Promise vs Problems in Latin America

Over the past 20 years Latin America has made significant, often painful, structural reforms that helped the region create a burgeoning middle class and to weather the 2008 economic crisis. But it still faces many challenges that prevent more Latin Americans from climbing up the economic rungs into ranks of the middle class. More reforms are needed to help the region boost productivity and increase its growth potential, but it is undoubtedly a region that treasurers at multinational corporations (MNCs) need to get to know.

Latin America’s recent success story contrasts with previous decades of turmoil. Not long ago, much of its population was accustomed to living through one financial and economic crisis after another. That stunted the efforts of many people to move from the informal to the formal economy.

Latin America now has more fiscal prudency, independent central banks, financial deregulation and more flexible labour markets. Since the 1990s, the region’s governments have boosted revenues through tax reforms, increased financial access for its citizens and eliminated trade barriers, among other changes. Such economic reforms have fostered domestic savings, entrepreneurship and increased investment in the last decade.

This has helped Latin America pass its biggest stress test – the global financial crisis of 2008-09. All of these changes have also led to a tripling of the gross domestic product (GDP) of the seven largest economies in the region – Brazil, Mexico, Argentina, Colombia, Venezuela, Peru and Chile – in the past 10 years. BBVA Compass expects that trend to continue, but growth could be further boosted if its leaders have the political will to make additional reforms.

Latin American Weaknesses

Across most of the region, for example, more jobs need to be created to reduce the number of people who must turn to the streets for employment in the informal sector, or shadow economy. Income inequality is still a major problem in Latin America, from Mexico’s border towns to the tip of Chile.

Mexico’s economy may be hot, but as everyone who reads reports about the latest drug war fatalities knows, the rule of law must be enforced for continued growth. The Mexican government must also introduce reforms to foster competition and reduce fiscal vulnerabilities.

The region’s economic darling, Brazil, needs to reform its tax structure to promote competitiveness and avoid excessive interference of the public sector in private economic activities. Peru, Colombia and Chile have vast informal sectors and still rely too heavily on commodities for their fiscal revenues. Investment in infrastructure is sorely needed in those three South American countries to improve competitiveness, trade and tourism, and reduce transaction costs. The trio also have poor education systems, which hamper human capital development and social mobility.

In Argentina and Venezuela, the decision-making processes are largely arbitrary and unpredictable, thus discouraging investment. Both countries also face weakening political and economic institutions. While each is rich in energy resources, the supply of power has constrained economic growth.

Latin America’s Strengths

Despite the many challenges that the region faces, it also has plenty of opportunities. Both Mexico and Brazil have sound financial systems, strong fiscal and monetary institutions, and have seen a significant increase in their middle class, which has become a source of stability and economic progress. Both countries have large markets and open economies, making them attractive to foreign investors.

Peru, Colombia and Chile are increasing their trade ties with Asia and offer favourable climates for foreign direct investment (FDI). The emerging middle class plays a growing importance in the political systems of all three nations, which all share the strengths of solid economic institutions and sound financial systems.

Venezuela and Argentina have vast quantities of natural resources and asset prices are low. While many of the savings of these nations are held abroad by the private sector, they could return to their home countries if conditions improve in each country.

Such opportunities mean we can expect continued growth out of Latin America. The region’s GDP growth should improve to 4% in 2013, up from 3% last year. That growth implies about a US$300bn gain for the region.

Leading the pack among the largest economies is Peru with GDP growth of almost 6%. In Chile, Colombia and Brazil, BBVA Compass expects GDP growth of close to 4.5%; Argentina and Mexico will each see growth of around 3% and Venezuela is likely to achieve no more than 2%.

With the exception of Argentina, for all of the countries in the region the outlook for 2014 is better than for 2013. Fiscal deficits will stay under control even under a stress scenario where the global economy decelerates sharply. And even if commodity prices drop sharply, BBVA Compass expects current account deficits to be manageable.

Conclusion

The developing world has come a long way in the past 10 years. Last year, the share of world GDP was evenly split between developed and developing economies. By comparison, developing countries accounted for just 38% of the world’s GDP a decade ago.

Although Asia has been a major driver of the growth in the developing world, Latin America has also played a big part and that trend can continue if the region’s leaders continue advancing much-needed reforms.

It takes years for structural reforms to pay off, but making these changes today can help Latin America enhance its potential; not just for its growing middle class but also for foreign corporate investors and the developed world. With a population of 550 million, larger than both the US and the European Union (EU), Latin America is a critical marketplace.

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