Before the outbreak of Covid-19, Latin America was the slowest growing region in the Global South and small increases in GDP prior to the crisis were largely contributed by labour input rather than productivity growth. Structural weaknesses, reflected in insufficient productive capacity development, left countries in the region particularly vulnerable to the dramatic shock of Covid-19.
Prior to Covid-19, the massive inflow of equity funds and buoyant demand for commodities (particularly from China) inflated asset and commodity prices. Since the beginning of Covid-19, these trends have been reversed dramatically. There has been a sudden stop in capital flows together with massive capital flight. In March alone, three of the largest economies (Brazil, Colombia and Mexico) experienced capital flight of over US$ 15 billion.
Furthermore, commodity prices plummeted as global production all but ceased. Oil prices contracted by over 100 per cent and fell below zero for first time in history. Coal prices fell by 55 per cent, copper by over 20 per cent, zinc by 19 per cent, lead by approximately 15 per cent, and soy beans by around 8 per cent. Yet, Brazil, Colombia, Mexico, Ecuador, and Venezuela are heavily dependent on oil revenues. Colombia is the world’s fifth largest coal exporter. Chile constitutes the largest copper exporter, and Peru relies on copper, zinc, and lead exports.
The Covid-19 shock will cause serious liquidity problems for Latin American companies. These have had problematic debt structures for some time (a result of financialization) and will face serious pressures on their balance sheets. With the fall in global and domestic demand and the increasingly tightened credit crunch, liquidity problems will soon turn to solvency problems and subsequent bankruptcies.
The low-wage and informal labour force will take the hardest hit from these developments. As welfare states have been hollowed out, workers have little to fall back on: no safety-net, no savings, and no access to quality healthcare. Highly indebted households will struggle to access food and medicine.
Another aggravating factor is the structural weakness of local currencies. The massive influx of liquidity pre-crisis and the inadequate response of central banks led to appreciation and overvaluation of local currencies. With capital flight and disinvestment from commodity assets, local currencies are under extreme pressure. Exchange rates have fallen more than after the financial crisis of 2007/08, while the value of the US dollar has surged. Given that most private and public debt in the region is held in US dollars, the Covid-19 crisis will seriously worsen an already parlous debt position.
The increasing pressure on public and private balance sheets is likely to lead to firms and households defaulting on their debt payments. Asset fire sales are likely to follow, forcing financial institutions to liquidate their holdings to meet funding withdrawal requests from investors, entailing serious financial risks. As most corporations and countries in Latin America depend on external financing, these financial insecurities exacerbate the credit crunch and increase risks of an economic depression.
According to the International Monetary Fund (IMF), the region’s economy will shrink by an average of 5.2 per cent. As the economic and health crisis deepens and global demand falls further, these dire economic projections may prove optimistic.
Multilateral responses, led by the IMF, have included an expansion of the Catastrophe Containment and Relief Trust (CCRT) to support balance of payments. The IMF will also need to create new special drawing rights (SDRs) and transfer existing ones – without conditionalities attached. This should help governments to free up fiscal resources to increase health care funding, to finance key imports, and to address crucial supply bottlenecks, particularly in food and medicine.
However, high levels of public and private debt could easily render these efforts futile if additional loans are used to finance the exploding debt burden. A moratorium on debt servicing is not enough: there is need for complete debt cancellation.
Finally, the looming economic crisis can only be addressed if Latin American governments radically rethink economic policymaking. The creation of new fiscal resources needs to go hand in hand with a reversal of privatisations and the nationalisation of commodity-extracting companies and banks. A state-led development model can use nationalised extractive revenues and newly created fiscal resources and compel nationalised banks to extend credit to the real economy.
As an immediate response, governments need to support businesses by extending loan maturities, deferring taxes, providing credit through direct central bank finance, and subsidising companies to maintain employment. In order to mitigate the pressures bearing on those in low-wage or informal employment, households could be supported by suspending payments on mortgage, rent and utility bills, by unconditional cash transfer programmes, and by investing in social services more generally.
These short- to medium-term stimuli would have to be accompanied by longer-term strategies to support strategic manufacturing industries, particularly those linked to renewable energy and innovative technology. This would break the vicious cycle of low-productivity growth and low-wage, precarious employment, and would tackle the region’s dependency on external financing and global demand for commodities.
The unfolding dramatic economic and social damage of Covid-19 calls for a progressive and radical reversal of the region’s failed neoliberal export-oriented development model driven by extractive and agro-industrial accumulation.
This piece was originally published by the LSE Latin America and Caribbean Centre.
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