How has the European debt crisis affected Latin America? Three experts share their insights.
BY LATIN AMERICA ADVISOR
European officials early on Monday agreed to provide a bailout package of 750 billion euros ($U.S. 955 billion) to rescue E.U. economies threatened by the debt crisis that began in Greece. Has the crisis affected Latin America? Through what channels is the region most likely to feel the fallout from the crisis and subsequent bailout? Will the size of the rescue package threaten the availability of emergency liquidity in future crises?
Mauricio Cárdenas, senior fellow and director of the Latin American Initiative at the Brookings Institution and former minister of economic development and transportation of Colombia: The events in Europe did affect the spread on Latin America's debt last week. There was an increase, reflecting a greater risk premium on the debt issued by Latin American governments, but it was a relatively small and basically reversed itself this week. In addition to that, stock markets in the region did fall along with others throughout the world before the rescue package was announced, although the reduction was smaller percentage-wise than in the United States and Europe. Moving forward, I think there will be a positive effect for the region because, if anything, Latin America now looks as risk-free as any area in the world. The level of public debt is on the order of 40 percent of GDP, whereas in most of the developed world it's around 100 percent. So I think we'll see a surge in capital flows and a compression in spreads in the next few months because Latin America is going to look better, especially the sovereigns that have investment grade. Regarding the bailout, first I think that the moral hazard associated with this rescue is very large. It is going to be hard in the future to enforce fiscal rules because these European governments know that they'll be bailed out. Secondly, the IMF has a major risk, because if Greece does not comply with the conditionality of this adjustment package, it is going to send a signal to other countries. They are going to look at the IMF and say if Greece isn't doing it, then why should we?
Alfredo Coutiño, director for Latin America at Moody's Analytics: Fortunately, and for the first time in many decades, Latin America is much better prepared to withstand external shocks, not only because it has corrected its major economic imbalances but also because it continues to maintain a strict macroeconomic discipline. The region is less affected by the European crisis since most Latin American economies maintain neither fiscal nor external imbalances, at the same time that inflation is under control and exchange-rate systems are flexible. The region ran a fiscal deficit of less than 3 percent of GDP in 2009, which is expected to decrease to 2.5 percent this year—far below last year's European Union average of 6.5 percent. In this sense, the real economy is relatively insulated from the financial volatility coming from Europe. However, Latin American financial markets have not escaped the volatility generated by the European fiscal crisis, but this has been mainly the result of investors' panic created by an increasing risk aversion. This means that market volatility in Latin America has been the consequence of a psychological effect, with investors trying to protect their assets as a precaution, not the result of structural problems in the region. In addition, Latin American financial markets do not have significant exposure to European sovereign debts, thus maintaining a reduced risk of contamination. The size of the European rescue package covers the financial needs of the four 'PIGS' for the next four years, thus reducing the probability of default in the four most fiscally imbalanced economies. By now, Europe seems to have solved one part of the crisis—the lack of confidence. The second and most important part—the lack of credibility in the fiscal adjustment—is still pending.
Paulo Vieira da Cunha, partner and head of research for emerging markets at Tandem Global Partners in New York: Latin America has important trade links with the European Union. Contagion, however, flows rapidly through financial markets and this case was no exception. The critical intervening variable is risk aversion: The crisis deepened on May 6 after European Central Bank President Juan-Claude Trichet said the ECB had not considered and would not entertain buying euro-area sovereign paper on the secondary market. Regional currencies gaped and local interest rates widened, in sympathy with the gyrations of the euro. They retracted on Monday after European leaders agreed on the emergency package (and the ECB started buying sovereign paper). The move, and the mood, is hesitant, nonetheless. The package stopped the panic, but the problem remains. If the so-called 'PIIGS' implement the requisite fiscal adjustment, their growth will suffer; their localized deflation stands in sharp contrast to the onset of rate 'normalization' by the ECB, with an eye in Germany-France causing a counterproductive (indeed, suicidal) increase in their real interest rates. If they do not implement the adjustment, the euro collapses. Either way, the prospect for Europe is difficult. This will affect global growth and eventually the trade channel with Latin America. Meanwhile, to the extent that investor confidence remains, markets such as Brazil could gain by reflection. The important aspect of this crisis (after the collapse of Lehman Brothers) is that the risk aversion is not with Latin America. On the contrary, ironically, the region now stands as a bastion of macroeconomic prudence—though, in my eyes, somewhat deceivingly.
Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter.