The Covid-19 crisis: Will Latin America endure a lost decade (2015-25)?
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Latin America's eventual recovery from the Covid-19 crisis is likely to be gradual and uneven.
This article was written by The Economist Intelligence Unit, with support from J.P. Morgan.
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Welcome, My name is Chris Aba and I'm responsible for the investments business at the Latin America Private Bank for J.P. Morgan. It's my pleasure to introduce to our audience Fiona Mackie, Regional Director for Latin America and the Caribbean at The Economist Intelligence unit, and author of an article commissioned by J.P. Morgan on the outlook of Latin America and Caribbean economies to face and recover from the COVID-19 crisis. How are you, Fiona?
Fiona:
Very well, thank you. Hello from London.
Fiona, all of our clients are very familiar with the state of their own economies. They're familiar with the things that are probably a little bit easier to measure, things like the number of ventilators that have taken a lot of-- gotten a lot of attention in the media. But one of the things I've found most interesting about your heat map is it compares the, really the largest economies in Latin America across a variety of metrics that are important both for the present and the future. Could you talk a little bit about that?
We thought in order to have a very clear understanding of where the investment opportunities are best and which countries are, are best place to recover faster and more sustainably, we had to look at more than the number of ventilators or the number of hospital beds. So, we looked a lot more broadly, and we looked at a series of indicators in four main areas.
So, we did look at health indicators, we looked at health policy and health systems because, of course, that's important apart from anything else in terms of public confidence in government going forwards. We also, of course, need to look at the macroeconomic stimulus measures, particularly fiscal stimulus. And we took a look at that, and we need to know that because we need to know just how much of a recovery and demand there will be on the part of both households and firms on the back of that fiscal, and later on monetary, stimulus.
And then we thought it was important to look a little bit further ahead and a little bit more deeply at the structure of Latin America and what's going on there, where its vulnerabilities lie, which countries are better placed than others. And I think doing that sort of comparative analysis is really interesting and telling for us. And I think finally, it was really important to understand what's happening with politics because it's become clear already in this crisis that that's really important.
So we looked at measures of political effectiveness, and then finally we looked at the broader business environment because we feel like you need to look at more than macroeconomic policy measures, but you need to look at the micro, you need to look at the business environment. And when we put all of that together, we had some interesting results.
So there were clearly some areas where, where everyone struggled. There were some weaknesses, for example, across the board in Latin America in public health systems or in a reliance on the external sector to drive growth. But there were some other areas where there was clear differentiation between markets, that we saw some clear winners, relatively speaking, and losers.
And I think in terms of winners and losers, it looks to us, based on the heat map, like the countries that are more vulnerable are in fact the very biggest economies in Latin America, Mexico, Brazil, Argentina, and the ones where, if you take all of those measures and you put them together, look, relatively speaking, better placed to maneuver through the crisis. That was the likes of Peru, Chile, and also Colombia. So in terms of the indicators that we're watching, where there was a lot of differentiation. For example, in terms of containment response or fiscal stimulus, Peru and Chile performed really well; Mexico and Brazil, less so. And also in terms of political effectiveness, we found that that was problematic in Mexico and Brazil.
And then in the business environment, there's a lot of strength in the business environment in the region actually. But countries like Argentina really struggle because of the imposition of distortionary controls. So if you take that picture altogether, we expect to see some of the sort of the second-tier countries within LAC, the LAC six, the big six economies in Latin America in our view to be sort of best placed to recover best and fastest.
So one of the things that I think has been very, very hard this crisis is it feels like so much depends on a medical solution. A vaccine, some kind of drug. And as you think about the future of the region when we come through this, how do you, how do you factor that into your outlook? Do you assume that there's going to be a solution 12 months from now, or you're trying to picture, irrespective of what happens, these are the themes that I think will play out?
We assume that there will be some efforts within the next year to produce on a large scale a vaccine that will really have sort of a definitive effect on eliminating coronavirus or reducing its impacts dramatically. In the meantime, although we expect to see sort of a flattening of the curve resulting in the elimination gradually, or less gradually depending on the country, of lockdown measures, we probably expect to see after an initial rebound, there's going to be difficulties. So maybe in the first quarter of 2021, or in the second quarter of 2021, we might see countries having to reimpose lockdown measures. So it's a really tricky environment in which countries are going to be trying to recover.
But it's for that reason that we're trying to look not just at the science, but to look at some of the more fundamental factors that can really tell us which countries will be best placed in terms, not just of policy capacity, but in terms of politics, political will, and policy implementation. So, we think that ultimately, although there will be ups and downs, and this crisis will be with us for several quarters to come at least, we'll be able to tell now which countries are likely to emerge stronger ultimately.
To address the fiscal challenge, there may need to be taxes, there may need to be other policies. You know, that's gonna be critical. Historically, not all, but many Latin American economies have addressed their fiscal challenges through the benefits of high commodity prices. You mentioned in the article that we've been hit by this double whammy of a self-induced economic coma because we've all gone into lockdown and social distancing, quarantines. But it's coincided with really a massive collapse in the price of some commodities.
How do you think Latin America gets through this? Does it get through this without a real pickup in global growth and an improvement in commodity prices?
I think there are a couple of issues here. One is around commodities and one is around fiscal policy and the fiscal position, and for example capacity to borrow. And I think it's the case despite the various strengths and weaknesses that we found when we did this assessment that all of the big economies in Latin America, barring Argentina, really have the capacity to borrow in order to finance spending, in order to produce some substantial fiscal stimulus. So I think that, that's positive. We don't see that as problematic, we don't think that there is a big risk.
For the most part of a, of a big series of sovereign defaults across Latin America, there are mitigating factors. They are sitting, for the most part, economies in Latin America on a big pile of reserves. So I think that's one thing. So, I think the fiscal stance and the public debt indicators are not too bad. So we're likely to see a big increase in public debt, but we think that it's manageable in the near and into the medium term.
And then, there's that question around commodities. And it's true that several economies are going to be hit, hit hard. And I think clearly we would sort of point to Colombia as one of them, as a big oil producer that's reliant on commodities. For some other producers, first of all, they're more diversified. So the likes of Brazil, Mexico, Argentina, they're commodity producers, but they're not, if you...you know, relative to the size of their GDP to the size of their economy, they're not reliant on commodities alone. So, that's important to bear in mind.
And then the other thing that's important to bear in mind is that not all commodities are created equal. And so the oil producers are being hit a lot harder than mining producers, which we expect to, you know, get up and running and to be producing at, at moderate levels in the near term.
And then, of course, there is agriculture and we think that there's a lot of potential in the agriculture sector because I think one of the things that coronavirus has shown, and one of the themes that is emerging, is around food security. And I think the economies of Latin America, particularly the big agricultural producers are really well placed to serve that demand. And we're likely to see on the part of-- speaking about investment, we're likely to see a lot of investments, for example in agritech, to actually help boost productivity and also address questions around for example climate change resilience.
So, we think that there's actually some opportunities there. It's not all about the threats from commodities. I think that there are some trends, around commodities and the global economy more broadly that will be positive for Latin America.
It's great to that there are certain parts of the commodity construct that are positioned to benefit, like agribusiness and agritech. But I was curious if there are other parts to the economy, sectors, countries, that you think are well positioned for what's to come. We've all been debating what is gonna change forever and what is gonna go back to normal to help inform our investment decisions. And as you look at the region, where do you see opportunity?
Another of the, the key trends that won't go away is around technology and our use of technology. And it's really changed rapidly. And this was something that was already happening around the world. And maybe Latin America was lagging a bit behind in terms of adoption of technology across economic sectors. But we think that there are important key sectors where Latin America will play a role and technology will play a role.
So, that is around agriculture and agritech, financial services and, and Fintech. And I think that's really important in Latin America. And that will be developed partly because of the high level of labor informality. So some of this development of Fintech is around getting money to people that don't, for example, have traditional bank accounts. So that's a really interesting development. And we also see that there are countries in Latin America, where there are a lot of skills in this area around technology. Argentina and its software-development capacity really stands out here.
But apart from agritech, Fintech, e-commerce, I think more broadly, around the world and in Latin America, I think coronavirus will mean that we're all adopting technology in all of the sectors that we're working in. And so we'll see countries across-- companies, excuse me, across the board sort of adopting robotics and AI into their processes. And that's something that won't change. So, that's something to look out for in LatAm.
Thank you, Fiona. Some great insights, clearly, some things to be worried about, but also some silver linings. We thank you for your time. And I hope that you and all of your loved ones are safe and healthy.
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The Covid-19 Crisis: Will Latin America endure a lost decade (2015-2025)?
On screen:
A bearded man with short dark hair, Christopher Aba, speaks to us remotely.
Christopher Aba, Head of Investments, J.P. Morgan Latin America Private Bank.
Fiona Mackie, a woman with long, straight brown hair, appears on screen, also speaking remotely.
A map appears, highlighting: Mexico, Columbia, Peru, Brazil, Chile, and Argentina.
Fiona Mackie, Regional Director, Latin America and the Caribbean, The Economist Intelligence Unit.
A bar chart appears, labeled: "Timelines of government response in LAC, select economies." The chart shows the number of days from the first confirmed COVID-19 case in country, to announcement of national lockdown by the federal government. It shows:
- Venezuela, El Salvador, and Guatemala at under 5 days;
- Honduras at about five days;
- Paraguay, Peru, and Costa Rica at about ten days;
- Bolivia, Argentina, Jamaica, Cuba, Columbia, and Panama between 12 and 14 days;
- Chile, about 15 days;
- Ecuador, about 18 days;
- and Dominican Republic at about 20 days.
Small print text appears.
Note: Federal governments in Brail, Mexico, Nicaragua, and Uruguay had not mandated a national lockdown as of April 15th.
Source: The Economist Intelligence Unit. (Lockdown defined as a suspension of all non-essential economic activity and closure of national borders.)
A bar chart labeled: "Real GDP per capita: LAC" shows percent change, year-on-year, with the 1970's averaging about 3.5%, the "lost decade" of the 1980's averaging at about 0, the 1990's averaging at about 1.5%, the "commodities boom" between 2000 and 2015 averaging at about 4%, and a drop to -6% in 2020.
Sources: World Bank, The Economist Intelligence Unit. (World Bank for historical data [1970 - 2018]; The Economist Intelligence Unit for 2019 estimate and 2020 forecast.)
A bar chart labeled: "Public Debt, 2007 vs. 2019" shows percent change, in the public debt -to-GDP ratio between 2007 and 2019. It shows:
- Jamaica, Nicaragua, Panama, and Peru in a range between -2% and 0%;
- Uruguay, Paraguay, Guatemala, Columbia, Bolivia, and El Salvador between 10% and 15%;
- Cuba, Mexico, Brazil, Dominican Republic, and Ecuador at about 20%;
- Chile at about 25%;
- Costa Rica and Honduras at about 30%;
- Argentina at about 40%;
- and Venezuela at 120%.
Sources: The Economist Intelligence Unit.
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"The Great Lockdown of 2020", as it has been dubbed by the International Monetary Fund (IMF), is set to overshadow virtually all other crises in modern history, plunging Latin America and the Caribbean (LAC) into its deepest recession since the 1930s. The crisis has also left economic forecasters scrambling to keep up, and plunged the region's long-term economic outlook into doubt. Covid-19 comes as much of the region was struggling to recover from the end of the commodities cycle. And so the IMF's Western Hemisphere Director, Alejandro Werner, now warns of a possibility of another lost decade (2015-25)—of nil GDP per capita growth—for the region.
Real GDP per capita: LAC
Sources: World Bank; The Economist Intelligence Unit.
World Bank for historical data (1970-2018); The Economist Intelligence Unit for 2019 estimate and 2020 forecast.
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A bar chart showing real GDP per capita for Latin America and the Caribbean (percentage change, year on year), highlighting the Lost Decade and the Commodities Boom.
Some basic trends are already evident. Latin American economies are extremely vulnerable, relying heavily on the external sector and commodities, and characterised by a significant—and largely unprotected—informal sector. The economic policy response, although not quite "whatever it takes", is likely in many cases to be firm, notwithstanding already high debt burdens and the likelihood of a long-term debt hangover for the region that could complicate the longer-term prospects for some economies. The containment response has, in most countries (with the notable exceptions of Brazil and Mexico), been rapid and robust, reflecting health system weaknesses that would amplify the effects of an unchecked escalation of the virus.
To examine these trends in more detail, The Economist Intelligence Unit has developed a "heatmap" which compares how the LAC-6 major economies are positioned to face the impacts of Covid-19. Ultimately, it seeks to help determine which countries are best placed to manoeuvre through the crisis and recover more quickly.
Disruption to domestic activity: Uses the contribution of Services to GDP to assess the extent to which quarantine measures affect aggregate output.
Informality: Uses proportion of informal employment to assess labour market vulnerability to economic shocks.
Commodity dependence: Uses the commodity exports-to-GDP ratio to assess countries' exposure to external demand shocks.
Containment response: A qualitative assessment by EIU analysts of the strictness of social distancing protocols, enforcement of border controls and measures taken to increase the testing rate.
Health security: Considers countries' capabilities to respond to epidemics and pandemics, as measured by the EIU's Global Health Security Index.
Forecast fiscal stimulus: Considers the magnitude of fiscal stimulus, as a percentage of GDP, deployed to minimise economic damage.
Business environment: Considers the quality and attractiveness of the environment for doing business, as measured by the EIU's global Business Environment Ranking.
Political effectiveness: A qualitative assessment of the effectiveness of public instiutions in enacting policy, as measured by the EIU's Operational Risk Briefing.
Source: The Economist Intelligence Unit.
Key areas to watch
While there is undoubtedly a high level of uncertainty surrounding potential outcomes, we believe there are several key areas to watch to see how the crisis—and recovery from crisis—play out in the region: firstly, healthcare-related factors including health system capacity and government containment policy; secondly, the economic policy response including fiscal and monetary policy; thirdly, structural economic factors; and fourthly, institutional factors that will ultimately be crucial in determining which of Latin America's big economies perform best over the coming quarters, emerge less weakened by the crisis and manage to post higher growth rates over the medium term.
1. Health sector capacity varies regionally
The quality and coverage of health systems varies across the region. The 2019 Global Health Security Index (GHSI), prepared by The Economist Intelligence Unit with support from the Nuclear Threat Initiative and Johns Hopkins Center for Health Security, concluded that "no country is fully prepared for epidemics or pandemics", but also noted that gaps in some countries were significantly larger than in others. In Latin America, the region's largest economies—Argentina, Brazil and Mexico—all perform relatively well on the GHSI. By contrast, the Andean nations (with the exception of Chile) have big deficiencies in their healthcare systems that reflect years of underinvestment. But all that said, as a whole, it is clear that Latin America spends less and has fewer hospital beds, doctors and nurses per capita than the OECD average. Healthcare system deficiencies are especially clear in the high level of out-of-pocket health spending in the region—which points to a lack of access to public healthcare, and which poses a major challenge in a context of plummeting disposable incomes.
Out-of-pocket health expenditure
Source: Out-of-pocket health expenditure
Data are from 2016
A bar graph showing the percentage of out-of-pocket health expenditures for North America, Europe and Central Asia, East Asia and the Pacific, the Middle East and North Africa, Latin America and the Caribbean, Sub-Saharan Africa and South Asia.
But even robust healthcare systems can only mitigate the overall economic blow from necessary containment measures, not prevent it altogether, as has been made all too clear by the European and North American experiences of dealing with Covid-19. In this context, governments across Latin America and the Caribbean (LAC) have, for the most part, recognised the need to act decisively; for the median LAC country, there were just nine days between the confirmation of the first coronavirus case locally and the complete lockdown of the country. Central American and Andean nations have been the fastest to respond, most likely in recognition of the extremely limited capacity of their healthcare systems to deal with a protracted public health crisis. By contrast, governments in Brazil and Mexico, countries which boast better healthcare systems, were slow to implement even the most basic non-pharmaceutical interventions, reflecting political leadership issues in response to the crisis in both countries.
Timeliness of government response in LAC, select economies
Lockdown defined as suspension of all "non-essential" economic activity and closure of national borders.
A bar chart showing the timeliness of government response in select economies in Latin America and the Caribbean. The chart shows the number of days from the first confirmed COVID-19 case in these countries to the announcement of a national lockdown by the federal government.
The containment measures, however, are only a means to an end. As the South Korean experience suggests, in order to exit lockdown and gradually reopen the economy, governments will need to implement an aggressive "test and trace" strategy. Governments in Chile and Peru have acted expeditiously to purchase testing equipment and expand laboratory capacity, giving those countries an early mover advantage. However, in most of the region, testing remains inadequate. A spike in global demand for testing equipment and chemical reagents has meant that LAC's low- and middle-income countries have had to compete against wealthier economies, in many cases putting them to the back of the line.
Covid-19 testing rate, select economies
Tests per day calculated as an average of the last 5 days for which testing data was available as of April 15th.
A chart showing the COVID-19 testing rate in select economies (tests per million people per day)—Mexico, Brazil, Argentina, Colombia, Chile, Peru and South Korea.
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2. Assessing capacity for economic stimulus
Unquestionably, the public health capacity of countries in the region will influence their response to the crisis. However, insofar as the pandemic generates a sudden stop to activity, governments are having to step in to minimise the economic damage. The severity of the downturn and the strength of the subsequent recovery in a given country will depend in large part on the space available to the government to deploy countercyclical policy, public confidence in the effectiveness of state policy and the economy's resilience in the face of external shocks.
With the economy in an induced comatose state, governments are using the levers of policy as much as they are able to provide households and businesses with much-needed support. Central banks across the region have been increasingly loosening monetary policy by cutting interest rates and deploying unconventional tools to unclog the financial system and ease liquidity constraints. However, the effectiveness of monetary policy will be somewhat limited in a context of plummeting demand. As a result, much of the burden will fall on fiscal policy to restart economic activity. In some key respects, the region as a whole is less prepared to weather the unfolding crisis than it was when the global financial crisis struck in 2008-09, with the fiscal and debt dynamics in most countries now significantly weaker than in 2007. The chart below shows how countries have taken on more public debt.
Public debt, 2007 vs 2019
A bar chart showing the percentage-point change in the public debt-to-GDP ratio between 2007 and 2019 for select Latin America and Caribbean countries.
But despite budgetary constraints, many LAC governments have already begun rolling out sizeable fiscal programmes. Plans to support consumption include direct cash transfers, increased social insurance benefits, higher pension payouts and payroll cost subsidies. On the investment side, governments have increased budgets for public works (particularly in health infrastructure), provided tax relief or tax deferrals for businesses and instituted low-cost credit lines to help small and medium-sized enterprises (SMEs) to stay afloat. Countries like Chile and Peru have responded with the most ambitious fiscal programmes so far (equivalent to 7% of GDP and 12% of GDP, respectively), and they should be able to finance their spending with relative ease owing to a history of prudent fiscal management and economic orthodoxy. More developed local capital markets than in the past will help, as will a reasonable reserves cushion in many countries. Even countries with high debt levels, like Argentina and Brazil, have committed significant resources (of over 3% of GDP) to combat the Covid-19 crisis. However, financing these packages will prove difficult, and the challenge of working off the resulting debt overhang will weigh on economic recovery on the other side of Covid-19.
3. LAC economies share common structural deficiencies
Even for countries that pull out all the stops on the fiscal front, a number of formidable challenges lie ahead. Many governments in the region face large administrative costs and low technical capacity, which will constrain the effectiveness of fiscal policy in stimulating demand. Implementing targeted fiscal policy is complicated even further by high levels of informality. In the median LAC country, over half of the workforce is informally employed, leaving a large share of labourers outside the ambit of traditional safety nets. Although some countries have policies in place aimed specifically at protecting informal workers, there are big implementation problems arising from a lack of financial inclusion. According to the World Bank's Global Financial Inclusion Database and the EIU's Global Microscope, only 55% of adults in LAC have an account with a formal financial institution. This is below the comparable level for South Asia (70%), East Asia and the Pacific (74%), and the overall global average (69%).
Account penetration
A bar chart showing account penetration through the percentage of adults with an account at a formal financial institution, for select Latin America and Caribbean countries versus the regional average.
Another major structural vulnerability, which fiscal policy can do little to address, is the region's dependence on the external sector. Having made only moderate progress on economic diversification in recent decades, many regional economies still rely heavily on commodity exports to drive economic growth. The region's commodity exporters are now faced with the double whammy of collapsing commodity prices (which reduce economic rents) and lower export volumes. Finally, for all of LAC, business disruption and uncertainty will cause inward foreign direct investment (FDI) to fall sharply this year. This will be severely damaging in a region where domestic savings are weak and FDI accounts for 3% of GDP and 15% of total fixed investment.
4. Institutional factors will also play a role
Going beyond these shared vulnerabilities, however, there is significant variation in the performance of LAC economies on other indicators of institutional strength. In our view, the investment climate fostered by governments over the years will play a determinative role in the strength of an eventual economic recovery. In this regard, countries like Chile, Peru and Mexico, are fairly well positioned, having made strides in strengthening their business environments by deregulating trade, strengthening investor protections and deepening domestic capital markets. By contrast, in Argentina and Brazil, several years of left-wing rule in the 2000s helped produce large regulatory states and inflexible labour markets, and increased investor concerns over contract rights.
All that said, policies and regulations are only as effective as the governments implementing them. Chile, once again, stands out in this regard: anti-corruption laws are duly enforced, public procurement systems are transparent, and judicial proceedings are both speedy and independent. Among the region's major economies, Argentina and Colombia have also made progress in reducing regulatory capture in recent years. However, in most of the region, political efficacy risk remains extremely high owing to a poorly trained bureaucracy and a rampant culture of corruption and political impunity.
Faced with pressures from many sides, Latin America's eventual recovery from the Covid-19 crisis is likely to be gradual and uneven. Countries like Chile, Peru and Colombia stand the best chance of emerging faster and more sustainably from the Great Lockdown. This owes not only to decisive action by the political leadership in the face of the pandemic, but more broadly to economic and regulatory frameworks that are conducive to medium- and long-term growth. By contrast, LAC's three biggest economies (Argentina, Brazil and Mexico) will face many more obstacles in restoring consumer and business confidence, weighing on their economic prospects well into the medium term, meaning that they face more of a risk of suffering a 2015-25 "lost decade".
Looking ahead, investors are beginning to position for the recovery phase to identify investment opportunities and see which sectors will be likely to perform better. Production and export of soft and hard commodities (and the logistics that they rely on) are unlikely to be significantly affected by continued social distancing measures, given that these sectors are less labour-intensive and are carried out mostly away from urban centres. With oil demand collapsing in the short term, and demand for metals soft in the meantime, the commodities outlook will hinge on a recovery in export demand from the main markets—China, the US and the rest of the world. Our forecasts suggest that after a recovery from this year's contraction, global GDP growth (at market exchange rates) will average just under 3% in 2022-25, providing a reasonable outlook for Latin American commodity exports.
Most large LAC manufacturing companies will manage to restart operations with social-distancing norms in plants fairly adequately. Despite official financial assistance even some of the larger companies may struggle, potentially revealing M&A opportunities for local and foreign investors. SMEs will be hit hardest and larger companies currently using them for inputs may well have to reassess and source their supplies from overseas providers, shifting supply chains. The crisis may well lead company executives to adapt AI and robotics technologies in their operations.
Services, which is by the far largest sector in the economy, will face the greatest challenges as people adapt to the new circumstances, and this will affect restaurants, travel, tourism and other hospitality sectors most. E-commerce activities, including retail, are likely to grow. Financial services are likely to be affected the least, as more operations move online, although demand for their services will hinge on an adequate recovery of household and business expenditure.
All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.
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