A crisis like no other

The word crisis in Latin America is usually associated with collapses in growth as a result of the accumulation of macro-financial imbalances.

These imbalances culminated in debt defaults with the consequent loss of access to international financing, in domestic banking crises followed by strong credit rationing and long deleveraging processes, and in large exchange rate adjustments or in hyperinflationary processes.

These crises lead to substantial revenue losses. Some countries in the region have taken decades to recover pre-crisis income levels, as was the case with the hyperinflation of the 80s, or the twin crises of the 90s.

But despite having plunged the region into an unprecedented economic contraction, the economic crisis resulting from the Covid-19 pandemic differs from these episodes in several respects.

The most important is that, in most countries in the region, the crisis does not originate from macro-fiscal or financial sustainability problems, but rather from a medical-related problem and how this phenomenon has conditioned economic activity.

The region is expected to recover the gross domestic product levels it had between 2019 to 2022 on average, although with a great deal of dispersion between countries. Some of the region’s economies have already reached pre-pandemic GDP levels. The case of Brazil stands out, but also smaller economies such as Paraguay and the Dominican Republic. Chile is also close to recovering pre-crisis product levels. The rest of the economies have a somewhat slower recovery trajectory.

Several aspects make the difference.

First, the global economic recovery favors the resurgence of activity in the region. Global trade and commodity prices exceed pre-crisis levels and most countries in the region maintain access to external financing, in contrast with the crisis of the 80s, for example.

Second, the balance sheets of domestic banks have remained strong, so domestic credit will continue to play a countercyclical role, unlike the banking crises of the 90s. This is in line with expansionary monetary policies, to the extent that inflation remains under control in most countries in the region, thanks to the greater solidity and credibility of domestic monetary institutions.

Third, households accumulated savings during the crisis, some of which will serve to prop up consumption once economies open.

However, the need to restore the sustainability of public accounts in the medium term could weigh on future growth in the region, particularly in countries that accumulated high levels of indebtedness before the crisis. But, for most countries in the region, nothing like the abrupt adjustments in demand resulting from the balance of payments or debt crises.

So sooner or later, depending on the development of the pandemic, things will settle down.

There is no doubt that recovery will be slower than advanced economies that will overcome the pandemic this year (such as the US economy), since the region still has a long way to go before the medical emergency is out of the picture.

Apart from Chile and Uruguay, vaccination processes are progressing slowly, which hinders the full reopening of economies and, consequently, employment recovery.

And the longer the pandemic drags on, the higher the likelihood of more permanent scars caused by the loss of human capital so long as people remain unemployed or informal, or by the closure of companies.

The problem is that the prospect of Latin America returning to pre-crisis income levels or even to its prior growth trend is not really an outcome to get excited about.

Since 2015, the weakening of activity in the region had undermined the process of convergence towards higher levels of per capita income and has halted the poverty reduction process in the region as well as equity improvements.

Discontent in the face of this stagnation was possibly one of the components that fueled the wave of protests that shook the region in 2019.

Returning to the pre-crisis situation will be insufficient for a substantial improvement in the living conditions of the region’s citizens.

So we should promote structural reforms aimed at shoring up growth and strengthening social safety nets, whose weaknesses became more than evident during the pandemic. 

Improvements in fiscal institutions will be required to guarantee the sustainable financing of social and economic infrastructure spending, while avoiding a premature withdrawal of fiscal stimulus. Depending on the situation in each country, this may involve revision of tax, pension and transfer systems.

To raise the region’s productivity and growth potential, an efficient reallocation of productive resources that were idle during the pandemic should be sought, reallocating for formality and faster-growing activities.

The key to this will be the deepening of trade integration in the region and the insertion of companies, especially SMEs, in international trade, investing in logistics and digital infrastructures, and training programs that facilitate reincorporation of unemployed workers and strengthen access to credit.

The resurgence of protests has not been long in coming, which makes these changes more pressing. The problem is that in polarized and fragmented political environments it will be an uphill struggle to reach the necessary consensus to advance the appropriate reforms to achieve more productive and equitable societies.

This is, perhaps, one of the biggest risks the region will face in the coming years.