Austerity vs populism tensions overhang LatAm debt markets
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Often dubbed the “Switzerland of central America”, Costa Rica is a beacon of relative peace and prosperity in the troubled neighbourhood of Central America. Well-heeled ecotourists enjoy its abundant tropical rainforests and rich biodiversity. Even coronavirus, which ravaged most of Latin America, was initially under control there.
But last month, Costa Rica erupted into weeks of violent clashes between police and protesters. The reason for the trouble? Short of cash to cover a yawning budget deficit, President Carlos Alvarado was attempting to negotiate a $1.75bn IMF loan. His plans involved temporary tax rises, the sale of state assets and pay freezes for public sector workers.
The crisis scarcely made waves outside Costa Rica. Few analysts cover the country. Yet its plight has wider significance: if a relatively well-governed Latin American nation rewarded with OECD membership only in May has hit serious trouble, what does this mean for the region?
On the face of it, despite taking a bigger economic hit from Covid-19 than any other emerging region, Latin America appears to have largely avoided debt drama. Two of its worst risks, dollarised Ecuador and serial defaulter Argentina, pulled off successful debt restructuring deals this year. Debt-to-GDP levels in Peru, Chile and Mexico, although rising fast, are low by international standards.
“Most countries in Latin America could come to market at somewhat reasonable yields,” said Eric Baurmeister, head of emerging markets debt at Morgan Stanley. “But what upsets the apple cart is a policy turn if countries don’t want to put in place policies to promote growth and fiscal restraint . . . over the medium to long term.”
On this definition, several red lights are flashing in Latin America. The biggest is Argentina. There was much fanfare over its August restructuring of $65bn of debt owed to private bondholders, involving a four-year freeze on most payments. However, the prices of the newly restructured bonds slumped within weeks. Some traders doubt that when Argentina needs to start paying again, it will. The economy will slump 11.8 per cent this year, according to the IMF, with only a 4.9 per cent recovery next year.
“The Argentine government is struggling to present an internally consistent economic plan,” said Claudio Irigoyen, head of Latin America economics at Bank of America. “Inflation is pumping up, the fiscal deficit is getting higher and the official exchange rate is artificially low while the central bank keeps losing reserves . . . the situation is really dramatic.”
A Costa Rica style drama also beckons in dollarised Ecuador, where a $6.5bn IMF agreement faces a tough test in a presidential election next February. GDP is forecast to plunge 11 per cent this year and the government has shut embassies and liquidated the state airline to save money. Andrés Arauz, a leftist, is mounting a strong presidential challenge vowing not to implement the IMF deal.
In Chile and Peru, populists have gained ground. Private pension schemes are under attack, with congress in both countries passing laws allowing early withdrawals of savings.
These dramas pale beside Brazil’s. Elected on a platform of fiscal austerity and structural reform which excited investors, President Jair Bolsonaro is discovering the joys of generous welfare spending, despite a national debt-to-GDP ratio of almost 100 per cent.
Mr Bolsonaro is seeking to extend his popular “coronavoucher” income support scheme well into next year, with an eye on his 2022 bid for re-election. Market optimists believe Brazil will not breach its constitutionally mandated spending cap; pessimists believe a way will be found to do so.
Although Brazil’s debt is mostly local, there are other problems. Most of it is very short-term and investors are increasingly betting that rates will have to rise. This year's budget deficit could hit 17 per cent of GDP.
The austerity-versus-populism dilemma playing out among Brazil’s politicians may not take long to reach the streets elsewhere as in Costa Rica. After Ecuador in February, Peru chooses a new president in April and Chile in November. Pragmatist incumbents, and those close to them, face populations refusing to embrace austerity.
Earlier this month, Costa Rica’s president withdrew the proposed IMF loan deal, but the protests continued anyway. The country now has few good options. “Costa Rica knows it needs an adjustment and knows it has a fiscal problem,” said Siobhan Morden, head of Latin America fixed income at Amherst Pierpoint Securities. “But no one’s coming up and accepting responsibility.”