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April 18, 2016
When the China-backed commodity price boom took place in Latin America 4 years ago, Brazilian President, Dilma Rousseff began her first term with a symbolic journey to Beijing. As Rousseff begins her second presidential term, and in the light of China’s slowing economy and collapsing commodity prices, Brazil’s President is looking to rekindle the flame with Washington. Having made almost no reference to Beijing since beginning her second term, this shift reflects broader changes taking place in South America’s commodity dependent economies. This sudden collapse in energy, food and metals prices has opened up a dangerous trade and financial gap that could force drastic economic and political change in the region.
The Pacific Alliance nations of Colombia and Peru have been especially hard hit by this abrupt change as commodities account for two-thirds of their respective exports. With the current account deficits expected to reach 5% of their gross domestic product in 2015, such disappointing figures have not been seen since the 1990s when default was rife in the Latin America. Argentina which is rich in soya and Venezuela with its production of oil are currently suffering from dwindling foreign reserves. In Brazil where commodities account for 60% of exports, the commodity star-child of Latin America registered a U$D4 billion trade deficit in 2014, the same as in 1999 when it was dragged into the global emerging-markets crisis.
Many predicted the commodity boom and prices to end sooner or later and even in 2008 when commodity prices peaked in the region, there was still a current account deficit equivalent to 1% of the region’s gross domestic product. If South America experiences a price drop to the levels registered in 2003, its current account deficit is estimated to reach as much as 7% of the GDP. The challenge of financing such a gap which would be approximately U$D350 billion is expected to be one of the region’s greatest threats in 2015. There is a scale of concern depending on the nation involved. At one extreme end of the spectrum are spendthrifts such as Venezuela where investors fear default due to the halving of the price of oil which makes up 96& of the country’s exports. Earlier this month, Venezuela received a major boost from China as Venezuelan President, Nicolas Maduro, returned from Beijing with a U$D20 billion bailout. With Brazil somewhere in the middle of the spectrum, at the other end of the scale, more prudent countries such as Chile and Peru have abundant and hard currency reserves.
There are a number of reasons as to why Latin America is unlikely to find itself in the sorry, debt-ridden situation of the 1980s. The region has improved its economic policy making especially in the use of floating exchange rates to act as a buffer. With the Brazilian, Chilean and Colombian currencies already dropping more than a quarter in the past 2 years, some investors may be beginning to panic. However, other countries such as Argentina and Venezuela have fixed exchange rates, while oil-exporting Ecuador is dollarized. Elsewhere in Latin America, the weaker currencies can close the trade gaps by boosting their exports. Another reason is that most of Latin America has low debt, enjoying access to a number of international funds allowing them to reduce or plug the financing gaps. Although there has been significant investment in Latin America in the past decade, more than a third of it has been in mining and energy, areas which could soon see investment dry up. As Russia has shown, it is not always the case that access to high foreign reserves can offer the necessary protection for indebted corporate figures when currencies fall. Companies and subcontractors may in fact become locked out of capital markets due to corruption or other scandals, as can be seen by Brazil’s recent Petrobras corruption scandal.
While many of the implications remain to be seen, broader implications such as tightening the belt on economies in order to slow growth may take place. Brazil is already cutting public spending by 2% while Colombia has increased its taxes in order to cover shortfalls in revenue. This slower growth in South America is now the new norm. Latin America needs to construct a new post-commodity boom economic model in 2015 especially if local manufacturers struggle due to cheap Chinese imports. For the United States, positives may come of this new economic climate in South America, with a re-emphasis and establishment of north-south trade ties. While trade between the United States and Latin America languished during the commodity boom, there are early signs of a desire to improve relations. Brazilian President Rousseff calling for stronger ties and even Washington’s recent reconciliation with Cuba may just be the start.
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