Carstens warns on US debt threat to Latin America

Carstens warns on US debt threat to Latin America

Latin America’s slowing economies could face “very severe” repercussions if US lawmakers fail to raise the government’s debt ceiling, Mexico’s Central Bank Governor Agustin Carstens warned in an interview with LatinFinance.

“If there is a major breakdown [in US debt ceiling talks] and this is a prolonged issue, the consequences could be very serious,” Carstens said.

His comments came as congressional leaders in Washington failed this weekend to break an impasse to avoid a possible sovereign default when its borrowing cap expires on October 17.

Carstens said that Mexico’s economy – which has disappointed following a sharp slowdown in growth this year – could face severe headwinds if a deal is reached in Washington that chokes off US growth as a result of sharp spending cuts. In the case of a default, “the shock would be very strong,” he added.

“The main point is how the US government reacts,” he said. “If they decide to cut government spending, they could go into recession. If there is a default then the financial sector and capital account would be the transmission mechanism [to the Mexico’s economy].”

His comments were echoed by Mexico’s public credit director Alejandro Díaz de León, who told LatinFinance the threat of a US default was “like having an explosive device that could be deactivated if both parties agree.” He added that while he expected a default to be avoided, uncertainty over US economic policy meant that “volatility will be with us for quite some time.”

Carstens said that Mexico’s economy – which faltered this year amid weak US demand for exports and a slump in construction – was nevertheless poised for a rebound.

If US leaders strike a longer-term budget deal and avoid breaching the debt ceiling, Carstens said a pickup in US growth to at least 2.5% would “give an additional push” to Mexico’s economy.

Carstens expects GDP to expand by up to 2.0% in 2013, compared to 3.8% last year.

Following Mexico’s sharp economic contraction in the second quarter and devastating floods last month, growth forecasts have been slashed. The IMF last week cut its 2013 growth forecast to 1.2%, from its July estimate of 2.7%.

Carstens refused to be drawn on whether the central bank would reduce interest rates further to boost growth. “I think we are entering into a phase where the economy can start to grow faster,” he said.

He added that the slowdown was due to an “unintended major fiscal contraction” that was partly the result of a lengthy transition period following last July’s election until the government took office in December.

Currency depreciation, following a sharp surge in the peso at the beginning of the year, would also “support the growth in exports” he said. 

Analysts expect further cuts by year-end of between 25 basis points and 50 basis points to the main policy rate, now at 3.75%. LF