"It is no longer only Turkey and Venezuela that are attracting the world's attention with their serious economic problems. The unstable situation in Brazil or dramatic events in the Argentinian market remind us of the crisis risk in the region. There are also concerns about the economic condition of other parts of the world," writes Marcin Lipka, Conotoxia Senior Analyst.
Although more than 30 countries belong to the Latin American and Caribbean region, only a few of them are economically significant. Two out of the three largest countries (Brazil, Mexico and Argentina) are facing increasing economic problems. If Venezuela is also taken into account, half of South and Central American GDP, 2.8 out of 5.6 trillion USD, may be at risk of recession. This also means that there is risk of crisis throughout the region.
Argentina's unfulfilled plans
Falsifying statistics, an official exchange rate that has little to do with reality, inflation out of control, zero currency reserves, top-down attempts to regulate consumer prices, ubiquitous bureaucracy, promoting state capital at the expense of the private sector, import barriers or lack of investment. All this was to end when Mauricio Macri, sworn in in December 2015, won the presidential election.
Unfortunately, several years of populist and protectionist ruling by Cristina Kirchner and her husband Nestor have been very difficult to repair, even with the best intentions and in accordance with the generally accepted state governance principles. In addition, shock therapy for Macri was not enough and it started to cause serious problems.
First of all, the Argentinean Government has been unable to cope with inflation. It’s now more than 30%. In addition, about 70% of the debt is denominated in foreign currency (mainly in the USD), which increases the financial pressure on the country, as global market conditions deteriorate. The current account deficit, exceeding 5% GDP, is also a significant threat.
Another serious problem over the past few months has been the government financing treasury instruments denominated in pesos with a very short maturity (35 days). When the peso was relatively stable, it was in high demand. High interest rates, of up to 40% per year, attracted high risk investors. However, when rampant inflation or the threat of a further recession caused the peso to be overestimated, the government faced the problem of a lack of liquidity (the value of vouchers in peso was 20-40 billion dollars), as demand for vouchers began to dry up.
Even IMF assistance may not be enough
in the middle of the year, the country applied to the International Monetary Fund (IMF) for assistance in order to prevent the financial squeeze from triggering the collapse of all other reforms and the return of extreme populism. The fund is not popular in many countries and is already infamous in Argentina in particular. In addition to imposing restrictive reforms, it was blamed by the Kirchners for the country's bankruptcy at the beginning of this millennium.
IMF granted aid quite quickly - the record 50 billion USD. Unfortunately, this was not enough to calm the markets. The Argentine peso lost 42 percent of its value between the beginning of the year and August 28th. However, this was not the end of the price discount. On Wednesday, President Macri asked the Fund to speed up payments, but instead of improving the situation, he caused panic because Buenos Aires may introduce capital controls. Still on Wednesday afternoon (CET), the dollar cost 31 pesos, and on Thursday, the value of 38 pesos was exceeded. It was only 18 at the beginning of the year.
Foreign capital, which has got Argentina's fingers heavily burned, is likely to reduce investment considerably. This will also make it more difficult to improve the country's competitiveness than it seemed a few months ago. Even stabilising Argentina's economy will be a demanding challenge and the failure of this process could lead to a change of power during presidential elections next year, which is another risk.
Brazil is another hotspot
The Argentinian economy, which accounts for around 10% of Latin America's GDP, may be less of a problem than Brazil. It is four times bigger than Argentina and its problems can also be serious.
The country went through a very severe recession in 2015-2016, with GDP shrinking by 6%, and the economic recovery has been very limited, with expected growth of around 1% in the first half of the year.
Brazil is also suffering from a total loss of confidence in its authorities. Dozens of parliamentarians have received prison sentences for corruption scandals. The upcoming elections in October only increase uncertainty, rather than hope for improvement. This is due to the predominance of extreme candidates and the continuing record high support for the imprisoned former President Lula (Luiz Inacio Lula da Silva), who will probably not be able to participate in the election.
Brazil has also not carried out sufficient reforms in recent years, including the lack of change in an over generous and inefficient pension system. 'National champions' still have a strong position in the economy, but due to the ubiquitous corruption, nepotism and limited competition they generate more problems than benefits for the country. The authorities also returned to fuel subsidies for the transport sector in the wave of protests in May and June, which only perpetuated the state’s too deep role in the economy and cemented non-competitive activities.
All the risks to the future of the Brazilian economy are very well reflected in the behaviour of the local currency. Nevertheless, at the beginning of March, we had to pay for the dollar about 3.2 reals and now it is less than 4.2. The real lost 20% to the American currency.
Threat to the region and more
The serious economic and political problems in Brazil and Argentina are threatening the entire Latin American region. It is possible that the revaluation of local currencies will also translate into the sale of assets in more stable economies, such as Poland. This would be quite a likely scenario, especially if China was to suffer from a customs war with the US and Italy were to confront the fiscal rules from Brussels.