GLOBAL GLOOM PLACES LATIN AMERICA ON ALERT / THE FINANCIAL TIMES ( A MUST READ )

October 5, 2011 5:59 pm

Global gloom places Latin America on alert

By John Paul Rathbone, Latin America editor


Every day Luis Castilla, Peru’s finance minister, says he lights a candle and “prays that China won’t crash”.


His prayers are echoed by many in a region that remains one of the world economy’s few bright spots. South America’s commodity-rich economies grew 5 per cent in the first half of this year. Last year, these new motors of the world economy added half a percentage point to global output.


But slowing Asian demand and plunging commodity prices have raised the spectre that South America, having largely escaped the 2008-09 Great Recession, may not be so lucky this time around.


Another recession would “hurt more than last time, as there won’t be the same positive effects from [growth in] China and India,” Sebastian Edwards, the World Bank’s former chief Latin America economist, said. A recession “would be more global, so it would affect us more”.


Abetted by US and European gloom, markets have swiftly priced in that possibility.


Copper, an export mainstay of Chile and Peru, respectively the world’s largest and second biggest producers, has fallen 27 per cent this year to $6,990 a tonne, below its five-year average. Soya, which accounts for a quarter of Argentine exports, has fallen by 11 per cent.


Meanwhile, oil, which accounts for 90 per cent of Venezuelan exports, has held up relatively well. But at $100 a barrel, Brent is 20 per cent below this year’s peak and only $17 above its five-year average. Further falls would limit President Hugo Chávez’s ability to boost spending before the 2012 elections.


Nonetheless, tight commodity supplies mean most predict only a downwards blip in commodity prices, rather than a crash.


“On a 12-months to two-year view the outlook is very good,” says Catherine Raw, natural resources portfolio manager at BlackRock, the fund manager.

Still, if the commodity price drop does prove prolonged analysts say there would be three main effects.

Tax revenues would fall and investment in marginal mining projects postponed or even cancelled. Peru alone has been expecting more than $40bn of mining investment.


“I really believe that [the drop in prices] will affect the decision for projects that  looked quite interesting with high prices,” Diego Hernández, chief executive of Chilean state-owned copper company Codelco, said.


“Now people will be much more cautious. I really believe that some of those projects will be delayed.”


Second, current account deficits would widen. In an extreme scenario – commodity prices dropping to the depths they fell to in early 2009 – Brazil, Chile, Colombia and Peru would run current account deficits in excess of 5 per cent of gross domestic product, estimates Capital Economics, a consultancy.


Third, a drop in commodity-related capital inflows would force exchange rates lower. That might help Brazilian and Mexican exporters of manufactured goods. But it would also crimp local purchasing power and curb consumer credit booms, both of which helped drive Latin America’s decade-long economic boom.


“Unfortunately, consumer credit and appreciating currencies are the main drivers of the consumer boom,” says Walter Molano, emerging markets economist at BCP Securities. “That means that it is vulnerable to a reversal in external conditions.”


To counter a domestic slowdown, the region’s better-managed economies still have powerful weapons to deploy. Interest rates have ample room to be cut, sovereign debt levels remain low and foreign reserves are high.


Against that, countries have less fiscal ammunition to fire off than they did a few years ago. The International Monetary Fund warned this week that government spending continued to run ahead in Argentina and Venezuela in particular.


Elsewhere, much of the region is also running structural budget deficits after unleashing powerful stimulus packages in 2009, although Latin America has generally managed the recent commodity price rollercoaster better than previous cycles.


Nobody, therefore, is predicting doom for a region that in many ways is in better macroeconomic shape than the developed world. Banking systems are sound – even if much of them are foreign-owned. Fiscal accounts are solid. And inflation is low.


The International Monetary Fund said in a report on Wednesday that the global economic slowdown will result in a “modest worsening” for Latin America’s fast-growing economies in 2011 and 2012.


Still, a prolonged commodity price drop would pose the first real test of what has almost become the region’s new economic orthodoxy. “Lulismo”, named after former Brazilian president Luiz Inácio Lula da Silva, combined social service provision with macroeconomic stability and lifted millions out of poverty. But it was also possible in large part thanks to cheap capital and the commodity boon.


“Every good sailor knows that if favourable tailwinds turn into stiff headwinds, you can’t keep up speed,” says Nicolás Ezaguirre, director of the IMF’s western hemisphere department and a former Chilean finance minister. “This is the biggest danger now: that governments try to keep up their speed by launching stimulus packages prematurely.”
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Additional reporting by Javier Blas and Jack Farchy
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Copyright The Financial Times Limited 2011