Financial & Economic Crisis hits Latin America

It was the turn of Latin America's stock market to take a nose dive this Wednesday - "Dark day for faltering LatAm stocks" . In Chile they dropped 6.3%, in Mexico by 7 %, in Brazil by 10%, and last but by no means least Argentina, where they dropped by 18%.

The magnitude of the drop in Argentina was provoked when President Cristina Fernandez announced plans to nationalise the private pension funds.

She said the nationalisation would protect retirement funds from the global financial crisis, but analysts said the move would drain company access to private capital. Argentina's Congress is expected to approve the proposal within weeks. BBC News: "Turmoil in Latin American Markets".

Privare investors have been upin arms, not least a Merrill Lynch executive who stated bluntly that his bank had now written off any investment plans in Argentina "for at least the next half decade." - AFP, "Latin America in Jaws of Global Crisis"

As I mentioned in an earlier post - "Global Depression: So What About Latin America" - much of the worry in Latin America on the back of the current world financial crisis, stems not so much from the so-called credit crunch, but rather the sharp recession that's meant to hit the world's major markets in the Northern hemisphere, and the decline in commodity prices that it will entail.

Correspondents say international demand is declining for many of Latin America's commodity exports, including oil, copper, iron ore and soy as global growth slows amid the current financial global crisis BBC News, "Turmoil in Latin American Markets".

Whilst demand may be faltering in the US and Europe, demand from the likes of China is still bouyant.

This is not to say that all is as gloomy as one could fear. Precious global recessions have tended to hit Latin America harder than most. The analogy of "when the US economy sneezes, the rest of the world cathces a cold, but Latin America catches phnuemonia" having proven to be quite fitting in th past. This time round things may be slightly different. According to former Mexican foreign minister, Jorge Castañeda:

the region would be largely impervious to the recent crisis. Mexico, Chile, Brazil and Uruguay should manage just fine, emerging with only bruises and scrapes, he argued. Colombia and Peru would weather the storm, though suffering greater harm. But he warned of "severe damage" for Venezuela, Bolivia, Ecuador, Central America and the Caribbean. BBC News, "Brazil squares up to an economic storm"

The severe damage awaiting Venezuela has much to do with the sudden drop in oil prices. Overdependent on oil revenues, Venezuela's extensive public spending could be seriouly affected if oil prices continue on this downward trend. It is therefore no surprise that Venezuela qill be pushing for oil output cuts at this week's hastily convened OPEC gathering in Vienna.

Venezuelan Oil Minister Rafael D. Ramirez said the OPEC members "have to take some action now, now," adding that Friday's meeting will reach "consensus to take a very, very, very fast action." Xinhua, "OPEC members divided over oilput cut"

Last week I attended a public meeting at the Houses of Parliament here in London, where Venezuelan ambassador to the UK, Samuel Moncada, whilst almost gleeful in his depiction of the collapse of the world's financial system, had to admit that Venezuela faced difficult times ahead. So what about all the windfall funds from record-high oil prices that the Venezuelan had been meant to have store away for precisely those times when the oil prices were on the fall? Well, according to the ambassador this would only cover Venezuela's problems for a mere 2-3 months.

Latin America Pays for the Price for Fuel Subsidy

Before sitting down in the library, to get on with my dissertation reading, I quickly paged through the Financial Times – one of the few, if only, British newspapers that tends to print interesting Latin American politics/economic articles. Today there was an interesting analysis piece about how Latin American governments are facing increasing pressures to cut fuel subsidies in the face of the ever-increasing oil prices. “Latin America pays the Price for Fuel Subsidy.”

Here in the U.K. a day doesn’t go by without further doom and gloom reports about the negative effects oil price increases are having on the average Brit, especially as they go to fill-up at the petrol station. A news story that is being played out across much of the world.

However in Latin America - as had been the case, up until recently, in Asia – governments have been subsidising petrol prices to tune of some ridiculously large billion-dollar sum. In this way Latin American motorists can still enjoy petrol prices a little as 5p a litre, whilst the rest of the world’s motorists have to dig deeper and deeper into their pockets to fill up their cars.

source: The Financial Times 17/06/2008

Why are they doing this? Perhaps Latin American governments are aware of the vital importance access to cheap petrol is for so many of their citizens. Any sudden increase in prices will surely effect these nations in more ominous ways than we in the West would be effected by such price changes. The FT rarely does economics with a ‘human face’ so these issues don’t get much of a mention in the FT piece. However what they do focus on are the possible consequences a sudden increase in petrol prices may have on inflation.

The reason for the lack of reform is pretty clear. Of all regions in the world, Latin America has most reason to fear the effects of inflation. During the 1970s, 80s and early 90s the pace and scale of price rises corroded the social fabric of many countries. Inflation rates of 100 per cent a year were commonplace, wrecking the ability of governments and businesses to plan for the future. As Guillermo Ortiz, the governor of the Mexican Central Bank, said: “Latin America has gone through high inflation for so long. Lowering the rate has been a cherished achievement.” In Chile, which imports almost all of its fuel needs and where annual inflation was running at 8.9 per cent in May – three times the central bank’s target – the new price subsidies will cut that rate by 0.3 percentage points, according to Angel Cabrera, a local consultant.

An interesting point.

However as the price for oil rises, the subsidies have to increase, and are subsequentlybecoming a conseiderable fiscal burden, which in itself may well curtail government spending in other important areas. The question is whether this outweighs the threat of higher inflation and the problems that would arise from that?

The FT ends by highlighting how cheap access to petrol does little to motivate a lower use of petrol in the long-run, something which mus be a desirable end in itself - be it to combat climate change, to free up some of Latin America’s clogged up innercity roads etc.

More seriously, the subsidies are distorting incentives. While higher oil prices have stimulated many developed countries to save energy and make more efficient use of resources, there has been no sign yet of this happening in Latin America. In Venezuela, for example, domestic petrol consumption is estimated to have doubled over the last five years to around 600,000 barrels a day. The low cost also creates incentives for smugglers, who sell petrol across the border in Colombia, where fuel is much more expensive.

Venezuelan Flags on London Buses

I have always found it slightly curious to see the Venezuelan flag plastered on the back of some of London’s red double-decker buses.

Travelling through Latin America you become accustomed to seeing little EU or Japanese flags dotted here, there and everywhere, announcing their financial support for the next important humanitarian project. But why should an already impoverished nation be making such an effort to help one of the richest cities in the world?

Well by means of subsidised Venezuelan oil some of the poorest people of London have been able to benefit from reduced bus fares. But what does Venezuela, or rather Hugo Chavez, get out of this? Well aside from the little Venezuelan sticker on the back of buses I guess it was no more than a slap in the face against Tony Blair, one of Chavez’s more vocal critics abroad. In the same essence Chavez has been providing cheap heating oil to poor inner-city neighbourhoods in the US.

I shouldn’t be so cynical, should I? This is how the deal was officially meant to look like:

“This was a mutually beneficial agreement through which Venezuela had assisted 80,000 of the poorest people in London who receive half price bus and tram fares as a result of a reduction in the price of fuel for London's bus fleet. In return, London provided Venezuela with specialist technical expertise and assistance in areas such as transport, town planning and protection of the environment and other issues related to developing a modern world city. The main beneficiaries of this technical aid would have been the poorest residents of Caracas”(Venezuela Information Centre 27/05/08)

However with the election of a new – conservative - London mayor, Boris Johnson, the deal has been scrapped. Despite how much I would have liked to have believed the official rhetoric, that there was some altruistic motive behind Chavez’s donation to the disadvantaged people of London, and that the world could indeed have benefited from such examples of North-South collaboration, it’s probably makes sense to end this deal. Surely the Venezuelan people are in more need of subsidized oil than us here in London. And Chavez really shouldn’t be playing such cheap political games with the very assets that are needed to develop Venezuela.

Still I have to say I’ll miss seeing those little Venezuelan flags on our buses here. They always bring a wry smile to my face with the realization that ripple effects of change in Latin America have is some strange and peculiar way reached us here in London.