LAC's Insecure Economies

This article was external pageoriginally publishedcall_made by the external pageEuropean Institute for Security Studies (EUISS)call_made on 21 January 2016.

With falling commodity prices, slowing Chinese growth and tightening financial conditions, the economies of Latin America and the Caribbean (LAC) have once again revealed their vulnerability to global headwinds – albeit to varying degrees. Dragged down by the fal­tering economies of Brazil, Argentina and Venezuela, the region has been experiencing economic decelera­tion for the past five years, with 2015 marking the first of overall regional contraction since 2009.

This comes at a time when popular disgruntlement with political leaders has been rekindled as a result of macroeconomic mismanagement, high-level corrup­tion and widespread urban insecurity. Amid looming policy paralysis, the outlook for the major LAC econo­mies is bleak.

With double-digit inflation averaging across the re­gion, the weakening of major currencies will continue to exert upward pressure on consumer prices, particu­larly through rising import costs exacerbated by an ap­preciating US dollar. The return of stagflation bodes ill for political stability, as opposition-led protests are already resurging. Amid growing levels of unemploy­ment, the urge to adopt austerity measures is already clashing with workers’ demands for higher wages.

Water recedes, rocks appear

The adverse global conditions have shed light on the structural weaknesses of LAC economies. Having largely benefited from the 2000s commodities ‘super-cycle’, region-wide fiscal profligacy took root. But with the recent fall in energy, metals and agricultural prices, foreign-exchange reserves have shrunk drastically. This has reduced the buffers needed to weather the storm generated by global markets – as evidenced by widen­ing current account deficits.

Brazil and Venezuela stand out as the worst regional performers. Their high dependence on Chinese de­mand and heavy reliance on oil has prompted a sharp fall in government revenue. This has been particular­ly true for Venezuela, as 45% of its budget proceeds and 96% of its export earnings depend on the sale of cheapened crude. And populist government spend­ing ahead of the recent legislative elections has only deepened the state’s budget deficit further. Although the opposition Democratic Unity platform now has a supermajority in Congress, its internal divisions may delay efforts to propose much-needed fiscal consoli­dation plans. In turn, President Maduro’s eagerness to cling to power may undermine political stability as social unrest could intensify in the event of prolonged political wrangling, especially amid rampant infla­tion (141% y/y) and protracted shortages of consumer goods. The recently announced emergency decree, should it be implemented, is unlikely to avert a full-blown economic collapse.

In Brazil, a political crisis has erupted following a congressional impeachment process against President Rousseff – relating to a corruption scandal involving top-level politicians. Consequently, a political gridlock has halted the administration’s push to implement spending cuts and the looming policy paralysis has damaged investor confidence. But with faltering ap­proval ratings, the government might still be tempted to implement populist (i.e. loose) fiscal and monetary policies; measures which could prove counterproduc­tive for an already overheated economy. Driven by rising food and transport prices, inflation rates are at a 12-year high (10.5%), and widespread anti-govern­ment protests calling for Rousseff’s resignation already erupted last December and in early January 2016.