Few things are as terrifying for emerging economies as the sudden stop that occurs when foreign investors lose confidence, take their capital and flee — usually triggering currency devaluations and recessions. Latin America and the Caribbean (LAC) is facing an unprecedented triple sudden stop involving major disruptions to human mobility, trade and capital flows. Meeting this challenge requires astute policymaking, discipline and creativity.
The first sudden stop involves the economic paralysis stemming from COVID-19 lockdowns imposed to protect public health.
A mobility tracker developed by the Inter-American Development Bank (IDB) for 20 Latin American and Caribbean countries shows that between the second week of March and the third week of June, the number of people traveling more than 1km daily fell by levels ranging from 22 percent in Brazil to 48 percent in Chile. Many people have been unable to earn money or spend it.
Illustration: Lance Liu
Travel restrictions have also affected international businesses and tourism. According to the Latin American and Caribbean Air Transport Association, airlines operating in the region carried just 1.08 million passengers in April, down from 35.3 million the previous year.
Tourism, which accounts for one in 10 jobs and an average of 18 percent of GDP in the smaller LAC countries, is also in a slump. It is still unclear when the sector will be able to reclaim its vital role in the region.
TRADE DISRUPTIONS
Trade is the second sudden stop. The region’s exports have taken a tremendous hit, and the prices for key Latin American products and commodities have continued to drop substantially.
From the fourth quarter last year to late May, oil prices have collapsed by 50 percent, and copper and soybeans are down 11 percent. The overall decline in global demand, owing to lower consumption and deferred investment, has spread from China to the US and Europe, affecting their LAC trading partners.
When one factors in the numerous global supply-side problems, the outlook is grim: By the end of the year, the WTO expects Latin American exports to have fallen by 13 to 32 percent.
Finally, there is the sudden stop in capital flows. By late January, four of the seven largest Latin American countries — Brazil, Chile, Colombia and Mexico — recorded net capital inflows of US$18.6 billion. By the end of March, that had reversed to US$15.6 billion in net outflows, according to EPFR and Haver Analytics data.
Moreover, the UN Conference on Trade and Development estimates that inward foreign direct investment fell by 40 to 55 percent.
Meanwhile, the average country risk, as reflected in the Emerging Market Bond Index spreads, rose from 420 basis points in early January to a peak of 1126 basis points in late April, according to Refinitiv data, although it has since subsided to 728 basis points last month.
In short, many countries in the region are seen as too risky: Borrowing costs have soared and in some cases become prohibitive.
REDUCED INCOME
Remittances, a key source of income for millions of Latin American households, plummeted at the beginning of the COVID-19 pandemic, as expatriates lost their jobs and could no longer send money home. According to data from their respective central banks, remittances in April fell by 27.9 percent in Honduras, 40 percent in El Salvador, and 20.2 percent in Guatemala, compared with April last year.
Nonetheless, remittances have recovered in the past few months, largely owing to unprecedented social assistance programs, which have underpinned a historic divergence between GDP and disposable income in the US, a host country for many LAC migrants.
Nonetheless, given great uncertainty about the continued increase in disposable income, remittance inflows to the region as a whole could fall 20 to 30 percent year-on-year, according to IDB calculations.
Classic sudden-stop crises are characterized by a self-correcting mechanism: A reduction in capital inflows causes the real exchange rate to depreciate, resulting in an adjustment in current-account deficits, a drop in imports, more competitive exports and an inflow of money.
GLOBAL REVERBERATIONS
Such deficits are widespread throughout the LAC region today. With a synchronized global crisis in full swing, it is hard to see how the region can export its way out of this crisis.
Indeed, with financial markets and global value chains more integrated than at any time in history, the effects of the COVID-19 pandemic are already similar to those of the 1980s debt crisis or the Great Depression of the 1930s.
It is highly likely that the region will suffer a large recession this year, losing 8 to 10 percent of GDP, implying that the it might take more than three years to recover to pre-COVID-19 GDP trend levels.
The situation is further complicated by dire pre-existing conditions, including low levels of productivity and social crises.
Addressing these problems would require higher healthcare spending, government transfers to the poor and loans to struggling firms.
However, fiscal balances and public debt ratios have deteriorated considerably since the global financial crisis of 2008 and 2009, making public outlays and stimuli extremely difficult.
LESSON LEARNED?
One lesson from previous crises is that a sudden stop is not the time to turn inward. On the contrary, the region should seek greater integration through trade agreements, and the removal of tariff and nontariff barriers, such as excessive customs controls.
LAC countries would also have to make cuts in public expenditure and eliminate inefficiencies that, according to an IDB study, average more than 4 percent of GDP.
Eventually, they would have to decide how to increase resiliency through capital spending that boosts productivity and spurs growth. Governments would also have to increase taxes to improve income distribution through social safety nets and provide better public services.
The good news is the region could get a big infrastructure dividend, and even small improvements in service efficiency can boost growth by 3.5 percentage points over a ten-year period.
The triple-stop danger means action must be taken on multiple fronts, even as societies learn to live with the pandemic and possible future COVID-19 waves. The region will likely emerge from this crisis poorer, more indebted and with greater inequality in income distribution.
The faster countries contain the pandemic, the sooner they can restart their economies without multiple sudden stops and their crippling consequences.
Eric Parrado is the chief economist and general manager of the Inter-American Development Bank’s research department.
Copyright Project Syndicate
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