Region quickly enacted harsh containment measures

Although the number of confirmed coronavirus cases (and deaths) is still lower than in Europe and the USA, Latin American countries quickly took harsh confinement measures (lockdown or curfews). Notable exceptions are Nicaragua and Brazil, though in the latter lockdowns happen on states level (e.g. Sao Paulo and Rio de Janeiro). The main reason is that the regional health care system has limited capacity to cope with a large outbreak of covid-19 in comparison with that of advanced economies. Moreover, the winter season that approaches in the Southern hemisphere could lead to a difficult and prolonged coronavirus epidemic in the coming months. In general, containment measures have a large negative impact on the economic activity due to (partial) company closures and a falling domestic demand in the short term. In the longer term, precautionary saving among households could increase while business investments are likely to be delayed, further eroding consumer confidence and economic growth. More specifically, retail (other than supermarkets and pharmacies), restaurants, hotels and transport are the hardest-hit sectors. Nevertheless, though containment measures inflict pain on Latin American economies, several other transmission channels from the global pandemic hurt the region even more. 

Covid-19 outbreak hits the region hard through various transmission channels 

The covid-19 global pandemic  is having large repercussions on the region through multiple transmission channels. Firstly, the drop in commodity prices particularly hits South American countries hard. Indeed, many countries in the Southern Cone heavily rely on copper (Peru and Chile) and oil and gas exports (Trinidad and Tobago, Bolivia, Ecuador, Venezuela and to a lesser extent Colombia, Suriname and Mexico). The large fall in commodity prices in the past months is likely to wider the current account deficits in these countries. Furthermore, commodity-dependent countries saw their currencies coming under severe pressure, leading to large depreciations (for freely floating currencies) and to decreasing foreign exchange reserves (for countries with a pegged exchange rate, e.g. Bolivia and Trinidad and Tobago). Another transmission channel is the falling remittances worldwide. This channel will especially affect Central American countries as they heavily rely on remittances from the USA, which currently reports the highest number of covid-19 cases worldwide and where unemployment number jumped in the past month. Thirdly, tourism revenues are plunging. The almost complete stop in global tourism is expected to last several months even as the crisis subsides. Caribbean islands are very vulnerable to this effect as many rely, for 70 to 90% of their current account revenues, on tourism. Fourth, the disruption of supply chains is hurting the region. Delays in raw material imports from China – where covid-19 first erupted - are affecting the whole region, from the manufacturing sector to the textile industry. This channel is also likely to hit Mexico hard. Indeed, the Central American country depends on the US business cycle (which is currently contracting) as the supply chain is very integrated with the country. Lastly, the sharp deterioration in global financial conditions has a significant effect as well. The covid-19 outbreak has led to a strong reversal of capital flows away from emerging markets. The speed and the size of that reversal has been the fastest and largest in recent history. In the past years, many Latin American countries have been relying on foreign direct investment (FDI) and portfolio inflows to finance the deficit on their current account (e.g. Brazil, Colombia). As large outflows are occurring and FDI are being delayed, many countries face increased difficulties to refinance their external debt, as investors have become increasingly risk adverse. In that context – widening current account deficits, capital outflows and no or barely access to the financial markets – it is not surprising that many emerging markets are more and more likely to face a balance of payment crisis. 

Constrained public space has led to multiple requests for financial assistance from World Bank and IMF

The region as a whole is less prepared to weather the unfolding crisis than it was when the global financial crisis struck in 2008 09. Fiscal and public debt dynamics are far weaker, as demonstrated by the elevated public debt levels in many countries (e.g. Brazil, Suriname and Argentina). That being said, these can also widely vary, with Chile, Peru and Paraguay having rather low public debt and ample space to introduce stimulus packages to help their economies. Nonetheless, in general, sovereign ratings have been downgraded in the whole region. Ecuador and Argentina´s sovereign ratings have even been downgraded into a semi-default scenario while Suriname is into a possible sovereign default scenario. Other sovereign downgrades are likely to follow. Considering the constrained financing conditions, the IMF, the World Bank and other regional lenders are set to play a critical role in the current crisis. Indeed, already 14 Latin American countries requested financial assistance from the IMF through their emergency tool (the Rapid Credit Facility). The World Bank is disbursing loans to aid public health responses as well, while the Inter-American Development Bank and the Development Bank of Latin America have also opened lines of credit. On top of that, the World Bank, along with the IMF, has also called for official bilateral creditors to suspend debt payments for IDA countries that request forbearance. It is unclear which countries will request and receive it, but Dominica, St Vincent and the Grenadines, Grenada, Guyana, Haiti, Honduras, Nicaragua and Saint Lucia are likely candidates.

Short-term impact will be harsh while medium-term outlook depends on many uncertainties

The impact of the current crisis is likely to be especially severe in the short term. Latin America was already the slowest growing region in the world before the covid-19 crisis and the commodity prices shock. Indeed, the region now faces the prospect of a sharper recession than during the 2008-09 financial crisis. Furthermore, currencies are plunging, exuberating the impact on their deteriorating business environments.

Liquidity is also coming under huge strain due to larger current account deficits and capital outflows while the access to financial markets is very constraint. In this environment, foreign exchange shortages or capital controls could pop up. Hence, 13 Latin American countries saw their short-term political risk downgraded. Financial assistance of multilateral institutions is likely to mitigate the risk of a balance of payment crisis and sovereign default in the short term, for many countries, depending on the level of financial assistance, the length of the current crisis and their fiscal policies. Nonetheless, the countries that were already facing severe financing challenges before the global pandemic will continue to struggle in the near future. 

Depending on the length and severity of the covid-19 crisis, both worldwide and in the region, and on the policy responses, macroeconomic fundamentals could be hit hard in the medium term as well. Many public debt dynamics will worsen in the coming months, increasing the risk of sovereign defaults. On top of that, the risk of protests could also rise (though unlikely in the midst of a covid-19 pandemic). Indeed, if policy responses are seen as inadequate (e.g. countries with little confinement measures or countries, such as Mexico, where the government refuses to help the private sector), or if the economic impact of the confinement measures are too severe, or elections are being postponed for too long (e.g. Bolivia and Chile), unrest might flare up as many people are already on the edge due to the large income inequality.

Analyst: Jolyn Debuysscher – j.debuysscher@credendo.com