Some Latin American countries may still suffer a severe financial adjustment as the region enters its fifth consecutive year of economic decline, a senior World Bank official has warned.
Augusto de la Torre, Latin America chief economist at the World Bank, said that the current improvement in the financial markets did not reflect the fundamentals of many economies.
The Institute of International Finance (IIF) said recently that the region is undergoing one of the “worst contractions since the 1980’s lost decade”.
However de la Torre warned that the nature of the current crisis was different. “It is no longer a slowdown because it became a recession in 2015,” he said in an interview with Emerging Markets.
He added that the recent improvement in financial markets was related to short-term factors rather than a sustainable trend. “So, 2016 will continue to be a difficult year for Latin America, and things may get worse in the short run before they get better,” he said.
The regional performance has been crippled by the recession in Brazil and Venezuela, which account for over 40% of Latin America’s GDP. Add Argentina, which is going through a promising albeit tough transition this year, and the region will struggle for some time, with little recovery in sight.
FINANCIAL TURBULENCE
The IIF projects a 1.5% contraction in the region this year, which would be worse than the 1.1% decline experienced last year. In 2017 however, the IIF expects a modest rebound with GDP growth at 1.7%. Without Brazil though, the IIF calculates that growth would stand at 0.6% this year and 2.4% next year.
De la Torre said: “It is not so much [current] financial conditions that matter for South America. It is rather the effects of falling commodity prices and deceleration in China. The adjustment is in the current account rather than the capital account. This is an important contrast with the 1980s,” he said. Nevertheless, it may over time lead to some financial turbulence. “As time goes by and the adjustment process continues, it may well be that some financial complications start appearing in countries where there are worries about macroeconomic viability.
“Now that [Brazil] is out of the investment grade status — this is an indication that financial markets are concerned about the viability of macroeconomic policy. For some South American countries, there is a risk of more problems.”
So far this has not been the case across the board, said de la Torre. But some investors are already vigilant. Morgan Stanley has recently included Brazil in its “most exposed” emerging market category due to its “extreme case of macroeconomic weakness, double digit inflation, weak and deteriorating fiscal picture as well as its political situation and corruption noise”. In addition, Mexico and Peru are ranked as “exposed to a lesser degree”.