Latin America: Business environment risk ratings are slowly improving but pressure remains due to weak currencies and high inflation

Deep economic recession in 2020 hurt business environment risk ratings

In 2020, Latin America witnessed it worst recession in decades as the economy shrunk by a steep 7%. Moreover, Latin America was the poorest performing region in the world in terms of real economic growth and it was clearly performing worse than the global average real GDP growth of -3% (see Graph 1). The reason why Latin American economies were so deeply affected last year can be mainly explained by three factors. First of all, most countries in the region had the most stringent lockdown measures in the world. Secondly, worldwide, Latin America was the region that was hardest hit by Covid-19 in per-capita terms (amongst other things due to the high urbanisation and the high level of informal jobs). Thirdly, the drop in tourism hit especially the Caribbean islands hard while the drop in commodity prices hurt the South American countries. As the business cycle is an important element in the business environment risk rating, the deep recession of last year largely explains the high business environment risk ratings in this region.

Regional economic recovery improves business environment risk ratings

This year, an economic recovery of 5.8% is in the cards for Latin America (compared to the global average of 6%). Despite regular Covid-19 waves, economic activity recovered in 2021 as lockdowns were less stringent, global economic activity recovered (especially in the main trading partners: the US and China) and commodity prices became stronger again. Thanks to the economic recovery, many countries saw an upgrade in their business environment risk rating in September. However, it is a rather slow recovery after the deep recession of last year, which explains the gradual pace of the upgrades. Indeed, despite the strong recovery, real GDP is not expected to reach its pre-crisis level by the end of 2021 (see Graph 2). Moreover, it is a very uneven recovery, and especially countries that are heavily depending on tourism are lagging behind, while global supply chain disruptions could slow down regional economic recovery. Furthermore, other indicators keep putting pressure on the business environment risk ratings such as the large exchange rate depreciation in the past year for many countries. On top of that, many Latin American countries have started to tighten their monetary policy as inflation targets were surpassed in nearly every country. The surging global inflation, led by food and energy, has led to aggressive interest hikes by central banks in Latin America (e.g. Brazil, Mexico, Chile), contrary to the response witnessed so far in many other economies in the world. The monetary tightening is likely to trickle down to higher borrowing rates and a lower amount of bank loans to the private sector, hurting the business environment.

Latin American business environment risk ratings remain under pressure

Looking forward, the regional outlook is gloomy. Yet again, Latin America is expected to be the slowest-growing region in the world in 2022, with an average real GDP growth of 3.2%, compared to a global average of almost 5%. Explanatory elements are manifold. First of all, vaccinations in the region are progressing rather slowly compared to advanced economies, and the population will remain vulnerable to Covid-19 waves until herd immunity is reached in most countries, which is estimated to be by the end of 2022. Secondly, most commodity prices are expected to level off in 2022. Thirdly, given the limited fiscal space in many Latin American countries, government stimulus programmes are being wound down, hurting economic activity. Furthermore, the ongoing interest hikes can hurt economic activity. Other indicators of the business environment risk rating will also face headwinds. Currencies in Latin America are forecasted to remain under pressure in the coming months. A potential monetary tightening in the US could exacerbate downward pressure on the exchange rates. And lastly, a key risk element in many countries will be the resurgence of violent unrest. The social protests of 2019 – abruptly ended due to the Covid-19 pandemic – are likely to return as poverty, unemployment and inequality have risen in the past two years. Moreover, rising food inflation and fiscal tightening have often triggered violent unrest, as illustrated by the Arab Spring in 2011, the 2007 tortilla protests in Mexico and recent (early 2021) protests in Colombia against proposed tax rises.

Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com