agreement to approve a new ceiling for the debt. Nevertheless,the failure of Congress to reach a consensus without any delay had created uncertainty that was felt resoundingly in the markets on August 4, a day now known as "Black Thursday."
The climate of distrust further worsened in the days that followed, after Standard & Poor’s decided to lower its rating of the credit worthiness of the U.S. from “AAA” to “AA+.” Analysts at the firm justified that as necessary because, in their view, the plan that Congress had agreed on was not strong enough to stabilize the condition of the national debt over the long term. Analysts at Standard & Poor’s also warned that political and economic tension in the United States could worsen the already difficult situation facing Europe, considering the significant budget imbalances in countries such as Greece, Portugal and Ireland – and, to a lesser extent, Spain and Italy.
Without doubt, the American "debt crisis" led to two important phenomena, says Joseph Ramos, professor of macroeconomics at theUniversity of Chile. "The first is that the market became aware that Republican Congressmen can make it harder to take the steps that are needed to to address the economic recovery,making this process move more slowly.” The second result, he notes, is that expectations that the U.S. economy will rebound and grow by 3% "have been absolutely thrown out, as analysts forecastan expansion of just 1.5% or even less."
According to Ricardo Patiño, the foreign minister of Ecuador, this slow growth rate is a sign that the United States is not moving in the direction that many had hoped for, and the U.S. runs the risk of having its economy slow down suddenly with no point of return.In an interview with a radio station in his country, he said that global GDP is now close to US$60 trillion, and the foreign debt of the United States exceeds US$14 trillion. "There is a possibility that it will increase to a point where the [U.S.] government cannot cover that debt, and the international upheaval that this would produce would be phenomenal.” He emphasized that the situation is worrisome, and “Latin America must take measures.”
A ‘Poorly Healed Wound’
Some analysts do not share that alarmist view. José Oscátegui, professor of economics at the Pontifical Catholic University of Peru, argues that at the moment, “we are only living on the brink of a slowdown in global economic activity, which is nothing more than a poorly healed wound from the debacle that erupted in 2008.”
In an effort to counteract the unfavorable situation created by the country’s real estate bubble, the U.S. government increased fiscal spending and, with that move, its debt, notes Roberto Durán, professor of international relations at the Pontifical Catholic University of Chile. “This was a reactive measure that partially alleviated national accounts.” The problem, he says, is that the United States has accumulated a deficit “of an extraordinary volume, which has begun to jeopardize the competitive advantages of its economy and [the economies] of the rest of the world.”
In addition, after the global financial crisis broke out, the countries of the European Union (EU) intensified their fiscal stimulus programs, increasing their spending to compensate for the strict monetary policy that was applied by the European Central Bank (ECB). In this way, they were able to mitigate the effects of the crisis, notes Victor Valenzuela, professor of economics and finance at Andres Bello University in Chile. “The result is that the fiscal deficit of Greece, Portugal and Ireland, which were already heavily indebted and had competitiveness problems, has shot up.”
Although the EU and the ECB have been working intensively on a package of measures to avoid the contagion of a massive default in Europe — thus helping to calm financial tensions — such initiatives have not been enough to regain the confidence of investors.
In other words, the international situation provides little encouragement for Latin America, notes Oscátegui. However, he makes it clear that in no way could this reach the devastating levels that characterized the crisis that took place 2008. “Nor could it wind up dragging down Latin American markets in the way that it did at that time.” The reason for that, he says, is that authorities in both the United States and the EU know what they have to do in order to counteract the impact of the slowdown “and to keep it from becoming a major crisis.” While there are political obstacles, he adds – referring to the Republican opposition in the U.S. Congress — “the authorities are aware of the high costs of not taking measures in this case.”
One of the best examples of this is the joint action taken in mid-September by the European Central Bank, the U.S. Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank, which agreed to loan European commercial banks the amount of dollars that they need in exchange for certain guarantees. Although some analysts said this measure was too late, it was directed precisely at guaranteeing sufficient liquidity for the U.S. currency and diminishing the volatility of the markets. Thus, “it was a demonstration that the central banks are going to do what they must in order to preserve the stability of the system,” noted Christine Lagarde, managing director of the International Monetary Fund, in a statement to the regional press.
In addition, the Fed announced at the end of September that it will maintain low interest rates (between 0.0% and 0.25%), and that it will exchange US$400 billion of short-term Treasury bonds in its power for other bonds that have a longer-term maturity. Its goal is to stimulate the slow, longed-for economic recovery of the U.S.
The Impact on Latin America
Nowadays, volatility and caution dominate the financial markets, which closely follow every move made by monetary authorities in the United States and Europe. However, export activity in Latin America has remained stable, without any major surprises in the prices of raw materials, says Ramos. Nevertheless, Ramos cautions that if the U.S. and Europe officially enter a recession, “that will have an impact on the commodities that the [Latin American] region exports to the United States and Europe [copper, iron, petroleum, soy beans, salmon, coffee, fruits and agricultural products, among others], and it will also have an impact on the investment climate.”
But the consequences will depend on how much exposure each Latin American country has to other markets, adds Javier Bronfman, professor at the School of Government of the Adolfo Ibáñez University in Chile. That’s because “it is very likely that the more open nations and those that ship more primary products to the United States and Europe will experience more problems [than other countries].”
For that reason, economist Ricardo Patiño, Ecuador’s foreign minister, has called on governments of the region to diversify their target markets to include other, new destinations while also increasing their own trade with other countries in the region.
While Oscategui recognizes that is an effective strategy, he believes that export diversification and trade integration in Latin America are both challenges that the countries of the region have made progress addressing, “at a slow but steady pace, through numerous significant alliances such as Mercosur, ALCA [the Free Trade Area of the Americas], UNASUR [the Union of South American Nations] and ALADI, the Latin American Integration Association.”
To mitigate the impact of a potential global recession, notes Oscátegui, Latin America should undertake other actions. “One of these is to follow the recommendations of the IMF, which suggests that nations that have low debt and significant foreign currency reserves should apply a counter-cyclical, expansive fiscal policy; expanding their spending while demonstrating their capacity to maintain a long term fiscal equilibrium.”
A Counter-cyclical Policy
According to Valenzuela, Chile and Peru are ideal candidates to apply a counter-cyclical fiscal policy since these nations’ level of indebtedness is low, and both countries have significant economic reserves. Since 2007, Chile has had its Fund for Economic and Social Stabilization (FEES), now valued at about US$13 billion, and it is looking to finance any eventual fiscal deficits, given the fluctuations in the global economy. For its part, Peru’s Fund for Fiscal Stabilization (FEF in Spanish) is currently nearly US$4 billion, “which gives sufficient confidence to both local and foreign investors,” adds Oscategui. In addition, he says, Peru has been growing at high rates of between 8% and 9% during the past three years, and “it is very likely that as a result of the deceleration, the country will only grow by 6% or 6.5% this year, which is still a good forecast.”
Brazilis another country on track to implement an expansionary fiscal policy, says Oscátegui. It achievedsignificant economic changes several years ago, "which have enabled the country to become one of the leading powers of the region today." Among those changes, he notes, are the fact that it kept inflation at bay, strengthened its flexible exchange rate, increased the fiscal surplus, and created reserves in various foreign currencies in order to reduce its external vulnerability.
Argentina is one of the countries of South America that has been growing the fastest in recent times, says Valenzuela. In fact, according to a report released in March byArgentina’s National Institute of Statistics and Census (INDEC), the nation’s GDP grew by 9.2% in 2010. "In short, the importance of the crisis becomes less if the country is growing sinceArgentina also has a capacity to implement a countercyclical fiscal policy [as a result]." However, some local analysts have noted that if the Argentine government opts for an expansionary fiscal policy, it will have to resort to financing from the Central Bank of Argentina (BCRA).
Apparently, there are only a few countries in the region that could follow the recommendations of the IMF. As a result, Bronfman recommends that the other nations monitor their rate of indebtedness, provide state subsidies to their weaker economic sectors and promote hiring, among other measures.