Behind Latin America’s Woes Stands China

January 20, 2016

Argentina’s peso has lost 40% of its value in the past six weeks. Brazil’s industrial output tumbled about 8% over the past year. Venezuela is on the verge of hyperinflation.

It used to be said that when the U.S. caught a cold, Latin America caught the flu. Nowadays, China has supplanted the U.S. as the main driver of economic fortunes (or misfortune) across much of the region. When China sneezes, South America runs a fever.

The global decline in commodity prices from the China slowdown has hurt Latin America more than any other region, causing economic output to decline nearly 1% last year, according to the World Bank. This year doesn’t look much better, with no growth forecast for the whole region.

“It’s going to be a challenging year, and a test of the resilience of these economies,” said Carlos Arteta, co-author of the World Bank’s global outlook report and an economist at the bank.

Still, there are big differences between countries across the region. Growth is expected to be moderate to good in Mexico, Central America and the Caribbean, compared to recession-hit South America. Panama is expected to be the region’s top performer with 6.2% growth.

Nothing symbolizes the region’s changing fortunes more than this year’s Olympics, to be held in Rio de Janeiro. When Rio won the nod in 2009, Brazil was enjoying boom times, and the games were supposed to crown the country’s rise to developed-world status. Instead, Brazil is caught in a deepening economic and political crisis. Even the games are being hit: Athletes now won’t have televisions in their rooms.

Even within South America, there is a big difference in outlook between countries that saved more of their windfall from the commodity boom like Chile, Colombia and Peru, and spendthrift nations like Brazil, Venezuela and Argentina, which all face a toxic combination of rising deficits, inflation and interest rates.

“The key theme is divergence,” said Bill Adams, senior international economist at PNC Financial Services Group in Pittsburgh. “Today we see pretty dramatic divergence between Mexico and countries like Brazil, not to mention Venezuela.”

Mexico is likely to see stronger growth of 2.8% this year from 2.5% last year, thanks largely to continued U.S. demand for its exports, according to World Bank estimates. Low oil prices, however, will crimp the government’s ability to spend and limit the upside from the country’s historic opening of its energy market.

The World Bank expects Peru’s economy to grow 4.5%, and Colombia’s 3%. Venezuela’s economy, meanwhile, is predicted to slump 4.8% on top of an estimated fall of 8.2% last year, the World Bank says. Brazil is seen slumping 2.5%, in addition to a recession of 3.7% last year.

Differences on the budget front are stark. Peru, which ran budget surpluses during much of the commodity boom, now has a fiscal shortfall of just 2.1% of annual economic output. Brazil, meanwhile, faces a budget shortfall of 10% of gross domestic product, and has a “junk” rating on its sovereign debt.

The case of Venezuela is still worse—the budget shortfall is now estimated at about 25% of GDP. The central bank is printing money to cover the gap, fueling inflation that could hit 1,000% this year, according to Bank of America.

A surprise bright spot this year could be Argentina, where new president Mauricio Macri has moved quickly to undo years of populist economic policies under his predecessor Cristina Kirchnerand her late husband Néstor. President Macri has scrapped currency controls, eliminated most agricultural export taxes, announced a $500 million shale-oil investment and began overhauling Argentina’s discredited statistics agency.

A telling indicator of Argentina’s newfound pragmatism: Mr. Macri will turn up at this year’s World Economic Forum in Davos, the first time an Argentine leader would be in attendance since 2003, when then-presidentEduardo Duhaldeattended.

Argentina’s return to the world’s premier gathering of capitalism says a lot about how Latin America may be ushering in a more pragmatic era. It’s long overdue.

“The lesson from this is these countries need to find ways to identify endogenous sources of growth that don’t depend on external conditions,” said Alberto Ramos, chief economist for Latin America at Goldman Sachs. “During the good years we didn’t see enough reforms, and some places went backwards.”