China’s economic slowdown and the collapse of commodity prices have taken their toll on Latin America, which is now moving towards negative growth this year, according to the IMF and the World Bank.
Nevertheless, Latin America is also in better shape to cope with external shocks than in the past, in spite of the magnitude of the current challenges, said Augusto de la Torre, the World Bank’s chief economist for the region.
Such challenges include the pending rise in US interest rates. Moreover, South America looks most exposed to a “significant decline from southeast Asia and China”.
“South America may still have to suffer additional adversities coming from external factors that Latin America cannot control,” de la Torre said in an interview with Emerging Markets.
The big uncertainty is how the region will cope when the US finally raises interest rates. Although this has a potentially destabilising effect on emerging markets, its impact may be cushioned.
“You cannot rule out that the moment the US starts raising rates, there will be some repercussion in the financial markets that may create waves and a decline in financial flows in Latin America,” said de la Torre.
But he said there were two good pieces of news in that respect. “Latin America no longer relies on short term capital inflows. In the 1990s, it was very dependent on borrowing from abroad. Latin America has made a shift from debt to equity. Now, the region is more dependent on foreign direct investment and is no longer so dependent on capital flows.
“So even if there is turbulence in non-FDI inflows, Latin America may not have the type of turbulence that it had in the past,” he said.
Latin America used to be a very large net debtor, but is now a net creditor. It lends money to the rest of the world and has a high level of international reserves, protecting it from volatility in financial markets.
“The second good news is that one of the best ways to deal with capital flows volatility is to let your currency adjust. Fortunately, many countries in Latin America now have a more flexible exchange rate regime” that can absorb part of the adjustment, de la Torre said.
While he argued it was impossible to predict whether a credit crunch could be avoided, de la Torre said policies overall had moved in the right direction, helping to reduce vulnerability to external shocks.
“There was a brutal collapse in commodity prices,” he said. “If this had happened in the 1990s, the region would have been swallowed in the middle of a great financial crisis. Now this is not happening, we have not had any major trauma or great banking collapse. This is not a small thing. Policies have improved a lot since.
“In the past, our immunological system in terms of macroeconomic policy and financial policy was weaker. So, whenever an external shock hit Latin America, we had weaknesses in our system and the shock was amplified. You had very significant adverse consequences domestically. Right now, maybe our systems are not cushioning the shocks sufficiently, but clearly they are not amplifying it any longer. In that sense, we have a very different story.”