LatAm is in weaker position than during Great Recession

LatAm is in weaker position than during Great Recession

Corporate & Sovereign Strategy Economy & Policy Capital Markets Latin America Central America Coronavirus

Latin American governments are in a weaker fiscal position now than during the global financial crisis to make use of fiscal policy to counteract the effects of COVID-19, the Inter-American Development Bank (IDB) said in a recent report.

The fiscal package available to the region today is about half of what was available in 2009,” said IDB research economist Victoria Nuguer in an online presentation on Monday. “This gives us a much smaller fiscal space from the one we had in the last crisis. 

In 2008 countries with less debt were able to react with a larger fiscal package. But in 2008, the average debt to GDP ratio in the region was 40%, while today it is 62%. 

Between 2016 and 2018, the weakest countries made progress in fiscal consolidation, but this effort stalled in 2018-2019. Revenues collected by governments in the region had already fallen in 2019, the IDB points out. Today, the typical country has a general fiscal deficit of around 3% of GDP and around one fourth of countries have a deficit of around 4% of GDP, the report said. 

Tapping financial markets to increase the fiscal space also faces constraints. 

We are having more difficult access to financing because of high yields, said Nuguer. 

In the wake of the coronavirus outbreak, “flight to quality” in financial markets has led to considerable increases in bond spreads in the region. The JPMorgan EMBI index showed yield spreads for Latin America and the Caribbean nation's debt doubled from 346 basis points at the end of 2019 to 703 basis points by the end of March 2020, the report said. And even though US interest rates fell over the same period, EMBI yields rose to 7.53% from 6.03%, indicating a higher cost of financing, the IDB report said. 

Latin American markets also experienced the worst sell off in equity markets, according to the IMF’s Global Financial Stability report issued on Tuesday. 

Given these constraints, IDB researches say that Latin American countries must focus on the quality of public spending.  

“The important thing is the quality of public spending. That is what we have said,” said Erri Parrado, chief economist and general manager of the research department of the IDB. Transferences must be temporary, opportune, transparent and above all, focalized in the segments that need it.”  

“What we saw in 2008, 2009 is that sometimes those transferences went to people that did not need them, and that is why we talk about leaks when we look at the quality of fiscal expenditures. These leaks can reach 5% of GDP as a region, and we don’t want this to happen again in Latin America and the Caribbean.” 

Earlier on Tuesday, the IMF unveiled its economic forecasts for this year and next, saying the rapid spread and lethal nature of the COVID-19 pathogen is resulting in the world being put into a Great Lockdown.

Latin America and Emerging Europe are both expected to see regional economies contract by 5.2% this year while the overall global economy will shrink by 3%, the IMF predicts. The global economy is expected to recover in 2021 with growth predicted to rise 5.8%.

The two largest economies in the LAC region, Brazil and Mexico, will see their economies underpeform by a significant margin. The IMF sees Brazil's economy contracting 5.3% while Mexico is expected to drop 6.6%. Both are expected to rebound with just around 3% growth in 2021. The LAC region next year is expected to recover with a 3.4% growth rate, the weakest among all emerging markets and developing economies, which on a combined basis are expected to rebound with GDP of around 6.6%.