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Lockdown and Commodity Prices

Latin America has been hit by a one-two punch of COVID-19-related economic shutdowns and a sharp decline in commodity prices.

Latin America has been hit by a one-two punch of COVID-19-related economic shutdowns and a sharp decline in commodity prices. While GDP growth estimates across the region for the year are almost uniformly negative, different countries’ ability to soften the blow and start the recovery are disparate.

Against a backdrop of tighter external funding conditions, the size of a country’s fiscal stimulus package in Latin America depends on its ability to absorb new debt, and the affordability of that debt.

Just as the spread of the coronavirus is influenced by government action, the length and severity of economic distress is driven by the size and nature of these stimulus packages—a harsh reality for some of Latin America’s most indebted countries.

In April, Argentina failed to make foreign debt payments on its mountain of public debt, which amounts to nearly 100 percent of GDP. The country is working to negotiate new terms with private creditors and the IMF, which alone holds 40 percent of Argentina’s debt pile, to prevent a default. However, the concessions these creditors are asking for might prevent the government from making the fiscal steps necessary to ease the economic crisis.

Similarly, Ecuador, an oil-producing country, is facing trouble with its large public debt load, amounting to around 50 percent of GDP. As a result of its size and the country’s urgent balance of payments needs, Ecuador’s debt has been downgraded to the lowest in Latin America, along with that of Argentina.

On the other hand, Peru’s public debt amounts to just 27 percent of GDP, the lowest among major Latin American economies. While it’s economy will be affected significantly by the decline in commodity prices, the country’s prudent fiscal management in recent decades puts it in an enviable position as the region’s governments race to spend.

Indeed, Peru’s economic stimulus package amounts to a gargantuan 12 percent of GDP—among the world’s largest, relative to GDP. Peru was also among the first countries in the world to introduce direct payments to citizens.

An indication of the expected economic success of Peru’s stimulus efforts, international investors have shown keen interest. Yields on Peruvian bonds remain low, making stimulus relatively cheap for the government, and the Peruvian Sol has gained around 5 percent over the last month, compared to widespread emerging market currency losses.

Comparatively, Argentina’s stimulus package amounts to around 3 percent of GDP, and Ecuador’s fiscal response has been similarly muted, and is largely based on tax deferrals and banking sector loan standstills. Encouragingly for Ecuador however, in May the IMF approved a $643 million emergency loan and the World Bank followed with a USD500 million loan to help cover the country’s budget needs during the COVID-19 emergency.

In the medium-term, countries like Argentina and Ecuador will face difficult discussions with their creditors. Debt from institutions like the IMF has historically been handed to emerging markets on the condition of fiscal prudence. However, the need for fiscal stimulus has never been more pronounced.

While the IMF has shown a recent willingness to soften its usually strict debt-for-reform stance in the face of COVID-19, the investors needed to support these economically-ailing country’s sovereign bond markets are unlikely to be so forgiving. As a result, an economic reboot will be far more expensive and, in turn, harder to achieve.

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