LATAM Government Debt: Brazil in the Spotlight

Public debt in Latin America has soared since 2008. We picked the seven biggest economies in the region and analyzed government borrowing. Spoiler: debt is increasing rapidly and could force policy makers to cut spending drastically if further FX depreciation is seen.

 

General government debt in Latin America’s seven biggest economies increased to 45.5% of GDP in 2015 from 34.3% of GDP in 2008. A mix of countercyclical fiscal policy, FX depreciation and a low-interest rate environment was responsible for higher debt across the region. The fall in crude prices has been critical too, as governments and state-owned oil companies have partially covered the forgone revenue issuing new debt. In the case of Argentina, the country is still trying to return to international debt markets. In the meantime, debt has risen as a result of more peso-denominated debt issuance. Ahead, the sharp FX devaluation and high interest rates could pose a challenge to Macri’s ambitions to issue USD-denominated debt while keeping public accounts healthy at the same time. The IMF estimates that debt as a percent of Argentine GDP would jump to 65% by 2020, which would place the economy as the second-most indebted one—just behind Brazil— within our seven-nation sample (Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela).

LATAMDebtchart1

Between 2008 and 2015, debt increased the most in Venezuela, followed by Colombia. Venezuela’s general government debt as a percent of GDP expanded from 23.1% in 2008 to 53.0% in 2015. Debt more than doubled in seven years as a result of massive primary deficits—surpassing now 20% of GDP next year. As for Colombia, the country has experienced fast accelerated growth in the last years and primary surpluses were seen for three straight years (2012-2014); but the massive COP (peso) depreciation has pushed external debt servicing up. Debt as a percent of GDP rose from 32% in 2008 to 51% in 2015. While the primary balance is expected to be flat (or slightly into the red) this year, further oil declines would present a serious challenge for public finances, and fiscal spending cuts could be triggered. Rising interest rates do not help.

LATAMdebtchart2

Peru was the regional outlier, lowering its debt-to-GDP ratio since 2008. In seven years, the Andean country’s general government debt as a percent of GDP lowered to 22.4% from 28.0% in 2008. Still, the depreciation of the Peruvian sol in 2015 caused the ratio to increase by 170 basis points in 2015. Contrary to Chile, the world’s largest copper exporter and the least-indebted country among these seven LatAm economies, Peru’s fiscal accounts are not expected to deteriorate much from declining copper prices as output from new/expanded mines will cover some of the lost revenue. Debt as a percent of Peruvian and Chilean GDP is expected to remain relatively well-anchored at low 20’s, at least for the next couple of years. Both are safe from drastic spending cuts.

Brazil’s debt-to-GDP ratio is by far the highest in the region. The federal government’s debt is slightly over half of the total sum, which is a relief. However, public entities and subnational governments are affecting the aggregate. Debt and a percent of GDP stood at a regional high of 70% in 2015—Venezuela comes second with 53%—, but that number is expected to climb this year by nearly 500 basis points. If the BRL (real) keeps deteriorating and the economy fails to begin showing signs of life, the IMF projection could easily prove conservative. The government is set to announce a $20-30bn cut in fiscal spending: a first step towards mitigating a burden that could easily run out of hands over the next few years. Policy makers should act fast.

Going forward, regional debt is expected to keep increasing. Excluding Colombia, all of the economies in this sample are expected to post primary deficits in 2016. This basically means that governments are expanding debt without even considering interest payments. Considering that oil/copper revenues are falling in most countries and taxes are collected in local currency despite massive currency depreciation, the prospects of debt reduction this year or the next look dim. The most worrisome case is Brazil, which could reach 80% of debt to GDP in the next 4-5 years. In case the government needs to bail out Petrobras (no longer a remote possibility), this figure could deteriorate further.


LATAM PM’s View: Venezuela is, of course, a major concern in the region is terms of default likelihood. The massive fiscal imbalances will not current themselves unless crude prices rebound sharply and Congress acts boldly to cut spending—both unlikely scenarios. However, Brazil is also in the spotlight, as debt-to-GDP could jump to 80% by 2020. Fiscal imbalances have not been corrected; commodity prices keep plunging; and the economy refuses to resuscitate, which could make the 80% IMF estimate look conservative by the end of this year. Another estimate that could prove conservative is Argentina’s. Macri’s (costly) efforts to settle with U.S. hedge funds, the peso’s devaluation, a renewed stats agency, and lackluster economic growth could all play a toll on debt. More on that later.