Can Latin American Economies Deflect the Financial Crisis?

Editor’s Note: The U.S. financial crisis has profound implications for emerging markets given the integrated and global nature of today’s economy. In this Q&A, Mauricio Cardenas, the director of Brookings’s Latin America Initiative, examines the likely impact on Latin American economies and discusses how they might deflect some of the aftershocks from the U.S. economic crisis.

Q: With the U.S. financial markets and other global markets suffering from the recent credit crisis, what is the current environment in Latin America? Do you think Latin America will experience a recession in coming months as many economists are predicting for the U.S.?

A year ago, most analysts believed that the subprime crisis in the U.S. was not going to have any repercussions in Latin America and other emerging economies. The idea that emerging countries would continue to grow fast even with the U.S. nearing a recession, was widely shared. Even the IMF’s World Economic Outlook predicted that growth in emerging economies was not going to decelerate considerably.

Very few people accept that as a valid assessment today. Markets are moving in tandem everywhere in the world. During the past week stock markets, currencies and sovereign spreads in Latin America and Asia were following U.S. trends almost to the minute. We are going to see more contagion from the U.S. to the rest of the world. With a slower growing U.S. economy, and with lower capital flowing to developing countries, I expect economic growth in the region to be lower than initially expected during the next 18 moths.

Q: What are some of the strongest industries in key Latin American countries now and can they ward off this downturn?

Natural resources and agricultural commodities were very strong given high price increases during the past year. But as the global economy decelerates, commodity prices will continue to decline. With lower terms of trade, countries in Latin America will show weaker current accounts and, in some cases, larger fiscal deficits. In the same vein, I do not think that currencies will remain as strong as we saw during the first half of 2008. Of course, a lot of this depends on growth in China, but even with sustained growth in China, the slowdown in the U.S., Europe, and in Japan will negatively impact commodity prices and therefore, these industries that were surging in Latin America.

Q: Brazil has experienced strong growth in recent years. Do you think its economy will suffer at all?

Brazil is in very good shape with a well diversified economy that recovered investment grade earlier this year. GDP growth was higher than expected during the first half of the year, but will slow somewhat. However, Brazil will continue to be a very attractive market and will remain in good shape.

Q: What about Mexico?

Mexico’s fate is more closely linked to the U.S. economy. In addition, growing security problems and lack of reform in the energy sector are generating some long- term economic concerns. Unless there is more support for reform in Mexico, and a more effective approach to public safety, Mexico would be an underperformer relative to other countries in the region.

Q: What are the greatest opportunities and challenges for Latin America during this crisis?

Latin America is still heavily dependent on commodities. Although lately that has been a blessing more than curse, energy and food prices are volatile and difficult to predict. While I don’t think that prices will remain high in the future, Latin America should focus on saving more of the current boom in commodities and, at the same time, invest in developing a more competitive export sector. Infrastructure is a big concern in many countries.

On the positive side, there are many reasons to be optimistic about Latin America’s economic prospects, including generally sound macroeconomic policies, single-digit inflation and low fiscal deficits, which today are the norm rather than the exception in the region. If anything, the region is much better prepared to deal with a negative shock.