Alarm bells are sounding all over Latin America as the credit freeze starts to exact a grim toll on jobs, employment, and confidence. Latin America’s aggregate financing needs in 2009 are more modest than those of Russia and Eastern Europe, but credit needs are l enormous and the global competition for funding severe for 2009, at least, and who really knows for how much longer after that?
Taking into account the regional current account balance that will plunge into deficit in 2009 and the substantial rollover requirements of Latin sovereign and corporate borrowers, financing needs are on the order of at least $250 billion. In fact, if short-term lines of trade finance are not renewed by foreign banks and if domestic banking and capital markets continue to contract as a result of a global flight to quality, the credit need could be twice as high, perhaps $500 billion.
Finding this much capital while minimizing the damage to growth must be the main concern in Latin America today. Make no mistake. The global flight to quality is going to leave the region out in the cold.
In its 2009 outlook, JP Morgan researchers find no compelling reason for investors to favor Latin American bonds, for example, over U.S. FDIC-guaranteed paper or U.S. high-grade corporate bonds, each of which offer comparable or even better yields. Latin American equity markets were the first to feel the effects of the “great sucking sound” produced by the exit of foreign capital; most of them are down on the order of 50-70%. Now the fixed income markets and syndicated loan markets for the region are caught in the vise of the freeze. No Latin American issuer has been able to come to the market since early September. Even bread-and-butter trade finance is in danger of drying up in Latin America. Slowly at first, but now at an alarming pace, the wheels are coming off the global financing machine in that has fueled the encouraging spurt of growth in Latin America in recent years.
The fear is rising that the region faces a period of prolonged currency weakness and stronger recessionary pressures than those currently anticipated in the marketplace. Yes, it is true that the region has some $450 billion in foreign exchange reserves and these should help to cushion the impact of the credit freeze. However, the frightening experience in Russia has shown that these reserves can evaporate quickly. Moreover, the credit freeze could linger for a very long time making it inadvisable for Latin American countries to burn reserves to defend exchange rate levels that might prove indefensible or to finance the exit of foreign investors who have no intention of returning.
Latin America is still in a period of relative strength by comparison to its state of preparedness in previous crisis periods. Fiscal accounts are in relatively good order, for example, the aggregate current account balance has been in surplus, and growth in the last six years has been stronger than at any time in the last forty years. Government external debt levels are far more prudent today and local capital markets have been taking up an increasing share of financing needs.
However, Latin America is still a very poor region and structural reforms are not well rooted. Some of the impressive economic statistics of recent years are little more than a thin veneer over vulnerable economic structures and societies. The plunge in global commodity markets is likely to thrust the balance of payments into deficit. Fiscal accounts are already under strain with declining tax receipts (often linked to the value of commodity exports). Promising investment projects are no longer finding international financing. Foreign direct investment flows are likely to wither. Local capital markets are reeling with the sudden stop and reversal in foreign credit and equity flows.
The issue is what Latin America can do and what the global community ought to do to head off a severe economic crisis in the region in 2009. Consensus forecasts show that the region’s growth will come to a screeching halt in 2009, with aggregate GDP barely growing and even that forecast dependent upon a U.S. recovery after mid-2009. The same JP Morgan report puts aggregate growth in Latin America at 0.9% in 2009, down from almost 5% in the last two years.
The region does have some resources of its own. Argentina, Brazil, and Mexico have been among the many Latin countries announcing some sort of increase in counter-cyclical fiscal spending. Chile is using its self-insurance, although it is the only country in the region remotely able to do so. Central Banks have been active to dampen currency volatility with only a modest loss of reserves to date. The Fed swap lines have been helpful to Brazil and Mexico. The IADB and the World Bank are stepping up their lending. Mexico, for example, plans to borrow some $5 billion from the multilaterals in 2009 after many years of reliance on the private markets.
When all is said and done, however, these sorts of actions will not amount to more than short-term palliatives. The reality is that fiscal policy in Latin America is likely to be pro-cyclical, perhaps viciously so, as authorities react to plunging tax revenues and alarming exchange rate pressures by cutting spending and postponing infrastructure.
My strongest conviction is that the region cannot and should not be left solely to its own resources as it copes with a crisis that came from outside the region.
Latin America should not be left on its own because the drastic declines in GDP growth forecasts for 2009, even under optimistic scenarios for global recovery, imply intolerable human costs. Early estimates suggest that at least 20 million people in the region will fall below the poverty line as a result of the crisis, and an untold number will be pushed into the ranks of the desperately poor.
And Latin America should not be left on its own for a much more pragmatic reason. It can play a constructive role in a global economic partnership to restore prosperity and to create a more balanced and sustainable global economic model in the medium-term. This would be a model which does not depend on the richest nation in the world consuming ever more in order to generate jobs in the poorer countries.
Latin America needs substantial assistance on an emergency basis from the multilateral lenders and other sources to avoid a severe adjustment in output and employment in the current crisis. The IMF’s SLF is a start, but the remaining $200 billion in this facility is woefully inadequate for the needs of the emerging world. The World Bank and the IADB are ramping up lending to the region, but they are limited in their ability to respond.
In the face of a possibly catastrophic reversal of fortune in Latin America, what is to be done?
A place to start would be to pay careful heed to the recommendations of the Latin American Shadow Financial Regulatory Committee under the guidance of Guillermo Calvo and other renowned Latin experts. Thee Committee is calling for the creation of an Emerging Markets Fund which could provide the sort of financial backstop and stimulus spending firepower that Hank Paulson can dispense on the steps of the U.S. Treasury, but which is totally missing in Latin America. How exactly and under what conditions an EMF would function for Latin America would need to be worked out, but the policy framework in most of Latin America is robust enough today so that a multilateral facility to provide emergency trade and investment financing along with some modicum of counter-cyclical stimulus could do a lot to prevent the destruction of jobs and investment projects which is what will happen in its absence.
What Calvo and his colleagues are proposing is a stark change in the global mindset which tends to treat places like Latin America as problem areas to be neglected in times like these while bigger issues in the U.S. and the G-7 are addressed. Yet this is a foolish and short-sighted approach to global economic management. The entire burden of global adjustment cannot rest on the shoulders of the United States. Other regions of the world, Latin America among them, should also be engaged in the task of economic stimulus. Recall that the G-20 group, with three very prominent Latin American members, has just made essentially this argument in its November meeting, albeit to deaf ears in the Bush Administration.
An emergency financing facility for Latin America, or some other sort of large-scale lending program to responsible Latin American governments (in my reckoning, the majority of them) could be a boon not only to Latin America, but to the U.S. and to the rest of the world as well. The U.S. has already made a first step toward building a basis for a much broader economic partnership with Latin America by electing Barrack Obama who is extremely popular in the region. Since the election, Obama has named as his advisors individuals such as Summers, Geithner, and Volcker who have had lengthy experience dealing with Latin American governments in overcoming past financial crises. These individuals in the new U.S. government know and respect Latin American policymakers and are aware of the role that the region can play in diminishing the intensity and duration of the global recession and in putting in place a more sane model of balanced global growth in the future.
The need is crystal clear. The pieces are in place, both in Latin America and in the U.S. Now is the time for action.