Greek crisis: How it could impact Latin America

The crisis in Greece is deepening and thus contagion fears arise. Could it impact Latin America? The region is not exposed directly, but may suffer the consequences of indirect impacts. The current situation in the region is not the best to deal with an international crisis.

Not a lot of business with Greece

Exports of the biggest economies of Latin America to Greece do not represent an important part in total exports: below 1% in Brazil, Argentina, Colombia and Mexico. Exposure to Greek financial assets is not known, but we can estimate that it is not significant, if there is any. Greek enterprises in the region do not play an important role. This makes the regions free of a direct exposure to a crisis. Also, Greece is suffering from an economic depression so parts of the effects are known.

Main risks

If the problem in Greece takes a greater dimension dragging other countries to a dramatic situation, then LatAm is likely to face a problem. The impact would be felt in the region through a decline in economic activity in the world (or a very pronounced one in the Eurozone), a decrease in the price of raw materials, a sharp rise of the dollar and an increase in interest rates (or a decline in the price of local bonds).

The above scenario would put the region on a risk in times when the outlook is not bright. Overall growth has slowed and fiscal and demand problems begin to arise, but for the moment it is manageable in most countries.

Deterioration in the Euro zone, leading to a decline in global GDP and a rise in the value of the US dollar, would force a rise in interest rates in LatAm, making borrowing costs more expensive. A sharp decline in local currencies could lead to inflationary pressures.

A decline in commodity prices is a big risk factor. While it is off the highs seen years ago, a continuous decline may harm not only the overall level of foreign trade and investment, but also public accounts, affecting tax collection.

On the bright side, if the global outlook worsens significantly, the Federal Reserve should announce a delay of the “liftoff” (when it begins rising rates). This could give a boost to stocks and raw materials prices.

Policy response

All these negative factors tend to weigh more in countries that are most vulnerable. Compared with 2010, when the Greek crisis began, LatAm may be worse off. There is a growing social discontent with political and economic weakness.

Fiscal policy tools are limited. Starting with Uruguay, covering almost all countries and especially Brazil, governments are cutting spending and looking for fiscal balance. This would make it difficult to implement an expansionary fiscal policy: increase spending or cut taxes to boost activity.

Monetary policy is not the preferred tool in a crisis situation to stimulate the economy in LatAm. In Colombia, Mexico and Chile, central banks interest rates are on hold and there is no prospect of change; in Brazil it has been climbing and could reach 14%. However, a sharp rally of the US dollar, would make it impossible to implement monetary stimulus through a rate cut. On the contrary, it could force an increase, in order to contain the fall in the exchange rate and to ease inflation expectations.

The volume of international reserves has declined in recent quarters from record highs in Colombia, Chile, Peru and Mexico, but still has a high firepower to defend the exchange rate. The regions are in a better position than the decades of 1980 and 1990, where international reserves were low and the burden of the debt service was elevated.

Conclusion

The region has a limited direct exposure to Greece but a global shock may hit hard: a decline in growth, a worsening fiscal outlook, rising interest rates and probably inflation (effects from currency devaluation). The tools to combat the crisis appear to be fewer than 2010, but better than those of decades ago.

Each country has its peculiarities. Currently the weakest seem to be Brazil, Argentina and Venezuela. Brazil's domestic problems are large and could worsen further. In Argentina the impact will be limited to the decline in commodities prices, as it remains out of capital markets; but a dramatic decline of the peso against the dollar would jeopardize the survival plan of the present government to hold out until December, when Cristina Fernández de Kirchner second term ends. A situation similar to Argentina is the Venezuelan situation, with a more dramatic domestic environment, with goods shortages, an economy in decline and a complex social landscape.

For several Latin American countries, China has become the main financier (the new IMF), especially as the doors of the capital markets are closing. If the crisis closes the door completely, it will be another opportunity for China to further increase the influence in the region.