Monthly Newsletter - October 2008

In the weeks following the collapse of some of Wall Street’s major financial institutions, Latin America has been rattled by the shockwaves of what is being called the worst financial crisis since the great depression. Economies were hit hard with effects such as: plunging currency values, sinking stock markets, and billions of dollars wiped off in share values. The Bovespa – the key stock market in Brazil - fell sharply by 50% from its highest point of the year and the real lost over half of its value against the US dollar.

These trends have caused observers to cut their projections for Latin American growth by whole percentage points in several cases. The World Bank, for example, cut its estimated growth for 2009 from 4.2 percent to as low as 2.5 percent, amidst predictions that the fastest period of growth experienced by the region in three decades is now drawing to an abrupt close.

The rapid and sustained economic growth that has been enjoyed by countries throughout Latin America over the last five or six years created an environment that did not foresee a crisis. The resource-rich region has been buoyed by high commodity prices, with revenues from oil, metals and agricultural goods supplying countries with large trade surpluses. This allowed governments to balance their budgets whilst giving them the freedom to indulge in generous social spending schemes. Central banks have been able to build up healthy reserves of foreign currency without having to seek securities backed by defunct mortgage payments. This has led an increasing number of commentators to proclaim that the region was beginning to ‘decouple’ from its economic dependence on the USA.

It was therefore somewhat unprecedented that Latin American stock markets would crash to the extent of October’s record lows. Credit flowing into the region quickly dried up as investors assumed Latin America to be too risky a venture and commodity prices fell sharply as their demand waned. Economists quickly began to predict a slowdown in line with the rest of the world, fuelling the uncertainty of potential credit providers who were looking for a safe bet.

These trends have ultimately proven that the financial health of the region is still closely tied to that of the United States. Only with the recent announcement of bail out plans by policy makers in Europe and the US have plummeting stock indices and currency rates shown any signs of leveling off. This may yet prove only to be a temporary antidote. Those ‘rainy day funds’ of foreign currency have already been tapped in an attempt to keep economies flowing smoothly. The World Bank predicts that Latin American nations are going to have to borrow more money in the future as these are exhausted.

Some countries will be better prepared to handle the crisis than others. In Peru, Chile, and Colombia, where policy makers have managed their spending frugally and built up large reserves of foreign currency, the blow will be softened to some extent. In countries such as Venezuela, Argentina, and Ecuador, governments may be worse hit as they have already plowed their foreign income reserves into social welfare programs. No matter what their individual circumstances may be, governments across the region will have to redraw their budgets so that they can weather the financial storm in the best possible way whilst taking the responsibility to reduce its effect on the poorest.

By
Simon Ross-Gill

Source:
Bloomberg
The Economist
The Financial Times
The Guardian
The Wall Street Journal

PAST NEWSLETTERS:

• Newsletter September 2008
• Newsletter August 2008
• Newsletter July 2008
• Newsletter June 2008
• Newsletter May 2008
• Newsletter April 2008
• Newsletter February 2008
• Newsletter January 2008