August 11, 2020

Volume X, Number 224

August 11, 2020

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August 10, 2020

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Latin America’s Slump Masks Big Economic Differences

The IMF and World Bank have now opened their fall meetings in Lima, Peru — forty eight years since the last time they met in Latin America. The twelve countries of the Trans-Pacific Partnership (TPP) (which includes the U.S. and Canada, Mexico, Chile and Peru) have just agreed on a historic deal to reduce trade barriers and harmonize approaches on labor and the environment. It is a good time to examine the regions’ complex economic and political realities, which will no doubt occupy the economic officials and business investment community gathered in Lima.

There is a lot going on in Latin America right now. The global recession which began in 2008/2009 ultimately walloped every country in the commodity-dependent region hard, threatening to stall or reverse important but insufficient economic and social gains painstakingly made since the “lost decade” of the 1980s. It also laid bare vulnerabilities and structural issues that were far less visible during the booms in China’s growth and in commodity export prices which buoyed Latin American growth until recently.

The region’s commodity-fueled above average growth actually lasted from 2004 to 2011, with GDP growth often exceeding 6 percent per year in major economies. But since then, as China’s growth slowdown really took hold and oil and other commodity export prices fell, things have turned sharply negative for some of its largest economies. There will be no growth at all in 2015, and countries such as Venezuela and Brazil will actually lose ground. The human toll of unemployment and lost economic ground is palpable; people in most countries of the region have grown impatient with their leaders and politicians, as in other parts of the world. But the macroeconomic starting points and policy reactions of the biggest economies — Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela — have been markedly different, and produced very different economic results.

And now, with China’s growth slowing further, overall commodity prices are slumping again and many (including IMF Managing Director Christine LaGarde) worry about global slowdown. Steady U.S. growth has provided some economic stability for the region, especially for those countries well-integrated with the North American economy, such as Mexico, Chile, Colombia, Peru, Panama and Ecuador. Still, when U.S. interest rates finally do rise, so too will external financing costs for all emerging markets, many still recovering from the last “taper tantrum.”  No one credibly paints a rosy picture for Latin America in the next few years, despite recognizing the region’s importance, its great potential for development and the enormous contribution that its youthful human and natural resources could make to global prosperity. The best that seems likely is “mediocre” global growth.  For some countries in the region, updated policies will be essential to stave off recession. Others look far better positioned.

Economic pain, popular frustration and elections are forcing frank discussions throughout the region. The role of government in the economy, how to raise productivity, competitiveness and accountability, and how best to deliver lasting improvements in living standards to the region’s people are being debated fiercely. To understand business and investment risks and opportunities going forward, the underlying differences between key economies need to be carefully unpacked.

Since overall regional growth dipped some five years ago, the economies of the Pacific Alliance Countries (Chile, Colombia, Mexico and Peru) — have substantially outperformed the regions’. Their GDP’s grew substantially (perhaps 40% to 50%) faster, investment rates were far higher and inflation markedly lower. Even before the recession, these economies had lowered trade and investment barriers, worked to integrate their economies and taken steps to improve business climates, support competitiveness and ensure stronger banking systems and access to global capital markets.

Together Pacific Alliance countries comprise 200 million people, a capital market as big as Brazil’s and together they would equal the world’s ninth largest economy. They are not without problems — their open economies allowed sharp stock market losses when investors pulled out early on in the downturn. More still needs doing on democratic inclusion and accountable governance, as well as to ensure that regulations and policies do not impede productivity and private initiative. But investors are being lured back by their relatively stable economic and political conditions. In late September, the four Presidents launched in New York a global roadshow on “Investment Opportunities in the Pacific Alliance Countries” which has continued to London and Singapore. Mexico is fresh off of a successful international auction of oil drilling rights, after taking practical steps to improve terms for investors. The IMF and other experts believe these countries have the access to international capital markets and the fiscal and financial health to weather potential global headwinds, and to make continued progress on development for their people.   Mexico, Chile and Peru also joined the Trans-Pacific Partnership deal just reached, which will further integrate them into the global economy and bring down trade and production costs.

Brazil, on the other hand, faces strong macroeconomic headwinds — private debt and the current account and fiscal deficits are very high, public confidence is low (especially after the far-reaching Petrobas corruption scandal). To date, rather than opening up and integrating with global and regional markets, Brazil has championed MERCOSUR, a customs union which in effect safe-guards its most protected industries. And concrete steps by Brazil’s Congress to rein in spending and to bolster economic competiveness — which likely would further anger voters — appear stalled by the difficult politics. The country has had access to international capital markets, but Moody’s recent decision to downgrade Brazil’s foreign currency sovereign debt to near “junk” bond status — the first time since 2008 — has spooked investors into abandoning Brazilian bonds. Brazil’s GDP and industrial production plunged this year and the Brazilian real is now spiraling downward, along with the popularity of the government, as interest rates and inflation head towards the sky. Sadly, with the weight of negative global conditions and domestic policy stasis, things in Brazil are widely expected to get worse before they get better.

Argentina and Venezuela share dismal economic similarities — limited access to international capital, high inflation and interest rates, high and growing deficits, low investment, falling foreign exchange reserves and dried up markets for their commodity exports. While Argentina’s economy is large, diverse and full of potential, experts expect it to contract again this year and any growth next year to be very low. National Presidential elections to replace outgoing President Kirchner will be held on October 25, so Argentina is in the midst of a tumultuous political transition. President Kirchner’s populist policies had expanded social benefits and reduced poverty in ways that were recognized. But extensive nationalizations, much higher taxes (including on agricultural exports) and other impediments to private investment have also alienated the business community and driven foreign investors to take a pass on Argentina, despite an uptick in their bond market based upon hopes of post-election policy improvements . If the elections do not lead to new policy approaches, Argentina’s economy is expected to remain a tough and risky place to do business.

Venezuela is almost unique in its degree of economic tragedy. At nearly 150 percent per year, its inflation rate is the world’s highest. In Mexico and Chile inflation is running well under 5 percent annually, despite the global recession. Venezuela’s GDP is expected to contract sharply this year, perhaps by over 6 percent, far the worst performance in a hard-hit region. Many international companies (banks, consumer product and manufacturing companies) have written off large losses in the past 12 months, and some have simply given up trying to operate in Venezuela. Venezuela’s markets and investors are shackled by a dramatically overvalued exchange rate and tight currency and price controls. Shortages of food and other basics exist alongside the rampant smuggling and hoarding typically experienced with heavy market controls. Kidnapping and violent crime are now so high that the U.S. State Department warns citizens of the dangers. Deportation of thousands to Colombia and a sizeable build-up along the border by Venezuela’s military, and it claims Guyana’s territory, have unleashed real concerns about regional conflict and the potential for Venezuela’s complete meltdown. And every single member of Venezuela’s Parliament faces an election on December 6.

Clearly, falling oil prices hit Venezuela particularly hard, but others in the region suffered the collapse of commodity export prices without such dire consequences.  Policy choices, and incentives, matter. Taking the long view of history, Latin America as a region clearly has not yet fulfilled its potential for growth and development, especially compared to East Asia’s successes.  Throughout the region, more transparency, accountability, participation and competition — especially in public expenditures, major projects and procurements — are needed to bolster trust, ensure productive results and accelerate progress.   International institutions such as the World Bank, IMF, Inter-American Development Bank and others such as the U.S., Canada, Europe and China should cooperate as partners in support of such game-changing reforms.

In order to manage the risks while participating in realizing the opportunities, investors must be aware of the extraordinary diversity in economic realities, policy and regulatory approaches and political dynamics in Latin America. The regional economy may reflect global booms and busts, but beneath that are dramatically different national realities.

Latin America has already produced examples dramatic, positive national transitions and transformations. We are convinced that the positive results achieved by the Pacific Alliance countries can be expanded, duplicated and multiplied to make Latin America a global engine of growth, rather than a victim of commodity-driven boom and bust, and political turmoil. U.S. and other investors want to be a part of that success, and have much to contribute. If the economic doors open and regional leaders welcome them with the understanding that all types of business can succeed alongside poverty reduction and social progress, this could finally be Latin America’s “found” decade.

© 2020 Covington & Burling LLPNational Law Review, Volume V, Number 282

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About this Author

Anne Pence, International Advisor, Covington Law Firm
Senior International Adviser

Constance Anne Pence, a non-lawyer, is a senior international advisor in Covington’s Washington, DC office. As a policy-oriented economist for over 20 years, Ms. Pence has tremendous experience advising sovereign and corporate clients, as well as coalitions in both domestic and international policy settings. Before joining Covington, she was the special advisor to the newly-created USG Millennium Challenge Corporation.  Ms. Pence also served with the U.S. State Department for 16 years.  For eight of those years she was the Department’s G8 Summit policy coordinator in the Office of the...

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