Drop in commodity prices poses risks to Latin America
Hilary Burke | Saturday, 16 August 2008
The Latin American economic boom of the past five years could take a hit if prices keep falling for the commodities they produce -- from soybeans to oil and metals.
Argentina and Venezuela would suffer most from a sustained slump in global grains and crude oil prices, mainly because those two countries have used windfall profits from record commodity prices in recent years to fuel growing government spending.
In contrast, Chile has meticulously built up a rainy-day fund to tap when copper prices take a dive, while Brazil and Mexico have more conservative fiscal policies and more diversified economies to cushion the blow.
"The boat will rock but it won't sink," said Alberto Ramos, senior economist at Goldman Sachs, referring to the Latin American economy as a whole. "It's a negative shock ... but it won't lead to a major collapse of growth or an overshooting of the exchange rate or a major financial crisis like in the 1980s and 90s."
"Argentina is the worst off by far in that its policy mix is leveraged very significantly on commodity prices," he said.
Argentina's center-left government has spent heavily to stoke economic growth of at least 8.5 percent in each of the last five years, but high inflation has put pressure on officials to raise public-sector wages and state subsidies.
Argentina is a top global supplier of soy products, corn and wheat, but unlike fellow farming powerhouse Brazil, Argentina heavily taxes its agricultural exports, making its finances more vulnerable to global price swings.
Export taxes, most of them on farm goods, account for 13 percent of government revenues, said Mariano Lamothe of Abeceb consulting group in Buenos Aires.
"Argentina has used the extraordinary income from export taxes to boost spending, so with less income, we'd have to cut spending or find a way to roll over debt," Lamothe said.
Another downside is that Argentina is locked out of international capital markets due to lawsuits by "holdout" creditors who rejected a 2005 restructuring, three years after the country staged the largest debt default in modern history.
Commodity prices have fallen back from record highs in the past month on mounting worries about global consumer and business demand as both Asia and Europe follow the U.S. into an economic slowdown.
The Reuters-Jefferies CRB .CRB, a global index of commodities prices, fell in early August to its lowest level in about four months.
Oil prices have fallen more than 20 percent from their mid-July peak above $147 a barrel, but they are still up nearly 80 percent on average from last year. Venezuela is the fourth-largest exporter of oil to the United States.
"Venezuela's dependence on oil is a huge vulnerability," said Roger Tissot, an independent consultant who specializes in Latin American energy issues. "Without oil revenues it's going to be very difficult for the government to maintain the trade balance, the fiscal balance and the level of government spending to keep Chavez's people happy."
Venezuela's socialist President, Hugo Chavez, has spent heavily on social programs, health care, and state takeovers of key economic sectors, while also spreading his country's wealth throughout the region to bolster political alliances.
But the country is still awash in oil money. "It would likely take a sustained drop to the $65-75 per barrel range for the government to likely be forced to make difficult fiscal trade-offs," RBC Capital Markets of Toronto said in a research note.
However, the region's two leading economies, Brazil and Mexico are likely to fare better in any downturn.
Brazil, the world's second largest soybean supplier and a crude oil exporter, was granted coveted investment-grade status by two major ratings agency earlier this year.
Although Brazil's trade and current account balances are already being hurt by falling commodities prices, analysts say the central bank's discipline in tackling inflation and high levels of foreign direct investment could help offset the impact.
In Mexico, the world's tenth largest oil exporter, the government uses conservative oil price estimates in its budget to avert difficult spending cuts if prices retreat.
Oil exports account for a third of Mexico's fiscal revenues, and extra income from higher-than-expected crude oil exports goes into state infrastructure projects.
But while high oil prices are good for Mexican government spending, record high energy costs have hurt the economy of the United States, Mexico's main trading partner.
"Healthy growth in the U.S. is much more beneficial (for Mexico) than a boom in revenue from very high oil prices," said Arturo Vieyra at Banamex bank in Mexico City.
Chile has among the most solid finances in the region, with record fiscal surpluses for the past two years and billions of dollars earned from the copper bonanza saved abroad.
In addition, copper prices are still relatively high since economists say anything over $2.50 per pound is excellent, and the red metal is fetching around $3.35 HGU8.
Minerals exporter Peru, which is enjoying its seventh year of economic growth, is also better-positioned than ever before to withstand a drop in metals prices, with hefty foreign reserves, little foreign debt, and strong domestic demand.
However, there is an upside to the fall in oil and food prices: less fuel for inflation, which is becoming a problem for the entire region.
Argentina and Venezuela would suffer most from a sustained slump in global grains and crude oil prices, mainly because those two countries have used windfall profits from record commodity prices in recent years to fuel growing government spending.
In contrast, Chile has meticulously built up a rainy-day fund to tap when copper prices take a dive, while Brazil and Mexico have more conservative fiscal policies and more diversified economies to cushion the blow.
"The boat will rock but it won't sink," said Alberto Ramos, senior economist at Goldman Sachs, referring to the Latin American economy as a whole. "It's a negative shock ... but it won't lead to a major collapse of growth or an overshooting of the exchange rate or a major financial crisis like in the 1980s and 90s."
"Argentina is the worst off by far in that its policy mix is leveraged very significantly on commodity prices," he said.
Argentina's center-left government has spent heavily to stoke economic growth of at least 8.5 percent in each of the last five years, but high inflation has put pressure on officials to raise public-sector wages and state subsidies.
Argentina is a top global supplier of soy products, corn and wheat, but unlike fellow farming powerhouse Brazil, Argentina heavily taxes its agricultural exports, making its finances more vulnerable to global price swings.
Export taxes, most of them on farm goods, account for 13 percent of government revenues, said Mariano Lamothe of Abeceb consulting group in Buenos Aires.
"Argentina has used the extraordinary income from export taxes to boost spending, so with less income, we'd have to cut spending or find a way to roll over debt," Lamothe said.
Another downside is that Argentina is locked out of international capital markets due to lawsuits by "holdout" creditors who rejected a 2005 restructuring, three years after the country staged the largest debt default in modern history.
Commodity prices have fallen back from record highs in the past month on mounting worries about global consumer and business demand as both Asia and Europe follow the U.S. into an economic slowdown.
The Reuters-Jefferies CRB .CRB, a global index of commodities prices, fell in early August to its lowest level in about four months.
Oil prices have fallen more than 20 percent from their mid-July peak above $147 a barrel, but they are still up nearly 80 percent on average from last year. Venezuela is the fourth-largest exporter of oil to the United States.
"Venezuela's dependence on oil is a huge vulnerability," said Roger Tissot, an independent consultant who specializes in Latin American energy issues. "Without oil revenues it's going to be very difficult for the government to maintain the trade balance, the fiscal balance and the level of government spending to keep Chavez's people happy."
Venezuela's socialist President, Hugo Chavez, has spent heavily on social programs, health care, and state takeovers of key economic sectors, while also spreading his country's wealth throughout the region to bolster political alliances.
But the country is still awash in oil money. "It would likely take a sustained drop to the $65-75 per barrel range for the government to likely be forced to make difficult fiscal trade-offs," RBC Capital Markets of Toronto said in a research note.
However, the region's two leading economies, Brazil and Mexico are likely to fare better in any downturn.
Brazil, the world's second largest soybean supplier and a crude oil exporter, was granted coveted investment-grade status by two major ratings agency earlier this year.
Although Brazil's trade and current account balances are already being hurt by falling commodities prices, analysts say the central bank's discipline in tackling inflation and high levels of foreign direct investment could help offset the impact.
In Mexico, the world's tenth largest oil exporter, the government uses conservative oil price estimates in its budget to avert difficult spending cuts if prices retreat.
Oil exports account for a third of Mexico's fiscal revenues, and extra income from higher-than-expected crude oil exports goes into state infrastructure projects.
But while high oil prices are good for Mexican government spending, record high energy costs have hurt the economy of the United States, Mexico's main trading partner.
"Healthy growth in the U.S. is much more beneficial (for Mexico) than a boom in revenue from very high oil prices," said Arturo Vieyra at Banamex bank in Mexico City.
Chile has among the most solid finances in the region, with record fiscal surpluses for the past two years and billions of dollars earned from the copper bonanza saved abroad.
In addition, copper prices are still relatively high since economists say anything over $2.50 per pound is excellent, and the red metal is fetching around $3.35 HGU8.
Minerals exporter Peru, which is enjoying its seventh year of economic growth, is also better-positioned than ever before to withstand a drop in metals prices, with hefty foreign reserves, little foreign debt, and strong domestic demand.
However, there is an upside to the fall in oil and food prices: less fuel for inflation, which is becoming a problem for the entire region.