The Recession in Latin America Will Transform its Geopolitics

 

Latin America will suffer a recession this year. According to the IMF, regional GDP will contract 0.3% in 2016. This will not only have economic consequences for the next three years, but we will also witness a transformation of Latin American politics that might end with last decade’s division.

This division was more evident after 2012, when Venezuela joined Mercosur, creating a common block of Mercosur and the Bolivarian Alliance (ALBA)—to be fair, Uruguay and Paraguay were trapped in between. Argentina, Bolivia, Brazil, Cuba, Ecuador, Nicaragua and Venezuela embodied the left: growth model based on public expenditure financed by the commodity boom; dependency on China; and explicit rejection to form close ties with the United States.

And there was this other group of Central American and the Pacific-Alliance countries: Chile, Colombia, Peru and Mexico. These countries were governed by center-right parties; had a more dependent growth model on free trade; were less dependent on public expenditure; and had closer ties with the U.S.

To better illustrate the point, take the 10 largest economies in the region and list them by the level of government expenditure relative to GDP. A clear division is evident. Filtering the countries with a ratio above 40% can illustrate interesting patterns. The level of government expenditure was already higher for this group of countries in 2000, but it increased significantly after the financial crisis of 2008 and slowed down after 2014. In terms of growth, after Argentina and Brazil overcame their crises in early 2000s, this group grew at a faster pace. Again, 2008 and 2014 changed trends.

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The year 2014 is especially important. That year, commodity prices—including oil—collapsed and China began to show signs of slowing down. Since then, one of our groups has sickened and the countries included in it are the reason why the IMF is forecasting a GDP contraction of 0.3% for 2016. (Now we know that growth will be different across the region.)

So what? The region as a whole will experience important challenges: lower fiscal revenue, capital flights, depreciating currencies, weaker demand for exports, etc. The difference is that Argentina, Brazil, Ecuador and Venezuela will have to go through a more painful process that will bring political change. The reason is that their governments are moved by a stronger ideology and refuse to change their economic models.

This has already started. In Brazil, Dilma Rousseff almost lost in a runoff with Aécio Neves in 2014. Since then, everything has been chaotic for Dilma the PT. Currently, the shadow of impeachment follows the president. While the real possibility that the impeachment succeeds is low, its presence has contaminated Brazilian politics, draining important energy and time from policy makers. Key policy changes to boost so-much-needed economic growth are hampered, together with the chances of PT win in the upcoming election.  As unemployment and inflation keep rising, the possibility of a turbulent transition will increase. The World Cup triggered important social instability in 2014, as the Brazilian government spent in things they felt were unessential. The Olympics might be yet another trigger.

In Argentina, the transition materialized. Cristina Fernandez was not as lucky as Rousseff, and her appointee, Daniel Scioli, lost to Mauricio Macri in November’s runoff. A lot has changed since. Macri has lowered tariffs and taxes on exports, and removed capital controls, to let the peso to float freely. He announced cuts in subsidies and new negotiations with U.S. hedge funds, too. Perhaps more importantly for the region, Macri affirmed that he wants Venezuela out of the Mercosur and that Argentina wishes to join the Pacific Alliance. Still, Macri has not won all battles; he will have to face a congress—controlled by Fernandez’s party—that resumes activities in March, as well as deep economic imbalances. Inflation is one example. Macri wants to bring down inflation to 25% in 2016, although this is seen as too optimistic by market participants.

Maduro and the PSUV have not only lost an important ally with Macri’s victory. In Venezuela, the PSUV, legacy of Hugo Chavez, lost the elections for the National Assembly big time. The opposition now controls 2/3 of the legislative and has threatened to call a referendum this year to remove Maduro from power. Although the PSUV still has several key institutions, such as the Supreme Court, under its umbrella, one thing is certain: transition has started. As in the Brazilian case, as the economic situation worsens—from an already disastrous 10% GDP plunge in 2015 and 300% annual inflation—, the risk for an abrupt and more violent transition increases.

Ecuador is not in a situation as critical as its peers. True, it is going through hefty fiscal consolidation. However, growth fell from 4% in 2014 to 0% last year. The government is expecting 1% growth in 2016, but even the IMF’s 0.05% forecasts looks too optimistic given the 12% budget cut in a country so dependent on public spending. Moreover, the government’s forecast for this year assumed an oil price of $35/b. (Oil is significant for fiscal and current account revenues.) The Ecuadorian oil mix reached $20.7/b on January 19 and Correa acknowledged that the country is already pumping oil at a loss—production cost is $24/b. Despite Correa’s 60% approval rate, he was not able to prevent important street protests last year. He even had to retract some unpopular law initiatives and announced that he is not running in 2017 in order to gain political capital to pass an amendment that eliminates the presidential reelection limit. (LATAM PM believes that he is trying to come back Putin-style in 2021, but that is a different story.) His strategy faces many risks.

All in all, the following years are going to be crucial in defining regional politics and international relations. It is important to recognize that the aforementioned countries had important achievements in terms of economic development during the last decade. Millions left poverty because of public spending. Still, it was shortsighted to make an important and risky bet to China and commodity prices, especially when the jobs of people are at stake. Time will tell.