Regional Focus: Latin America more resilient to the global downturn than in 2001-2002

Author: Countries and Consumers

Date published: 21 Apr 2009

As the global economy slows, Latin America's economy is also faltering. This is reminiscent of the region's last major economic crisis in 2001-2002, which followed Argentina's debt default and economic collapse, and spread to other countries, particularly neighbouring Brazil and Uruguay. However, regulatory reform and orthodox economics since 2002 mean that the region is better positioned to ride out the global economic slowdown than in 2002. The exception is Venezuela, which will suffer more in 2009 than in 2002.

Key points

In 2001-2002 Latin America suffered a major economic crisis, sparked by Argentina's economic collapse and subsequent debt default;

This crisis mainly affected South America, with the countries worst affected being neighbouring Brazil, Uruguay and Paraguay, owing to their exposure to Argentine banks and reliance on trade with Argentina;

Following the 2002 crisis, countries such as Brazil introduced greater financial regulation and orthodox economic policies, often overseen by the IMF. The region is better placed to withstand the impact of the 2007-2009 global financial crisis and economic slowdown;

Although economic growth in the region will slow in 2009, this is largely the result of external factors, such as slowing export demand and unwillingness to invest in emerging economies;

Exceptions to this are Argentina, whose 2009 economic problems are domestically generated, although the crisis will not be as bad as in 2001-2002, and Venezuela, where ineffectual economic policies will worsen the impact of the global economic crisis.

2001-2002 financial crisis in South America

Argentina's economic crisis began in 1999 and culminated in 2001, when surging international debt, owing to rising inflation and declining market confidence, and capital flight left the government unable to service its debt. In December 2001 the government defaulted on all its sovereign debt, cutting it off from international financial markets and help from international financial institutions;

In January 2002 it removed its currency peg to the dollar, leading to surging inflation and a lack of domestic and international confidence in the peso. Argentina's economy contracted by 4.4% annually in 2001 and by 10.9% annually in 2002;

This had a major knock-on effect on neighbouring Brazil, Uruguay and Paraguay, led by a rapid decline in Argentine import demand. Brazilian exports to Argentina dipped to 4.0% of total exports in 2002 from 11.5% in 2000. In Paraguay the proportion dropped from 29.8% in 1999 to 4.0% in 2002, while in Uruguay the proportion fell from 18.0% in 2000 to 4.9% in 2002;

As a result, the economies of all three countries slowed. Uruguay's economy in particular slumped by 11.0% annually in 2002, after contracting by 3.4% in 2001;

Real GDP growth in Argentina, Brazil, Uruguay and Paraguay: 2001-2009

% annually

Source: Euromonitor International from International Monetary Fund (IMF), International Financial Statistics and World Economic Outlook/UN/national statistics

Additionally, a run on banks in Uruguay in August 2002 owing to a decline in customer confidence (many Argentines held deposits in Uruguayan banks) nearly led to a Uruguayan debt default, only averted by an emergency loan from the IMF;

Brazil experienced similar economic contagion, with investor concerns about potential left-wing policies of President Lula leading to capital flight and near-debt default;

Although these countries were the most affected, the region as a whole suffered an economic slowdown owing to financial contagion and negative investor sentiment, growing by 0.8% and 0.4% in 2001 and 2002 respectively, from 4.3% in 2000;

While Venezuela experienced a contraction of 7.8% in 2003 this was due to domestic problems (a two-month general strike) rather than the knock-on effects of the regional crisis.

Impact of 2009 economic slowdown

The 2009 crisis originated in the US sub-prime mortgage sector in 2007 and caused a recession in the USA. This has impacted Latin America largely in terms of lower global export demand and less investment potential. Latin America primarily exports commodities, such as oil, gas, copper and nickel. Declining demand and lower global commodity prices have reduced export revenues across the region;

However, the region's economies are more resilient and better able to withstand the impact of the economic downturn than in 2001-2002;

In Brazil, President Lula made macroeconomic stability a main aim of his first term in office (2002-2006), reassuring investors who feared that he would introduce left-wing reforms. Macroeconomic improvements have been achieved by reining in public spending, introducing structural reforms and targeting the reduction of inflation;

Even Argentina is better placed than in 2001 although its situation is worse than any other country bar Venezuela. Although economic growth is slowing, it has been relatively insulated from the global financial crisis since it is still cut off from international markets. However, the Argentine economy has major problems, which are largely export-led, with industrial production falling by 4.6% annually in January 2009;

Argentina’s industrial production and economic activity: January 2008-January 2009

% growth annually

Source: National statistics

Note: January 2009 economic activity figures are not yet available. Economic activity is a rough measure of monthly GDP production and is a proxy for GDP growth.

While these problems will lead to a major economic slowdown in the region, economic contraction on the scale of 2001-2002 is unlikely. Many countries have increased fiscal regulation, with countries such as Colombia, Chile, Peru and Brazil now possessing investment grade sovereign bond ratings, up from only Chile in 2002;

Countries have also been prudent in building up foreign reserves. For example, Uruguay had central bank reserves of US$6.7 billion in March 2009, which should guard against the kind of capital flight experienced in 2002.

Negative impact

Some countries in Latin America will, however, perform worse than in 2001-2002:

Mexico's economy is forecast to contract by 0.3% in 2009 as opposed to a contraction of 0.2% in 2001. Mexico will suffer worse in 2009 because its economy is closely linked to that of the USA. 76.2% of exports were destined for the USA in 2008. The 2001 downturn in Mexico was also linked to the US recession and additional downturn following September 11th;

Some countries will face reduced tourism. For example, Jamaica's economy is forecast to grow by 0.6% in 2009 as opposed to 1.5% in 2001. Overall, tourism-dependent economies will not experience a major difference in 2001/2009 growth. In 2001-2002 the global tourism industry suffered a severe downturn following the airline industry crisis sparked by the 9/11 attacks in the USA;

Venezuela is likely to suffer more than in 2001-2002. Although its economy contracted by 7.8% in 2003 this was due to domestic strike action rather than external events;

In 2009 Venezuela is suffering from slumping oil prices, which were trading at US$45 per barrel in March 2009, from US$147 per barrel in July 2008. This is putting pressure on government finances and will limit its ability to launch fiscal stimulus plans.

Government preparations

Governments across the region are attempting to insulate their economies from the global economic slowdown:

Brazil increased state investment by 66% above original plans for 2009-2010 as a means of providing fiscal stimulus;

In January 2009 the Uruguayan government announced a state of agricultural emergency, introducing measures including subsidies for agricultural food costs and temporary tax relief;

The Argentine government is pursuing unorthodox economic policies, such as relying on high inflation (estimated by local analysts to be as high as 25% at end-2008) to erode public sector wage costs and increase US$-denominated export tax revenues. This will damage consumer spending and prolong the economic downturn instead of improving it;

In Venezuela, a strategy of price controls on basic goods and currency controls has created surging inflation (approximately 28% in 2008) and a flourishing black market. These will prove unsustainable in the medium term.

Prospects

Overall, Latin America is better placed to weather the 2009 economic slowdown than in 2001-2002:

The economies badly affected in 2001-2002 will experience economic growth in 2009-2010. Brazil's economy will grow by 1.8% in 2009 and 3.5% in 2010, Argentina's by 0.1% and 2.0%, Paraguay's by 0.2% and 2.7% and Uruguay's by 1.5% and 1.9% respectively. However, risks remain to the downside as the depth of the global crisis unfolds;

Venezuela will perform worst, growing by 0.6% in 2009 and 2.0% in 2010;

The 2007-2009 economic slowdown has illustrated the extent to which Latin America has improved its economic fundamentals since 2001-2002 but also its ongoing vulnerability to slumps in export demand;

The region's economies will pick up once demand in the USA and Europe improve in 2010-2011.

Countries and Consumers