In Colombia, a group of graduates — all with master’s degrees from foreign universities — are in shock. The rapid depreciation of the peso has them tightening their belts to pay back dollar-denominated loans of up to $50,000 to Colfuturo, a public and private sector-funded initiative that has enabled 9,000 Colombians to study abroad since 1991.
Colfuturo encourages young Colombians to educate themselves abroad while seeking to avoid a brain drain by cancelling half the debt of those graduates who return home after completing their studies.
But for these peso earners, repayments are now over 30% higher than a year ago. Despite futile Facebook campaigns and letters pleading that the organisation take on some of the costs of the increased payments, much of the financial benefit of returning to Colombia has been lost.
It should not come as a surprise to highly educated Colombians that a currency can weaken as well as strengthen. But amid talk from the more pessimistic investors and analysts of a “lost decade” for Latin America, it seems clear that Colombia, Peru and Chile — for several years rising stars of EM — were not fully prepared for a new reality.
“For Andean nations there is no way of escaping the commodity shock,” says Juan Lorenzo Maldonado, economist and vice-president at Credit Suisse in New York. “The first impact is on external accounts, which feeds into fiscal accounts and then into economic activity.
“The differences between countries are found in where each country was before the shock hit and the policy decisions they have made.”
Here it is clear that Ecuador, out of the four nations that line South America’s Pacific coast, is in the most precarious position.
But even the governments that have followed more orthodox economic policies have suddenly found themselves scrutinised over whether they made the most of the good times.
“It has become clear as the commodities shock has hit that Andean governments have done a lot of things wrong,” says Wilmar Ariza, portfolio manager at Bogotá-based hedge fund Andean Capital. “Admittedly,
the economic management of Colombia, Peru and Chile has not been as catastrophic as in Ecuador and Venezuela and the floating currencies are helping to smooth the adjustment.
“But in my view even the first three better-run economies still wasted the opportunity offered by the commodities boom and loose US monetary policy.” Ariza says these governments should have been “developing the competitiveness of their economies and trying to provide added value”, but he believes that policies were “too populist” in the good times.
“There was not enough investment in infrastructure and education,” he adds.
PACIFIC ALLIANCE, SLOW BUT STEADY
Another LatAm economist says that it is “politically unrealistic” to expect governments to be so disciplined that they completely avoid vote-winning spending policies in favour of the kind of investment that Ariza wants to see.
Furthermore, he says, these governments — particularly Peru and Colombia — have at least taken the chance to shore up their macroeconomic stability. Peru, which as recently as 2008 was sub-investment grade, now boasts an A3 rating from Moody’s. Colombia only gained its third investment-grade rating in 2011 and is now firmly Baa2/BBB/BBB.
Yet though the Pacific Alliance trade bloc, dependence on commodities and orthodox economic policies make Colombia, Peru and Chile easy to group together, the new conditions are highlighting differences in their crisis management.
Maldonado says that of Colombia, Peru and Ecuador (the countries he covers), Peru has had the most fiscal space to react to the shock of lower commodity prices. With low debt, large savings and running fiscal surpluses until 2013, the country faced the shock in a privileged position.
“Peru has had the luxury of being able to reduce the revenue side of the equation to provide stimulus, for example by lowering income taxes,” says Maldonado. “In past years, critics have said that Peru does not put sufficient resources to work, but I think that we can see the benefits of running austere fiscal accounts.”
Unlike Peru, Colombia ran a fiscal deficit even during the days of oil at $100 per barrel. Like the Colfuturo graduates, the government has had to tighten its belt with what it has described as “intelligent austerity”.
With the oil shock having begun well after the slump in metal prices, the downturn in Colombia is still beginning. But Maldonado argues that, although Peru had more space to react to the commodity shock, Colombia has the better “automatic stabilisers”.
Indeed, unlike Peru, Colombia’s central bank BanRep has so far not intervened in the FX market, happy to let the peso fall rapidly lower. “A clear example of the adjustment capability of Colombia’s economy is how far the currency has depreciated without causing a major crisis,” says Maldonado.
GROWTH CONUNDRUM
In 2012, when the Colombian peso was the best-performing currency in the world, finance minister Mauricio Cárdenas repeatedly said it was also the economy’s major weakness.
Andean Capital’s Ariza is therefore in the majority when he says that the depreciation of the peso is a good thing. But this will cause inflationary pressure in the short term, “requiring higher interest rates that will reduce liquidity and slow economic growth”, he says.
If macroeconomic stability seems assured, a more challenging question is what can drive growth while commodity prices remain low.
There is little evidence yet that non-oil exporters are benefiting from the weaker exchange rate, with one economist saying that many export sectors have been “hollowed out” by lack of investment while the peso was strong.
Under Juan Manuel Santos’ government, Colombia has ideas to drive growth — but the execution has often been lacking. Progress on his flagship 4G infrastructure programme, for example, is disappointing many.
“Colombia has tried to invest in infrastructure but projects have gone too slowly,” says Ariza. “Now we’ve hit a problem: the cheap money that was available for so long is no longer there, so financing the projects could become a challenge.”
Peru at least appears to be in recovery mode: the economy grew 3.26% in July after growing just 1.73% in the first quarter and 3% in the second. But some argue this is down to an increase in mining production that cannot sustain growth on its own. Indeed, the manufacturing and construction sectors shrunk in the second quarter.
Hope for Peru, however, again comes from its thrift in previous years. Public investment was down more than PEN2bn ($625m) from January to August, but Maldonado thinks fiscal stimulus will be more effective in the second half of the year.
“The government is taking big strides to unlock public spending and on a microeconomic level is working with regional governments to make spending more effective,” he says.
CHILEAN TURBULENCE
In Chile, the best rated sovereign in Latin America, solid macroeconomic fundamentals have also served the country well. Yet Chile is the country that is facing the most serious questions about economic management.
“In 2013 I would have said the slowdown was 90% because of external factors,” says Benjamin Sierra, financial markets economist at Scotiabank in Chile. “But with time this has changed as the economy adjusts to new external conditions, and now I’d say slow growth is just as much down to internal as it is external factors.”
Michelle Bachelet took office in 2014 proposing corporate tax rises to pay for education reform, leading to emotional spats between the business sector and the government. After modified tax reforms, little progress on education reforms and a new more moderate cabinet, tension between the government and private sector has calmed.
Ariza says that, at the very least, “it does not look like the government can make things any worse at this stage”.
But confidence remains low and Sierra says that even a recovery in China would not enable a fast recovery in Chile “without an improvement in internal factors like business confidence”.
As Maldonado says, what happens in China is “undoubtedly a big risk for Andean nations” given it is not only a key trader but also a driver of commodity prices.
Yet it is becoming clearer that these nations’ capacity to combat economic cycles is as dependent on their internal management as on external factors.
With this in mind, indebted Colombian students may curse the weak peso, but as they look for work in their home country, they will surely be thankful they do not have the pegged exchange rate of their neighbours in Ecuador.
ECUADOR IN A SQUEEZE
With oil a big part of its economy, the country has some harsh decisions to make
Of the nations lining South America’s Pacific Coast, Ecuador’s adjustment will undoubtedly have to be the most aggressive, with oil accounting for 52% of exports and 28% of government revenue at one stage.
“Ecuador is a dollarised economy, was running a fiscal deficit and does not have fiscal savings,” says Lorenzo Maldonado at Credit Suisse. “They have already announced spending cuts, a tax amnesty law to raise funds in the short term and have had difficulties covering their financing needs.”
Indeed, nothing highlights the country’s troubled position more than its rapidly declining fortunes in bond markets.
Ecuador made a triumphant return to international markets in July 2014 when it raised $2bn of 10 year money at a yield of just 7.95%. But that was before the slump in oil prices began, and when the sovereign made its first market outing of 2015 in March, it paid 10.5% for just $750m of five year paper.
A Bank of America report published in August says it is clear that the government cannot finance all its planned expenditures. “The adjustment will occur through cuts in public investment, with potential consequences for productivity, fiscal revenue and the current account in future years,” says the report.
Indeed, with oil prices falling even further in the second half of the year, these bonds have plummeted in secondary markets, with some investors fearing the country will struggle to meet its obligations.
Economists in general are sceptical that another default is on the way: rather, a sharp recession is in store.
“I think the extent of the downturn will be lower economic activity rather than a credit event,” says Maldonado. “Imports are already falling at double digits, which is helping avoid a sharper deterioration of external accounts and the financial system remains healthy.
“Moreover, the debt dynamics are not unsustainable and the government has made it very clear it recognises the importance of keeping fiscal and external balances sustainable.”—O.W.