Inflation runs rampant around the world. US interest rates, the most powerful force driving money across borders, from which no economy can hide, rise faster than at any time in 40 years, taking a clutch of banks down in their path.
Not least in Latin America, you might expect economic chaos to have ensued.
After all, Argentina is… Argentina. In Brazil, a new president lashes out at the central bank and tries to relax the country’s budget rules. Mexico’s leader takes aim at its electoral institutions and hands a slew of new authorities to the military. Chile’s takes a second shot at redoing the constitution after failing the first time. And Peru’s tries to shutter Congress but is put in prison instead.
The injection of economic turmoil into political tumult would be more than enough to invite the present day into the company of Latin America’s distinguished line of economic catastrophes, starting with the debt crisis of the 1980s, courtesy of the anti-inflationary crusade by the Federal Reserve chairman at the time, Paul Volcker.
And yet, somehow, the region’s famously vulnerable economies are holding their own. Capital flows to emerging markets tracked by the Institute for International Finance turned more volatile since the Fed started raising rates last year. But money has not turned tail. Carmen Reinhart, former chief economist at the World Bank now at Harvard’s Kennedy School, notes that markets are reacting positively simply because “they saw macro policy was on a reasonable trajectory.”
Foreign portfolio flows into Latin American equity and bonds averaged more than $10 billion in the first two months of the year and add up to more than $50 billion since the Fed started raising rates in April last year. There is little data on capital flows since Silicon Valley Bank went under. But the currencies of most of Latin America’s bigger economies (right, not Argentina’s) have strengthened against the dollar over the last couple of weeks.
Things may still go sour south of the border. But so far, Latin America has convinced the capital class that it can disentangle its macroeconomic policy from its messier, livelier politics.
The latest Fiscal Monitor from the International Monetary Fund, published last October, estimated that as a whole, Latin America would run a balanced primary budget (before considering debt servicing) in 2022 and a small primary deficit this year of 0.4% of gross domestic product.
This is much tighter fiscal policy than what prevails in most other regions of the world. But not only is fiscal policy tight. Compared with the Federal Reserve, central bankers across Latin America look like steely-eyed monetary hawks. They started raising interest rates earlier and tightened much more aggressively. For all the tightening by the Fed, real rates in the US are still negative. Brazil’s policy interest rate is about 8 percentage points above inflation.
In Mexico not only are real rates roaming at around 3.5%. An ostensibly lefty administration has been running its fiscal accounts like an A-plus student from the IMF. (So much so that at the heights of the Covid pandemic IMF economists accused Mexico’s government of being too stingy.) It is not really that surprising the peso has been trading at around its highest level against the dollar in five years.
It looks pretty much like a story of lessons learned. Latin America has been through the fire of financial crises too many times to allow itself to give in to another one without a fight.
Economic orthodoxy has taken hold across most of the region (yeah, not in Argentina). Not only are more central banks independent, pursuing credible inflation targets. Current account deficits are not large and most debt is in domestic currency, rather than dollars. Fiscal rules like the one president President Luiz Inacio Lula da Silva rails against are prevalent throughout the region — putting a lid on the buildup of debt. And foreign reserves remain fairly solid.
Latin American countries still have work to do to combat inflation at home. The world economy is slowing. And unlike during the great recession, when Chinese appetite for commodities bailed out the region’s economies, China today is in no shape to help anybody.
Moreover, the Fed has not yet brought inflation in the US under control. Once it gets over its fears about bank fragility, it is very likely to raise rates aggressively again — putting the brakes on international capital flows to the developing world. “Increases in international interest rates are never good news for emerging economies, and for Latin America in particular,” Reinhart said.
And then there’s the feisty politics. Martin Castellano, chief economist for Latin America at the Institute of International Finance, underscores the value of Latin American institutional stability in the face of political challenges. “There are more checks and balances,” he said, “that have helped contain radical policy proposals.”
But that may not hold for long, especially if slower economic growth invites more disgruntlement. “Policy consistency has helped the region overcome the tough moments it has been through in the past few years,” Reinhart said. “But if the political side starts embracing populism it will all become more difficult.”
If that happens, then 2023 may then join the club, alongside the debt crisis of 1982, the tequila affair of 1994, the Asian debt crisis that took down Brazil in 1998, the bursting of the first internet bubble, the global financial crisis of 2008, the end of the commodity super cycle in 2014 and Covid in 2020, when some part of the global economy twitched and took down a chunk of Latin America. (https://www.washingtonpost.com/business/2023/04/04/latin-america-has-learned-how-to-fight-a-financial-crisis/45dc472a-d2d7-11ed-ac8b-cd7da05168e9_story.html)
