Latin America has been saved
Cover image by: Jaime Austin
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The Latin America economic outlook provides an overview of how the region was impacted by the COVID-19 pandemic and the challenges it faces, as it begins to enter a phase of economic recovery, which is heterogeneous among countries. Only a few will manage to surpass the prepandemic levels of growth this year, while the majority will take longer.
The report analyzes the fiscal policy responses to the COVID-19 crisis and the debt position of the Latin American countries. It also attempts to identify the factors that are helping drive economic growth in the region in 2021.
In addition, the document underlines the high social costs that the pandemic has extracted, as well as its impact on the medium- and long-term economic growth projections.
The report argues that the pandemic has exacerbated deep-rooted structural problems in the region’s economy and aggravated social inequalities.
Finally, it talks about the urgency for governments to implement structural economic transformation to reverse years of slow growth.
In the last sections, the report provides a more in-depth analysis of four economies of the region: Argentina, Chile, Colombia, and Venezuela.
The COVID-19 pandemic forced countries around the world to implement a range of unprecedented measures in an attempt to control the spread of the virus—schools and colleges were shut, public mobility and travel were suspended, restaurants and theaters were asked to operate under stringent capacity restrictions, and many other businesses, small and large alike, were closed down. These measures resulted in a 3.3% fall in global GDP1 in 2020. In advanced countries, GDP contracted 4.7% versus 2.2% in emerging economies. GDP dropped 3.5% in the United States, 6.6% in the Eurozone, and 4.8% in Japan. Among emerging economies, India was one of the most severely affected countries, with GDP contracting by 8.0% annually. China, in contrast, was the only large economy that posted a positive growth (2.3%). Latin America, meanwhile, emerged as the region that witnessed the highest economic contraction (7.0%), with Panama, Peru, and Argentina accounting for the major chunk of this slump (figure 1).
Besides being the region dealing with the largest economic impact in the world, Latin America is also among the most affected regions in terms of the number of COVID-19 cases and deaths. Between February 2020—when the first confirmed case of coronavirus was detected in Latin America2—and June 2021, the virus infected more than 36.4 million people and caused more than 1.2 million deaths. Nearly 90% of those deaths have been recorded in Brazil, Mexico, Colombia, Argentina, and Peru.3
The economic and social costs of the pandemic have exacerbated existing structural inequalities in the region, such as the need for more effective public health systems and better equipped hospitals. The pandemic also brought to the surface other areas of concern, such as low productivity,4 a large informal economy, an over-dependence on natural resources, depressed investment levels, and low value–added productive sectors.
In addition, the pandemic has worsened living conditions and poverty. It is estimated that in 2021, the region may return to the poverty levels seen in 2005, which is 37.3% of the total population, compared to 30.3% in 2019.5
Although many countries entered the pandemic with sizeable fiscal deficits and high levels of public debt, governments deployed considerable resources to strengthen health systems, provided monetary support to households, and financially helped businesses.6 Brazil, Chile, and Peru introduced the largest stimulus packages in the region, amounting to an estimated 10%–15% of GDP. As a result, public debt in the region increased from 68.4% of GDP in 2019 to 77.7% in 2020 (figure 2) and is expected to remain around 76% until, at least, 2025.7
This significant uptick in the trajectory of public debt has led to a deterioration of the region’s credit ratings.8 In 2020, many Latin American countries, such as Argentina, Ecuador, Chile, Colombia, and Mexico,9 suffered government debt downgrades, and this year, the Fitch Ratings agency has placed some of them under scrutiny.10 Meanwhile, the rapidly changing global financial conditions have aggravated this situation even further. While the world has so far benefited from low international interest rates to issue debt, the latest increase in consumer prices, especially in the United States, has turned financial markets upside down,11 as this could lead to a rise in interest rates in the medium term. This phenomenon is likely to lead to further deterioration of the fiscal standing of Latin American countries.
Consequently, fiscal sustainability is at stake in Latin America and related reforms are needed, which should mainly address two issues:
1. The way in which spending is managed in the region, as regards both its long-term effect on the productive sphere and the efficiency with which it is delivered, considering corruption levels in Latin America. Many countries in the region are placed at the bottom of the Corruption Perception Index (CPI). Venezuela, Dominican Republic, and Mexico, for example, stand at 176, 137, and 124 positions, respectively, out of a total of 180 countries.12
2. Tax revenues relative to the size of the economy are very low. Latin America collected 22.9% of GDP on average in 2019 (figure 3), which is far below the OECD average of 33.8%.13 For 2020, this ratio, although not published yet, will certainly be lower due to the significant drop in economic activity during the pandemic.
Implementing tax reforms, however, may prove to be more challenging than expected, as acute political polarization in several countries in the region may jeopardize any attempts at tax reform. In Colombia, for example, the government had to recall an ambitious tax reform bill in the face of nationwide protests.14
Despite these challenges, there are some bright spots. The expected revival of the economic activity this year holds promise for a significant rebound in key sectors. Furthermore, global trade in goods has begun to increase, as some of the largest economies of the world (especially United States and China) are rapidly reversing the poor performance recorded last year. This will certainly benefit the LATAM region. The United States is the main destination of trade for Mexico, Colombia, Ecuador, and the majority of Central American countries, while for Argentina, Brazil, Chile, and Uruguay, exports to China play a decisive role in maintaining their trade balances.
Thanks to the quick recovery of the global economy, prices of most commodities are now higher than the prepandemic levels,15 which is a good news for the region, considering its agro-industrial base and dependence on oil exports. For instance, the agricultural exports of Uruguay, Paraguay, Ecuador, and Argentina account for more than 35% of their total exports (figure 4). A similar picture holds for Peru, Colombia, and Chile in terms of mining-related exports (more than 54% of their total exports). It is only for Mexico that the majority of the exports comes from manufacturing (80% of the total). However, this process is posing some concerns on the upward trend of inflation in the majority of LATAM countries, which eventually may contribute to depreciations of their currencies.
The growth in remittances (especially from the United States) have also contributed positively to the economic performance of the LATAM region in 2020. The same behavior is expected to continue this year, and in some countries, the remittances could reach record highs. In Mexico, for example, remittances hit a historical record of 40,606 million dollars in 2020, equivalent to 3.8% of GDP. In fact, Latin America was the only region to witness an increase in remittances in 2020 (of 1%), whereas the amount sent to Africa and Asia dropped by 9% and 8%, respectively.16
In contrast, the services sector has observed a sharp decline—especially tourism, which will likely take longer than any other activity to reach prepandemic levels. This will weigh heavily on Central America and the Caribbean. According to the ECLAC, the tourism sector, which represented 26% of the total GDP in the Caribbean and 10% in Latin America in 2019,17 recorded a plunge between 60% and 80% annually in 2020.18
The policy response to control the pandemic has varied across governments. Argentina, for example, was quick to institute a nationwide lockdown, imposing strict confinement measures on March 20 until November 8, 2020, making it the longest in the world.19 In June 2021, the country, along with Brazil, Peru, Costa Rica, and Colombia, have reintroduced quarantine measures in a bid to stop the spread of the virus, especially as conditions have worsened due to the emergence of more potent coronavirus variants.20 Although most countries remain reluctant to impose the type of blanket lockdowns that were in place in 2020, partial restrictions might continue this year, which will likely sap consumer and business confidence.
As the region lacks access to adequate number of vaccines and necessary medical supplies, vaccinations in Latin America lag behind other regions, except in the case of Chile and Uruguay, which are on track to reach herd immunity (defined as full vaccination of 60%–70% of the population) in the foreseeable future. As of June 21, 2021, only 26% of the LATAM population has received at least one dose (figure 5) compared with 38% in Europe and 41% in North America. Only Asia and Africa have lower ratios (at 22% and 2%, respectively), according to Our World in Data.21
In the short term, as the scale of vaccinations increases across Latin America, so will economic activity, as inoculation reduces mortality and severe effects of COVID-19. Unfortunately, accelerated vaccinations alone will not be sufficient. It will be necessary to rely on long-lasting government policies that address the structural economic problems that exist in Latin American countries, such as low levels of productivity and investment, the large informal labor sector, insufficient tax collection, and high dependency on commodity exports. To put this into context, labor productivity in Latin America decreased by 3.4% between 2010 and 2019, while in Asia it grew by 38% in the same period.22 Investment in the region is equivalent to 18% of GDP, while in the European Union it is 22%.23 And finally, the size of the informal labor market exceeds that of the formal market in the vast majority of LATAM countries—in 2019, it represented 54% of the total population.24
Economic performance in the coming quarters will depend on several factors, including the scope of new coronavirus outbreaks, the progress made in the delivery of vaccinations, the extent and composition of fiscal support measures, public confidence in government, and policy effectiveness.
The countries in the LATAM region should avoid a premature withdrawal of economic support and maintain it throughout 2021, albeit at lower levels, and ensure they are oriented toward sectors that can have larger spillover effects on the rest of the economy. This could work as insurance for recovery.
Full retrieval is still a long way ahead, though. We forecast that the region will go back to its prepandemic levels of output between the end of 2021 and 2022, although some countries will take longer. Guatemala and Paraguay, for example, are expected to return to 2019 levels this year. Brazil, Chile, and Colombia will reach there in 2022, while Argentina and Mexico may take one additional year (figure 6). Furthermore, according to IMF projections, income per capita in LATAM countries will likely not catch up with its prepandemic levels until 2024 or 2025.25
In summary, healing longer-term scars of the COVID-19 pandemic will require accelerated structural reforms26 in the areas of productivity, investment, fiscal policy, and institutional affairs, to support a long-term economic growth trend.
The economic recovery lost momentum in recent months, amidst the second wave of COVID-19. However, the reach and scale of the vaccination campaign have improved in recent weeks, allowing a lifting of restrictions on mobility. This should improve growth prospects in the coming months, although political tensions and accelerating inflation (despite price and FX controls) pose downside risks.
Recovery from the COVID-19 crisis started in Q3 2020, with an upward push provided by the uptick in the construction and production of machinery and equipment in the automotive industry, with positive spillover effects on other sectors such as iron, steel, and plastics industries. However, economic conditions worsened in recent months, as a second wave of infections prompted authorities to tighten lockdown measures. In fact, although year-on-year growth accelerated on a favorable base effect, monthly GDP showed three consecutive contractions in February (-0.1%), March (-0.3%), and April (-1.2%).
The reach and scale of the vaccination campaign have improved in recent weeks, with the share of people who have received at least one dose of the vaccine hitting 48% in mid-July.27 In response, the number of positive cases has subsided, with an average of 15,000 cases a day in mid-July, versus a peak of 40,000 at end-May.28 This allowed a recent partial lifting of COVID-19 restrictions, which would weigh positive on economic activity in coming weeks.
Inflation accelerated in the first semester of 2021, with a 3.8% monthly average, bringing the 12-month inflation to 50.2% in June,29 the highest percentage since February 2020. In this context, the economic authorities are using the official exchange rate as a nominal anchor for inflation. In fact, the depreciation was around 1.0% in June (around 13% in annual terms), compared with a monthly inflation of 3.2% (around 46% annualized). Furthermore, they are working with unions and industrialists to contain wage increases this year, while applying increasing price controls on food products and utilities tariffs.
In turn, the parallel exchange markets remained calm during the first part of the year, owing to high commodity prices, the improvement of fiscal figures, and, as a result, a reduction in central bank financing to the Treasury. However, pressures have resurfaced in July (with the exchange rate gap between the official and the parallel markets rising 10 percentage points to 76% as of July 1630) amid higher political uncertainty and devaluation expectations in the proximity of the November legislative elections (primaries will be held in September).
After restructuring the dollar-denominated debt with the private sector (both with foreign and local creditors) for US$108 billion (28% of GDP) in August 2020,31 the government is seeking to reach a new agreement with the IMF to restructure a further USD 44 billion. However, this is not likely to occur before the midterm legislative elections, to be held in November 2021,32 as the IMF would ask for a higher fiscal consolidation, which will likely weigh negatively on the ruling party’s electoral chances. Anyway, at the end of June, the Government reached an agreement with the Paris Club to avoid default, setting a partial payment of USD 430 million (on a debt of USD 2,485 million) and extending the negotiation term March 2022, pending an agreement with the IMF.
The fate of Argentina’s economic recovery will be subject, partly, to how the pandemic evolves. If the current restrictions impact a larger number of productive sectors or are extended over time, they could slow down the pace of the ongoing recovery.
Real GDP—bolstered by a positive statistical carry-over from 2020, estimated at 5.0%—is expected to grow at 6.5% this year. In quarter-on-quarter terms, we expect Argentina to experience only modest growth in 2021.
Additionally, the recovery will be highly uneven across sectors. The agricultural sector will benefit from the increased domestic and external demand. The construction, manufacturing, and mining sectors will also lead the improvement, owing to private consumption recovery. However, the private sector employment will remain stagnant, given the validity of the ban on double redundancy payments and the firing of employees.33
Fiscal consolidation will be slow against the backdrop of an election year. The primary fiscal deficit is expected to come down only moderately, from 6.5% of the GDP to 3.6%. The adjustment will be driven largely by the withdrawal of the emergency pandemic-related relief and curtailment of pension spending and real income growth in the context of the economic recovery and low base of comparison.
In fact, after a significant improvement of fiscal accounts during the first five months of the year (with a primary fiscal deficit of 0.15% of GDP versus 2.5% one year before), the government will likely accelerate public expenditures in the run-up to the legislative elections. Therefore, the fiscal accounts will probably deteriorate in coming months, requiring more monetary issuance to finance the fiscal deficit, and consequently, adding pressures on the exchange market and inflation.
Our base case scenario assumes the implementation in 2022 of an economic program that determines a path of fiscal consolidation, with credible stabilization and macroeconomic recovery policies, which would facilitate the reduction of inflationary risks, restoring public confidence on the economic administration, and supporting the economic recovery after the pandemic.
Economic growth in 2021 will depend on vaccine rollout, consumer demand backed by a third round of pension fund withdrawals, and higher prices for copper. However, risks to economic growth remain. The decline in unemployment and pick-up in services sectors have been sluggish. The potential for further protests against social inequality (similar to the October 2019 episode) during the process of rewriting the country’s constitution, may also threaten economic growth.
Economic growth in Chile started showing signs of recovery in Q4 2020, as a result of the measures adopted by the current administration and the gradual lifting of the lockdown. The recovery then continued into 2021, driven by domestic consumption, investment, and exports. In Q1 2021, GDP expanded 0.3% YoY, a substantial improvement from the flat growth recorded in Q4 2020, as domestic demand benefited from robust monetary and fiscal stimulus measures.34
This recovery, however, has been uneven, varying across sectors. The supply side witnessed promising growth, pushed primarily by retail trade and manufacturing. In contrast, in tourism, food services, and culture and entertainment sectors, the growth remained sluggish.
Chile has made remarkable progress in vaccine procurement and distribution. It boasts of one of the fastest vaccination rates globally, with 71% of the population having received at least one dose35 and 61% fully vaccinated.36 The COVID-19 outbreak, however, persists, weighing negative on the economic rebound.
In mid-May, after a month-long delay due to the pandemic, citizens of Chile elected 155 representatives to the constituent assembly, whose mission will be to draft a new Constitution for the country.37 The changing of the current Constitution (which was drafted in 1980 under the military regime of Augusto Pinochet) was one of the main demands of the protesters during the “social outbreak” that began in October 2019. Surprisingly, most of the elected members are independent candidates. As a result, there is consensus that the new constitution will introduce sweeping changes, involving not only a greater provision of public services, but also greater public control of natural resources and changes to the form of government and the legislature. A national vote to approve or reject the new Constitution is scheduled for 2022.
GDP is expected to bounce back sharply in 2021, supported by the gradual easing of restrictions domestically and abroad, and accommodative fiscal and monetary policies introduced by the government.
A substantial fiscal stimulus and the continuation of a successful vaccine rollout will likely make Chile one of the fastest-recovering economies in Latin America, with a 6.2% expansion and output returning to prepandemic levels this year. Fixed investment will rebound strongly on the back of the Paso a Paso38 recovery plan, which aims to streamline private investment projects. In turn, the recovery in private consumption will be bolstered by a clear, albeit slow, improvement in employment rate, and especially by consumers’ ability to withdraw funds from their pension accounts, following the approval of the third withdrawal law39 and increased social spending by the government. Furthermore, rising copper prices and a recovering global demand (especially from China) will continue to support exports.
Chile’s careful fiscal management and low public debt (32.5% of GDP in 202040) will provide scope for further pandemic-related fiscal support in 2021. The deficit, however, will remain large this year, and it is expected to come down only moderately, from 7.4% of GDP to 4.7%, due to the recent fiscal stimulus announced by the government and the need to address demands for increased spending on public services.
Risks, nevertheless, remain. Political risks stemming from the constitutional process and November’s general elections threaten to cloud the outlook. In addition to electing the constituent assembly, primaries for the presidential and parliamentary elections were held on July 18, while the presidential and congressional elections are set for November, with a possible presidential run-off election in December.41 The upcoming presidential election will be the most uncertain and closely fought in many years, reflecting the rise of candidates from outside the center-left and center-right coalitions that have dominated politics in Chile for decades.
After struggling through its worst recession in history, the Colombian economy is set to rebound in 2021. Growth in the first quarter of this year exceeded market expectations, thanks to a strong domestic demand. Higher prices of commodities such as coal and petroleum will also help spur growth for the rest of the year. However, a slow vaccination rollout, fallout from a low credit rating, and continued nationwide protests against tax reforms, violence, and poverty may threaten the prospects of economic growth.
Last year, due to the COVID-19 pandemic, Colombia recorded its worst economic performance in its history. Annual GDP contracted 6.8%,42 the average unemployment rate rose from 10.5% to 16.1%,43 and the poverty rate hit an eight-year high at 45.2%.44 The situation could have been even worse had it not been for an aggressive spending package that increased the initially approved budget by 10.8%.45 If we consider this situation and the significantly low tax collection, public finances deteriorated: The government deficit grew from 2.5% of the GDP in 2019 to 7.8% in 2020, and public debt increased from 48.4% of the GDP to 60.5% in the same period.46
The pandemic dealt a hard blow to Colombia: The country currently ranks 10th in the number of infections and 10th in total deaths.47 To mitigate the effects of the pandemic, the National Vaccination Plan was established in January 2021, which aims to achieve herd immunity (75% of the population) by the end of 2021.48 This could be feasible in urban centers, but not so much in far-flung rural areas.
We forecast that GDP will grow 5.8% in 2021.49 Despite the challenges faced for the most of 2020, the economy began to pick strength in the second half of the year, as lockdowns were eased. The GDP growth in Q1 2021, +1.1% YoY,50 confirmed this trend and also demonstrated the strength of domestic demand. Moreover, leading indicators such as automobile and housing sales, industrial production, and retail sales have performed well. Although GDP growth is forecast to slow down in 2022 to +3.8%, it should be enough for the economy to return to prepandemic levels.
Foreign demand is also expected to contribute to Colombia’s recovery. The United States and China, the country’s two main trading partners, will grow 6.4% and 8.4%, respectively,51 and that, in turn, will fuel their demand for oil and coal, both of which, in the current economic atmosphere, have surging prices and comprise more than 40% of Colombia’s exports.52 Furthermore, remittances from Colombian workers abroad, an important source of national income, are expected to go up as well. Around half of them originate in the currently expanding economy of the United States.
We also expect the Central Bank to continue its expansionary policy and maintain its policy rate at 1.75%, an all-time low, throughout the third quarter of the year. Currently, inflation is not a concern: Consumer prices rose 1.6% in 2020, which is well below the target of 3%.53
The main risk to economic growth in Colombia remains the slow pace of vaccination, which is in line with many other Latin American countries. The government expects to administer 66.5 million shots to 33.75 million people by the end of 2021 (75% of the total population).54 However, considering that the delivery of vaccines has experienced frequent delays recently, the vaccination campaign may not go as planned.
Colombia is also face to face with a significant financial risk. The country’s deficit is expected to reach 8.6% in 2021, up from 7.8% in 2020. A tax reform bill proposed in April 2021 to reduce the deficit triggered a wave of nationwide protests that continued even after its eventual withdrawal. We expect that the weeks of protest will have an impact on the GDP figures for the second quarter. The bill’s repeal prompted Standard and Poor’s to lower Colombia’s credit score from BBB- (investment grade) to BB+ (noninvestment grade).55 Other agencies may make similar decisions, making Colombia´s already large deficit more expensive to finance by issuing debt.
On the political front, Colombians are slated to vote for a new president and congress in 2022. It would, thus, be unwise to anticipate any ambitious reforms in the next legislature.
Finally, if international inflation were to affect Colombia, via a stronger dollar, higher commodity prices, and rising international transportation costs, the Central Bank may have to reduce its expansionary policy.
The economy continued to contract in 2020 and now the GDP is only a quarter of what it was in 2013. The current crisis is compounded by a hyperinflation episode that could soon become the longest in history. Hopes for the Venezuelan economy rely largely on oil exports, but China’s new tax on bitumen imports could seriously harm the country’s economic outlook.
The Venezuelan economy has experienced contraction for eight consecutive years. In 2020, GDP decreased by 30%, and at present, it is only a quarter of what it was in 2013.56 According to the IMF, Venezuela is now the second poorest country in the region, after Haiti. Annual inflation reached 3,413% in 2020,57 which means that prices double roughly every 10 weeks. This phase of hyperinflation started in November 2016 and is currently the third longest in the world’s history and is poised to become the longest.58 In November, the price of one American dollar exceeded one million VEB, even after two monetary reconversions (in 2008 and 2018) that removed three and five zeroes from the local currency, respectively. The price of one American dollar using the original bolivar, is equivalent to one hundred trillion bolivares. The number of ATMs has halved since 2015 because handling cash has become too cumbersome, and two out of every three transactions are made in US dollars.
A dismal performance of the oil sector is at the core of the current economic difficulties. In 2020, daily production averaged 626 thousand barrels, the lowest in 77 years.59 In December, that average dropped to 431. Despite having the largest proven oil reserves in the world, Venezuela is currently the sixth largest producer of oil in Latin America.
Political turmoil, meanwhile, has been a constant feature of Venezuela for quite some time now, and the country continues to perform poorly on international rankings of institutional quality. The most recent Index of Economic Freedom from the Heritage Foundation ranked Venezuela 177th out of a total of 178 countries,60 only ahead of North Korea. Likewise, it ranked 143rd out of 167 in the Economist’s Democracy Index, falling behind Cuba for the first time.61
We forecast a 4% drop in GDP for 2021,62 the smallest contraction in seven years. Several other indicators show that the downturn could ease out. Heavy use of foreign currency has diminished the effects of the hyperinflation, and remittances pouring in from abroad have increased by 8% in the first quarter of the year. Oil exports have stabilized at around 700 thousand barrels per day, and in March earlier this year, they reached a ten-month high.63 Venezuela could also enjoy the benefits of a commodity boom led by the recovery of the US and Chinese economies. Analysts expect the revenue of PDVSA, the state-owned oil company, to increase by US$800 million, thanks to increased production and higher international prices.64
A Chinese tax on bitumen could severely harm Venezuela’s finances. The new law, set in mid-June, taxes bitumen at 1.2 yuan per liter, approximately US$30 per barrel.65 This could wipe traders’ profit margins, making Venezuelan oil commercially unviable: The bitumen mix sells at US$45, while the benchmark Brent price is nearing US$70. President Maduro’s regime is expected to lobby against this tax.
Furthermore, the COVID-19 vaccination rollout in Venezuela is the slowest in the region—so far less than 4% of the population has received at least one shot (1,079,134 doses66) and its distribution has been opaque. Venezuela was also unable to obtain its share of a global IMF COVID-19 help package, because the IMF´s executive board is yet to decide who the rightful president is.67 Venezuela will receive 2.4 million shots from the COVAX scheme in July.
There should be a monetary reconversion before the end of the year to eliminate six zeros from the national currency. Economic analysts and trade associations have pushed for one, citing concerns about increasing computing costs associated to very large numbers. Although there are talks about digitalizing the currency, we don’t expect this to happen anytime soon.
Cover image by: Jaime Austin