Thursday, April 9, 2009

Is the Worst of the Crisis Over? Implications For Latin Countries

It seems that the G20 package is helping the markets. As reported by Bloomberg, emerging market stocks have surged 33% from this year’s low on March 2 as the G20 leaders announced the $1 trillion package. As we previously explained the main goal of the G20 package is to build confidence in the market. In other words, Emerging Markets in Latin America are doing extremely well. Countries like Chile and Brazil have extremely solid macro-foundation and their fundamentals (reserves, primary surplus, trade account) will not be significantly affected by this crisis.

In contrast, other countries like Argentina, Venezuela and Ecuador were not doing well even before the crisis. These countries were following a mixture of economic populism and lack of solid macroeconomic policies. All of them had some type of price control, pegged exchange rate, problems with debt restructuring/holdouts/default (Ecuador and Argentina). In turn, in the face of an adverse external environment and facing a sharp decrease in commodity prices these countries are facing even more pressing constraints. The point here is that the G20 package tend to foster confidence for countries with sound foundations, like Chile and Brazil. Countries like Argentina, Ecuador and Venezuela, will not benefit from the G20 package for two reasons. First, neither Argentina nor Ecuador can qualify for an IMF loan because both are in technical default with the Fund. Argentina defaulted in 2002 and is yet to regularize its situation with the Fund. Ecuador defaulted in December 2008. Clearly, the country cannot qualify for an IMF loan either.

Is the Worse of the Crisis Over?

In our view, the worse of the crisis is over. In other words, this crisis was mostly driven by the lack of supervision and regulation in the US financial markets. Nobody knew the extent of the problem until the Treasury and the FED allowed Lehman to fail by mid September 2008. The set of measures that the US Treasury and the Federal Reserve have been implementing since then are extremely aggressive and in the right direction. In other words, besides the TARP, the FED created the many other liquidity facilities to increase the overall liquidity of the system geared towards unfreezing the credit markets. Besides that the government is addressing the homeowners’ problem. Given the significant number of homeowners that cannot afford to pay the installments of their mortgages and are being evicted from their houses, the government created a plan to renegotiate these mortgages and prevent the eviction. On the banking side, the Geithner Plan is addressing the toxic asset problem in the financial system balance sheets. The government will probably buy back the toxic asset and hence will allow the commercial banking system to start again and be solvent. The fact that the US and the UK government are implementing policies of ‘quantitative ease’ means that the both countries are buying back bonds and injecting money in the system to prevent deflation. While the fear of deflation was imminent two months ago, now we do not have this fear anymore. So things are better.

For Latin America and for Asia, this year will not be as bright as the previous years. However, most countries in South America are implementing the right set of policies. In Chile, for example, monetary authority will possibly cut rates to 1.75% from 2.25% today. The economy shrank 3.9 percent in February compared with a year earlier. The contraction was the deepest in almost 10 years and the third worst since at least 1996. While it is possible that Chile post a recession in 2009 (-0.5% in 2009) the monetary authority and the fiscal authority are implementing the right set of policies (counter-cyclical fiscal policy and monetary easing).

It is not a matter of being Pollyanna (the one who is always trying to be happy). Instead, the point here is that different from the recent past, where Latin countries faced a significant amount of high external debt, large set of vulnerabilities (current account deficits, pegged and overvalued exchange rates, price controls, lack of fiscal discipline, high inflation) we have a situation where Latin countries are ready to boom again. In other words, while it is impossible for any country to display high rates of growth when the whole world is slowing down it is possible to infer that Latin countries will be ready to display sustained growth paths very soon.

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