Fears mount of a new Latin American debt crisis

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Latin America Updates

Latin America is at the center of the coronavirus pandemic, suffering from some of the worst infection rates and highest death toll in the world. Today, economists warn that the region faces more bad news: Its sickly economies risk slipping into another debt crisis even worse than the last great crisis of the 1980s.

The continent struggled with multiple ‘pre-existing conditions’ before the virus took hold: sluggish growth, weak health systems, low tax revenues, high borrowing levels and overdependence on it. of commodity exports.

Today, some of the world’s longest lockdowns, and the costly bailouts that go with them, have taken their toll on public finances. Chile, Brazil and Mexico were among the five emerging markets in the world with the largest increase in debt-to-GDP this year, according to the Washington-based Institute for International Finance. Chile’s total debt rose 30% year-on-year in the first quarter.

Latin America “already had a lot of debt before the crisis,” José Ángel Gurría, secretary-general of the OECD, told the Financial Times, adding that after the “brutal reality” left by the virus, the region would need to “much more resources”. and / or debt relief ”.

Public borrowing in the region is skyrocketing, alarming investors. “It’s definitely the elephant in the room,” Claudio Irigoyen, head of Latin American research at Bank of America, said of the debt problem.

“The compromises in Latin America are much worse than in other regions. There is a very underdeveloped health and sanitation system, which dictates strict closures, but there is also a very high degree of work informality, which means you cannot extend the closures on time or you risk social chaos. ”

Residents of Héliópolis, São Paulo, line up to donate food © Alexandre Schneider / Getty

Advanced economies can tap vast resources from central banks because they have hard currencies and investors willing to keep buying their debt. Latin American countries do not have such a safety net and work under the weight of a history of debt crises stretching back over a century.

Argentina and Ecuador are already in default on their external debt and are negotiating restructuring. Argentina took a more confrontational stance, while Ecuador was praised for a more consensual approach. Neither has yet reached an agreement with all of the bondholders.

Brazil, the region’s largest economy, has seen its debt soar as its precarious public finances are impacted by a deep recession and a sharp increase in public spending. William Jackson of Capital Economics predicts that Brazil’s debt-to-GDP ratio could climb to almost 100% this year, from 76% last year. “It’s a time bomb,” he said.

Alberto Ramos, chief economist for Latin America at Goldman Sachs, said Brazil needs to convince investors it can put its public finances in order. “If you start with a very fragile budget situation, you will end up with an even uglier budget situation that requires. . . the right signal from policy makers that this was just a one-off expansion. . . and after that you will adopt a fiscal adjustment, ”he said. “The biggest fear in the market is when exactly the authorities will adopt such an adjustment.”

President Jair Bolsonaro’s government insists pro-market reforms are still ongoing and will resume later this year. But Brazil faces elections in 2022, making it highly unlikely that ministers will pass painful austerity measures ahead of the vote.

Line graph of Latin America and the Caribbean, gross public debt as% of GDP showing that debt in the region tended to increase before the virus hit

Mexico, the region’s second-largest economy, triggered the pandemic with relatively healthy public finances and low debt levels. However, President Andrés Manuel López Obrador’s decision to continue with an austerity program, instead of spending to save the economy, is likely to deepen the country’s recession and hamper its recovery.

The IMF predicts that Mexico’s GDP will fall 10.5% this year, making it the hardest-hit large emerging market in the world. Falling oil revenues and the impact of the virus mean the country’s sovereign debt is likely to lose its coveted investment-grade credit rating in 2022, unless policy changes, according to Morgan Stanley. Colombia, the region’s fourth-largest economy, has sounder government policies but risks a deterioration in the first half of next year due to weak public finances, according to the bank.

José Ángel Gurría, Secretary General of the OECD, says Latin America will need more debt relief © Stefan Wermuth / Bloomberg

OECD’s Gurría, a former Mexican finance minister, said investors have little tolerance for rising debt in emerging markets. “Once a country exceeds 50 percent [debt to GDP] they put it on alert once it goes over 60%. They put flashing lights on it and once they go over 70% or 75%. . . then all the alarms go off, ”he said.

Colombian President Iván Duque has argued that rating agencies should suspend their normal assessment criteria for sovereign ratings due to the pandemic, but his calls are unlikely to be heard. Instead, investors are likely to favor countries that had accumulated surpluses on rainy days before the virus and are in a better position to weather the storm.

Peru and Chile are the best examples. “Peru’s financing strategy before Covid was practically a zero debt policy,” Maria Antonieta Alva, Peru’s finance minister, told FT. The country’s debt-to-GDP ratio stood at 26 percent at the end of last year and even after a generous stimulus package, it is still only expected to rise to around 30 percent, she added.

Eric Parrado, chief economist at the Inter-American Development Bank, predicts that the average level of debt in the region will drop from 57% before the pandemic to 71-76% by 2022. He said the speed of the Debt build-up was of particular concern.

“It is not so much the absolute level of debt that matters, as the speed at which it is increasing,” he said. “It’s a bit like a bullet: if you throw it it has no impact, but with a gun it’s the speed that kills you.”

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