Within the framework of this generally bleak outlook, in which the factors driving growth in Latin America and the Caribbean in the past few years have all but disappeared, the international crisis is being transmitted through various channels that are, in turn, having different effects on each one of the countries of the region.
1. The drop in world demand
The looming recession in developed economies and the significant slowdown in the emerging ones will reduce demand for exports from Latin America and the Caribbean. The trend in the region’s exports to the United States and China illustrates how the international financial crisis has been affecting the region’s economies through trade. The United States’ total non-oil imports have grown relatively steadily since mid-2007, when the financial crisis erupted.
This implies that, on average, the effect of rising prices for imported commodities was more or less counterbalanced by the decrease in import volumes. The situation regarding imports by the United States from Latin America and the Caribbean has varied considerably from country to country. Non-oil imports from Mexico began to slow in mid-2007 and continued to fall to the point where they registered a year-on-year contraction of 2.4% in the third quarter of 2008. Imports from the Central American countries have, on the other hand, behaved similarly to imports worldwide. This is because, although there is evidence of a slowdown and even of a contraction in Central American manufactures destined for the United States market, this decline has been offset by the higher prices obtained for commodity exports. United States imports from the Andean countries and MERCOSUR, a large proportion of which consist of commodities, rose in step with commodity prices from mid-2007 until the third quarter of 2008, when they began to level off. China’s imports from Latin America and the Caribbean, which are most significant in the case of the Andean countries and MERCOSUR, followed a similar pattern, but peaked towards the end of 2007 in the case of the Andean countries and in the first quarter of 2008 in the case of MERCOSUR. The data for November 2008, however, show a 2% drop in exports and an 18% drop in imports in the region (compared with November 2007), a decline that has not been seen since 2001.
The decrease in merchandise exports can be expected to have a greater impact on growth in the more open economies, in those that trade more with developed countries and, in particular, in those that sell a larger proportion of manufactured goods to developed markets, as it will be more difficult to find alternative markets for such goods quickly. As shown in figure, in Mexico, Ecuador, Chile, Costa Rica, Bolivarian Republic of Venezuela and Honduras, trade with developed countries accounts for over 10% of GDP. An examination of manufacturing exports alone, however, reveals that such exports account for over 10% of GDP only in Mexico and Costa Rica, and close to 5% in Honduras.
In some of the region’s countries, part of the negative impact on growth will be the result of lower demand for services —particularly tourism, for which demand is extremely income-elastic. Although this issue is explored in greater depth in the accompanying box I.1, the following figure shows that Caribbean countries and some Central American economies may be among the most severely affected. In the Caribbean, exports of tourism-related services represent around 20% of GDP, compared with an average of 5% in Central America (although the figure is just under 10% for the Dominican Republic, Costa Rica and Panama).
2. Expected trend in remittances
The weaker job market in developed economies will have an adverse effect on the remittances that emigrant workers send back to their families in their home country. Remittances have been an extremely important source of external revenues in Latin America and the Caribbean, where they have helped to increase the well-being of low-income families. Any reduction in remittances will therefore have a negative impact on the situation of this socio-economic group, as is discussed in box I.2. Thus, the major challenge facing the region is to prevent poverty indicators from increasing.
Here again, certain Central American and Caribbean countries are the most at risk, as in many such economies remittances represent between 15% and just under 40% of GDP. These countries are, in decreasing order, Haiti, Honduras, Jamaica, El Salvador, Nicaragua and Guatemala. Slightly less at risk are countries where remittances account for between 5% and 10% of GDP. This category includes some South American economies, such as Bolivia and Ecuador (as well as Belize, the Dominican Republic and Grenada).
3. Commodity prices
Falling commodity prices in the wake of slower world growth will result in a deterioration in the terms of trade for the region as a whole, although the actual effects will vary from country to country.
The rate of increase in commodity prices rose steadily between mid-2007 and mid-2008. Although there was an across-the-board surge in commodity prices, the increase was particularly striking in the cases of petroleum, certain metals such as copper, and foods such as soybeans, maize and wheat (as part of the global “food-price inflation” experienced at that time).
The index for most of the region’s exports peaked between June and August 2008; the total aggregate (not including petroleum) skyrocketed in July. From then onward, sharp declines ushered in the new recessionary and deflationary phase of the international crisis. In the case of petroleum, prices at the end of November 2008 were similar to those recorded in late 2004, while metal prices were similar to those observed at the end of 2005. Food prices, which had shown a smaller increase previously, fell less dramatically, with prices in November 2008 being more or less equivalent to those of mid-2007.
For most of the region’s countries, commodities make up a considerable proportion of the export basket and, for many countries, they are a significant source of public funds. For all of these countries (including those in South America and Mexico, which had all benefited from improved terms of trade since 2003), commodity price patterns over the next year (or more) are expected to cause one of the region’s recent engines of growth to come to a standstill.
For the region as a whole, it is estimated that the terms of trade will grow by 0.8% in 2008 and fall by 7.8% in 2009. For Chile and Peru, which are both metal exporters, the terms of trade are expected to deteriorate by around 8% in 2008 and 30% in 2009. For countries that export fuel, the terms of trade are expected to rise by 13% in 2008, before falling by almost 20% in 2009. As for MERCOSUR, where food accounts for an extremely significant proportion of exports, the rise in 2008 will be almost completely offset by the decline projected for 2009. In Mexico, the terms of trade are expected to improve very slightly in 2008 and then drop by over 2% in 2009.
In contrast, as Central America and the Caribbean are net importers of commodities, the fall in oil, metal and cereal prices alleviates and partially offsets the consequences of the world economic slowdown and the above-mentioned fall in remittances. In a departure from the figures presented in the previous paragraph, the terms of trade in Central America are expected to deteriorate by over 3% in 2008, before rising by almost 8% in 2009, which represents over a third of the decline observed in recent years.
Recent trends in food and energy prices are easing inflationary pressures. Given the rapid devaluation of many currencies, this has yet to be reflected in price indices. However, inflation rates are expected to be lower as a result in 2009.
4. Financial contagion
As stated previously, in the wake of the failure of the Lehman Brothers investment bank, the crisis had an increasing impact on the financial markets of Latin America and the Caribbean. In the final four months of the year, the region has experienced a slowdown then a decline in portfolio flows, huge falls in regional stock markets and drastic depreciations, attributable in part to previous speculative positions based on expectations of appreciation for Latin American currencies.
The cost of international borrowing soared, mainly for businesses but also for sovereign debtors, although the region’s experience in this regard is merely a reflection of the widespread increase in risk aversion sparked by increasing global uncertainty and what is occurring with the debts of emerging economies in general. As shown in the following figure, the increase in the sovereign risk premiums of the region is actually smaller than in previous crises, although this varies a great deal across countries.
Although the region’s financial activity has not been exposed to toxic assets, the problems existing on the interbank market and the impact that the tightening of external credit has had on local credit markets are two ways in which turmoil in the financial markets of developed countries can be transferred to the region. The available information (most of which corresponds to the third quarter) is not sufficient to allow the scale of this impact to be calculated, however.
Of particular concern are the conditions of access to credit for a series of large regional enterprises from various countries that usually find financing on international markets. Given the credit crunch and the higher price of credit in global financial markets, it is expected to become more difficult to meet borrowing requirements. The reduced availability of external financing will force the larger private enterprises to turn to the domestic market. This, along with increased uncertainty, will probably make it more difficult for small and medium-sized enterprises to access financial resources. The backdrop to all this is a liquidity squeeze in local credit markets.
In the final part of the year, companies with debt in foreign currency have seen their balances negatively impacted by the devaluations of several of the region’s currencies. This is a striking and somewhat unprecedented feature of this cycle as, unlike the situation in previous crises, it is the private sector that is the most exposed to exchange-rate volatility in many countries.
5. Impact on foreign direct investment (FDI)
It is also likely that the tightening of international financial conditions will have an adverse effect on inflows of foreign direct investment (FDI), which had been such an important source of resources for some countries in recent years. The figure below shows the high inflows of FDI into countries of the Caribbean (related to tourist activity) where they account for between 15% and 25% of GDP, into the Dominican Republic, Costa Rica and Panama (between 6.5% and 8% of GDP) and into Chile and Peru in South America (with FDI accounting for around 5% of GDP in 2008).