The Contrarian: Does Europe Matter Anymore?

How might Latin America fare in such a gloomy environment?  Surprisingly well thanks to its own fiscal and monetary discipline and an historic pattern of declining European trade and investment links.

Many Latin Americans are proud of their European heritage and go to great lengths to sustain their cultural links to the old continent.  Fortunately for the region, their economic ties to Europe are far less sentimental.  In 2012, the EU-27 countries will buy only 12 percent of Latin America’s exports and will be responsible for less than 15 percent of foreign direct investment entering Latin America.  As the European debt crisis pushes the Euro zone into a 2012 recession, Latin America may once again escape relatively unscathed.
European governments, even the well run ones, are bleeding with red ink.  For example, Germany, held aloft as an example of industry and austerity, is saddled with government debt equal to 83 percent of its GDP.  Irish, Italian and Greek public debts all surpass 100 percent of GDP.  With still inflated real-estate prices in much of Europe, public debt may be just the tip of the iceberg in a European consumer society that has lived beyond its means ever since the common currency was adopted.  In a best case scenario, where debt is gradually paid down in an orderly fashion, Europe faces anemic growth for a decade.  In a worst case scenario, the euro collapses and financial flows grind to a halt.
How might Latin America fare in such a gloomy environment?  Surprisingly well thanks to its own fiscal and monetary discipline and an historic pattern of declining European trade and investment links.  Trade between Latin America and its traditional northern partners, the US and Europe has grown at a small fraction of the pace of intra-regional trade and trade with Asia, most particularly China, as well as emerging South-South trading partners like India, the Gulf states and Africa.  In 2012, China will for the first time replace the EU-27 as the 2nd largest trading partner to Latin America.
Until recently, European firms held one– third of Latin American FDI stock, having led foreign investment in key sectors such as banking, electricity, telecoms and automotive.  But Europe’s share of fresh FDI pouring into Latin America has slowly declined to an estimated 20 percent in 2010.  The debt crisis will severely limit the ability of European companies to re-invest in Latin America, let alone deploy new capital to the region.  For that reason, some estimate that European FDI to Latin America will barely reach 12 percent of the total or $15 billion in 2012.  By contrast, Chinese FDI in 2011 will surpass $20 billion and could reach $30 billion in 2012, double European levels.
While trade and investment linkages to Europe may be too weak to hurt Latin America, the more fungible world of capital flows could deliver some unwanted contagion to the region if the European debt crisis further devolves.  Some of Latin America’s largest banks come from Spain (Santander, BBV) and the UK (HSBC).  The 2008/9 financial crisis taught us that foreign banks that must de-lever their ba-lance sheets will necessarily stop lending, albeit for a short while.
More ominously, Latin America remains reliant on international debt markets to run its economies.  Because Latin American  savers keep about half their piggy banks abroad ($3.5 trillion overseas savings), the region is chronically under-banked.  Latin American public debt is modest by European standards (36 percent of GDP) but is still too large to be funded domestically by the region’s thin capital markets.  If investors are spooked by a collapsed euro, then it will prove more costly than normal for Latin American governments and large companies to raise money internationally.  More costly credit will slow Latin America down a bit.
In the end, the European debt crisis should not prove more challenging than the US led financial crisis of 2008/9.  That time round, Latin America’s currencies and financing flows took a beating for about 6-9 months but the region showed that it could withstand the hit and investors gladly returned.  Latin America is economically less reliant on Europe today than at any time since the Spaniards first arrived.   For that reason, worst case scenario forecasts for 2012 growth in Latin America are a healthy 2.5 percent.

John Price is the managing director of Americas Market Intelligence and a 20-year veteran of Latin American competitive intelligence and strategy consulting. jprice@americasmi.com

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About the Author: John Price is the managing director of Americas Market Intelligence and a 20-year veteran of Latin American competitive intelligence and strategy consulting. jprice@americasmi.com.

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