- Cristina J. Orgaz @cjorgaz
- BBC News World
The last time the US Federal Reserve raised interest rates as aggressively as we are seeing these months, the IMF had to bail out Mexico.
The rest of the Latin American economies did not fare much better.
Because when the Central Bank presses, the region suffocates.
Experts predict that now it will not be any different and each economy will feel differently the sharp rise in interest rates by the Federal Reserve, which in just 3 months increased the reference rate to a range between 1.5% and 1.75%.
The goal is to fight runaway inflation, the highest in more than 40 years, but the danger is that by trying to contain rising prices, the US economy enters a recession dragging the rest of the world.
Admittedly, it’s not all bad news.
Kirstie Spence, fixed income manager at Capital Group, recalls that “some countries in Latin America have been somewhat protected against rising food prices, as they produce locally and are less dependent on wheat and cereals”.
Some more prepared than others
In addition, there are countries that have been preparing for this scenario for some time.
But, which one is better placed? Who will be able to face the economic environment that is coming without its citizens feeling the blow?
“Economies that are best prepared to deal with Fed hikes are those with moderate levels of fiscal debt and deficit, flexible exchange rates and modest external financing requirements,” Claudia Calich, manager of emerging fixed income at M&G Investments, explains to BBC Mundo.
Within Latin America, that would include countries like Peru, Guatemala and Paraguay.
On the contrary, for the analyst, the worst prepared would be El Salvador and Bolivia.
And what about the rest?
We review who will be able to face the situation that is coming with more calm and which of the major economies could be in trouble.
What happens when the Fed raises interest rates is that investors withdraw their capital from risky markets to place it in safer investments, such as US debt.
The tightening of global financial conditions broadly means that investors earn more or more sureeither In another side and they take elsewhere the oil that allows the gears of an economy to run at full speed: money.
“A change in direction of capital flows exposes imbalancessays David Rees, senior emerging markets economist at Schroders.
“Capital outflows make deficits no longer financeable, which, combined with higher interest rates, leads to recession.”
“In the Mexican peso crisis in 1994 external vulnerabilities were exposed when the Fed hiked rates aggressively and at a time of political change,” recalls Rees.
But we are no longer in the 90’s and the second largest economy in Latin Americaanalysts agree, has been doing things right.
At the moment the country enjoys a balanced fiscal situation.
“Mexico’s economy is much better than during claughter of youequila-as the crisis of 1994 was called-. This time, the external shock absorbers are strong. Foreign currency debt is low and the Mexican peso floats freely,” explains Edward Glossop, an economist at Abrdn.
“As such, the economy should certainly be able to get ahead without a crisis“, Add.
And it is that unlike other Latin American countries, the Mexican government decided not to stimulate the economy during the pandemic and that is why the fiscal situation “has not deteriorated much.”
In fact, says Patricia Urbano, a fund manager at Edmond de Rothschild AM, your position is solid.
That means that the Central Bank of Mexico has some room for maneuver to put some measures in place.
In addition, “Mexican exports are gaining market share between what the United States imports and the inflation is moderate“.
“If we look at the long term, the Mexican economy is expected to benefit from the offshoring trend, in which the United States is diversifying its supply chain and decreasing its dependence on China,” says Urbano.
Mining has made Chile the world’s largest copper exporter, but the coronavirus pandemic has slowed production.
In a context of rising rates from the United States, Chile tends to outperform other Latin American countries in relative terms.
That’s because “that the Chilean economy is more related to China and with the electric vehicle supply chain, due to its role not only as a major exporter of copper but also as the cheapest,” says Urbano.
If the United States slows down, Chile will suffer but its ties with China can act as a buffer.
In addition, the Edmond de Rothschild AM expert recalls that the Chilean government is little indebted.
But Chile has also accumulated external imbalances and since it needs to buy its energy abroad “this could cause a further deterioration of the current account deficit”, believes Schroders economist David Rees.
“In Latin America, the economy worse prepared is Colombia, that has a high twin deficit,” says Urbano.
The twin deficits refer to a macroeconomic imbalance, where an excess of spending must be financed with another deficit: that of the current account of the balance of payments. The foreigners finance the largest expenditure.
“Even though Columbia is an oil producer and high oil prices for longer could support its economy, the country has large imbalances,” adds the economist.
“Colombia needs structural reforms to reduce its fiscal and trade deficits. The need for external financing is key,” he says.
Combining the solution of the fiscal deficit with the fulfillment of the promises of social changes will be a major challenge for the new government of Gustavo Petro.
Petro’s Victory will fuel short-term uncertainty among investors, since the markets fear that it could alter Colombia’s historic regulatory stability and business-friendly environment,” says Jimena Blanco, head of the Latin American division at Verisk Maplecroft.
For the analyst, those doubts will be stronger within the extractive sector, since Petro has promised to move the country’s economy away from these crucial industries right now for its economy.
And it is that the evolution of the price of raw materials will be key to determine how much it affects Colombia that the growth of the United States slows down.
“A key thing to consider will be to what extent the slowdown in the United States will drag down the prices of raw materials. That would weaken trade with the region and lead to further slowdowns,” Rees explains.
According to the UN, there are 5 countries in the region with severe financial vulnerabilities: Argentina, Venezuela,Ecuador, Belize and Grenada.
“On the list of the worst prepared, there are obvious candidates like Venezuela, where the economy has been rock bottom for years,” says Blanco.
In the case of Argentina, the country “struggles with one of the highest levels of inflation in the world and received one of the biggest economic blows during the pandemic.”
The policy and the measures that can be adopted will be key for the country, but “the ruling coalition cannot set a straight course in terms of macroeconomic policy,” he says.
And with the country heading into another election year in 2023, “any hope of a coordinated economic policy and sustainable is ephemeral”, explains the analyst.
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