What impact will a commodity price correction have on Latin America? Three experts share their insights.
BY LATIN AMERICA ADVISOR
The commodity boom that has powered so much of Latin America's growth in recent years may be finally coming to an end, say many economists. What is the capacity of Latin American economies to absorb a "correction" in commodity prices? Have countries taken advantage of the boom to diversify their economies and reduce their dependence on commodities?
Alberto Ramos, Vice President and Senior Economist at Goldman, Sachs & Co: Latin America has accumulated a fair deal of macro and financial resilience over the last few years. Part of that structural adjustment was certainly anchored in the amazing rally seen in commodity prices since 2003 rather than from the active pursuit of structural reforms to increase the overall productivity of local economies. Given the major reduction of perennial external vulnerabilities recorded during 2003-07, Latin America is today quite well equipped to deal with a negative external shock, such as a potential decline in commodity prices. However, it is important to underscore that while Latin America is resilient it is not immune to or insulated from a commodity price decline. If such a shock materializes, growth will certainly decelerate due to the loss of external income, but we are very far from running the risk of seeing a major fiscal and/or balance of payments crisis associated with a collapse of growth (i.e., recession) amid a large overshooting of local currencies and interest rates. Admittedly, the macro performance of Latin America improved pretty much across the board over the last few years. However, with a few exceptions (e.g., Chile, Colombia, Peru) most of the countries in the region did not maximize the opportunity they were presented with (e.g., Argentina, Ecuador, and Venezuela). Many, rather than saving the windfall in a countercyclical fiscal fund, have used the commodity revenue windfall to over-stimulate their economies, postpone needed structural reforms, and in some cases finance populist, inward-looking, heterodox models that have been spectacular failures elsewhere. Consequently, these economies are certainly more vulnerable/exposed to a commodity price decline than economies that used this opportunity to pursue a balanced mix of conventional policies and to increase investment levels to boost potential GDP.
David Malpass, President of Encima Global, LLC: US macroeconomic policy has been good for most of Latin America—better than for the US itself. Super-low US interest rates in 2003-2006 and again in 2008 have allowed many Latin countries to lower their financing costs and convert to local currency debt rather than dollar debt. The weaker dollar has caused high commodity prices directly (to offset the dollar weakness) and indirectly by supporting temporarily high global growth rates. As a major commodity producer, Latin America has enjoyed strong growth. I don't think the recent downturn in commodity prices spells the end for Latin America's expansion. First, the US and Japan have incredibly low interest rates, arguing that there hasn't been much lasting constriction on global liquidity. Second, the commodity price decline came from July's super-high level, leaving commodity prices still very high. Third, many countries in Latin America used the boom times pretty well—much better than in the 1970s (although Venezuela did very badly in both the 1970s and the 2000s.) Fourth, if the dollar continues strengthening and commodity prices falling (not my view), Latin America will get some benefit from a resurgent US and from lower inflation. And if commodity conditions stabilize at a reasonably high level, Latin America should do as well as it has been. Bottom line: whatever happens with commodity prices, most of Latin America has benefited from the solid expansion and is in a position to deal with current commodity price gyrations. This leaves structural reforms a key goal—Brazil's tax code, Mexico's petrochemical paralysis, Venezuela's sad populist impoverishment. While we're hoping for structural change, Latin America would be a huge beneficiary of faster US growth, a better tax code, and fewer trade barriers.
Alfredo Coutino, Senior Economist for Latin America at Moody’s Economy.com: Finally, prices of commodities are adjusting down, particularly prices of crude oil, metals and grains, among others. Due to the inflated prices, compared with those determined by their fundamentals, and given the steady decreasing trend shown recently, it seems that the market is under a process of structural correction rather than under a temporary move. This correction should bring prices to levels more consistent with supply and demand forces. Undoubtedly, commodities are important for Latin America, but their role vary from country to country. At the aggregate level, however, regional exports contain a higher manufacturing component (55 percent of total exports), which is the result of the region's industrialization level generated by the profound process of structural reforms initiated more than two decades ago. Being a net exporter, a fall in commodity prices will have an impact on the region, but will not cause a crisis as in the past. This is because federal budgets and economic programs are based on very conservative estimates for commodity prices. Therefore, the adjustment in prices will only reduce the amount of additional revenues, affecting only the marginal growth above the region's potential rate. In addition, nations have taken preventive measures for the adverse future. Most countries increased infrastructure investment and social programs, but some others were able to save part of those foreign resources as international reserves, stabilization funds, or sovereign funds, like in the case of Chile and Brazil. These funds are allowing local governments to implement countercyclical measures, but also are being used to increase the stock of capital, which in the end will increase the region's capacity to grow.
Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.