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AmericasJuly 27 2021

Latam banking tightly linked to precarious recovery

The region’s largest banks have weathered the pandemic, but their fortunes are dictated by stubborn structural imbalances and potentially short-lived economic rebounds. 
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Latam banking tightly linked to precarious recovery

The Covid-19 pandemic is reshaping Latin America and the Caribbean, with governments looking for the best ways to continue their responses while designing more resilient economies for the future. 

The economic hit to the region was broader and steeper than in any other part of the world, and several countries in the region have the highest Covid-19 death rates per capita on record. Social pressures are mounting just as the region’s electoral cycle moves into full gear. 

While the economy will rebound in 2021 and the regional financial system survived the pandemic, there are substantial problems that require answers.

Battered economies

Latin America’s overall gross domestic product (GDP) fell by 6.5% in 2020, according to the World Bank. By contrast, the world economy declined by 3.5%, while emerging and developing economies excluding China shrank by 4.3%.

The region is home to six of the 10 countries with the highest number of Covid-19 deaths per 100,000 people, according to John Hopkins University’s coronavirus tracker. Peru is the clear leader internationally, with its mortality rate more than double that of second-placed Brazil. 

Despite two countries, Chile and Uruguay, being in the top 10 countries for the percentage of the population vaccinated as of mid-July 2021 — Chile was seventh with 61.8% vaccinated and Uruguay eighth at 59.2%, according to the university’s tracker — the same cannot be said for the rest of the region. Next on the list was the Dominican Republic, ranked 34th with 34.4% vaccinated. None of the big countries are close. 

Large banks are in good standing, with significant provisions

Liliana Rojas-Suarez

Latin American economies were already fragile, with the regional gross domestic product (GDP) contracting by 1.2% in the five years before the onset of the pandemic, creating conditions for a perfect storm when it arrived. Covid-19 not only wreaked havoc, but exposed serious structural flaws in these countries

Giorgio Trettenero, secretary general of the Latin American Federation of Banks, says the region needs to address several major obstacles going forward. “Weak institutions; justice systems that have trouble doing their job; political instability and social discontent are threats to investment, durable consumption and foreign direct investment (FDI),” he adds. 

Liliana Rojas-Suarez, president of the Latin American Committee on Macroeconomic and Financial Issues, says these and other issues put the region at a disadvantage when the pandemic hit. 

“If you had taken a picture of the region prior to the pandemic and compared it to others, you would have seen very low growth, high debt ratios, low tax collection, lack of political leadership and a middle class getting increasingly upset that they were falling back,” she explains. 

Ms Rojas-Suarez adds that although the region will rebound this year — the World Bank pegs average regional growth at 5.2% — this is an “automatic rebound”. Most countries fell so far that the only way is up. 

“The question is whether the recovery can be sustained. This will depend on governments implementing short- and medium-term fiscal policies that can take advantage of the rebound,” she says. 

Supply and demand

Commodity prices are a key piece of the puzzle. High prices for raw materials are helping countries increase revenues as they continue to spend on the pandemic response, including the need to acquire vaccines. 

The high price of copper encouraged the Chilean government in July to increase its growth forecast from 6% to 7.5% for the year. Peru has done the same, and is now expecting its economy to expand by 10.5% this year. These two countries are the world’s first and second biggest copper producers, respectively. The price of copper reached an all-time high in May, and is expected to remain strong as the global economy returns to normal and industrialised economies undertake massive infrastructure-building programmes. 

Argentina, Brazil and Paraguay are seeing their fortunes improve thanks to agriculture prices, especially soybeans. Argentina is the leading exporter of soybean oil and the price in July was up 120% compared to a year ago. It is forecast to produce 8.4 million metric tonnes of soybean oil in 2021/2022, while Brazil will turn out 9.2 metric tonnes. 

Liliana Rojas Suarez

Liliana Rojas-Suarez, Latin American Committee on Macroeconomic and Financial Issues

Shelly Shetty, co-head of sovereign ratings for Americas at Fitch Ratings, says that commodity exporters are already benefiting from high prices, which has slowed account imbalances. 

“We are seeing some of the large countries in the region posting trade balances or current account surpluses, which is good news,” she says. 

Peru, for example, posted an $11.2bn trade surplus in the first five months of this year. It is not only a record, but nearly double the $6bn surplus in May 2019. Mineral and agricultural exports count for the bulk of export earnings. 

Waldo Mendoza, who ended his tenure as Peru’s finance minister in July, says strong exports were behind the country’s recovery and that the incoming administration needs to be aware of the motors behind the improvements. 

“There is a strong impact from prices, which is something we need to be clear about. The prices of gold and copper are good and there has been an increase in volume. We are going to set a record of $54bn [in exports],” Mr Mendoza told a group of reporters during a mid-July press conference.  

Ms Rojas-Suarez says high commodity prices will make balance sheets look good, but governments need to manage windfalls better than in the past. 

“The history of Latin America is one of booms and busts. Everything looks good when commodity prices are high, but the region stops growing as soon as prices decline,” she says. “Commodity prices are coming to the rescue right now, but this is going to be temporary.”

She says countries need to undertake reforms to address the serious deficiencies exposed by the pandemic, especially in health and social safety networks, but this needs to be managed well to avoid social explosions. The pandemic, she says, has people on edge. 

Tensions and taxes 

A startling example is Colombia. President Iván Duque’s government faced huge, violent protests when it tried to push through tax reforms this past April. While planning the reforms for nearly a year, the administration overlooked not only how people were responding to the pandemic, but also that many Colombians had little faith in the state following through on promises. 

The reforms would have lowered the income bracket for taxes, and would affect people earning more than $685 a month. The administration pledged that low-income earners would be compensated with tax refunds after they paid, but few believed that they would get a refund – and their reaction was swift. 

Hundreds of thousands of Colombians protested throughout the country and the police employed deadly force, exacerbating the situation. The media reports that 66 people were killed in anti-government protests in April and May, the highest total in the region in pandemic-related protests. Congress opposed the reform and the government withdrew it as domestic and international pressure increased. 

A new reform was presented in the first half of July. The government wants to raise around $4bn from the reform, around a third less than what it had hoped to get from the initial plan. The tax on businesses will increase five points to 35% and exonerations will be eliminated. 

Failure to pass the earlier reform not only sparked protests, but led Fitch and S&P Global to lower their credit ratings for Colombia. Fitch announced on July 1 that the downgrade from BBB- to BB+ “reflects the deterioration of the public finances with large fiscal deficits in 2020–22, and a rising government debt level”.

The debt ratio due to the pandemic increased from 44.7% of GDP in 2019 to 58.3% in 2020, and is forecast to hit 60.8% this year. 

Ms Rojas-Suarez says the failure of Colombia’s tax reform “raised huge red flags for any government that wants to do [the same]. It was a good reform on paper, but it did not fly because people did not believe what the government promised.” 

Tax reform is a recurring issue in Latin America, but the majority of countries have yet to figure out a way to do it that actually increases revenue. According to the Organisation for Economic Co-operation and Development (OECD), tax collection in the region averages 22.9%, compared to 33.8% among OECD member nations. 

Argentina and Bolivia instituted a wealth tax in 2020; Chile considered, but ultimately rejected, this option in May 2021. Chile, which currently has a constituent assembly rewriting its constitution, is contemplating an increase in taxes and royalties in mining. The lower house of Congress approved legislation that would impose a 75–80% tax on copper in May. The legislation is unlikely to clear the Senate in its current format, but a tax hike for miners will happen. 

Chile’s economy contracted by 5.8% in 2020, according to the World Bank. While not as rosy as the government forecast, in June the World Bank increased its projection for Chile to 6.1% for the year. This is 1.9 points better than its January 2021 forecast. 

We are seeing some of the large countries in the region posting trade balances or current account surpluses

Shelly Shetty, Fitch Ratings

Peru’s new left-wing government is considering a similar approach, looking to mining to increase revenue. President Pedro Castillo’s government is looking at changes to taxes and royalties, as well as reviewing tax stability and accelerated depreciation agreements used since the 1990s to attract investment. Mining is the largest source of FDI in Peru. The country’s economy shrank by 11% in 2020, according to the World Bank — the steepest decline of the larger export-driven economies in the region. 

Ecuador, where conservative president Guillermo Lasso took office in late May, is taking a different tactic, focusing on reducing and even eliminating tariffs in order to reactivate the economy. The government announced on July 9 that it would begin a progressive reduction in tariffs as part of its efforts to jumpstart production. It will reduce them on 667 items and eliminate them altogether on a few key things, such industrial machines and computer parts. Mr Lasso’s government expects the changes to benefit more than 6000 companies and potentially add more than 500,000 new jobs. 

The country, which has a dollarised economy, saw its economy shrink by 7.8% in 2020, according to the World Bank. Growth this year for the oil exporting economy is forecast for 3.4%, but it could improve if the price of oil remains at current levels or higher. 

Ecuador registered a trade surplus of nearly $730m in the first quarter of 2021, more than three times the same period the previous year, ahead of the pandemic. This was primarily the result of crude prices, which went from around $39 per barrel to $54, according to the central bank. 

Although the country faced a debt crisis prior to the pandemic, it managed to restructure $17.4bn in August 2020. 

Cuba is the latest country to experience pandemic-linked upheaval. The country saw unprecedented protests in July, sparked by food and fuel shortages. Tourism, the island’s primary source of income, fell by 75% in 2020 and was nearly non-existent in the first quarter of 2021 to control a second wave of the pandemic. The government blames the ongoing US economic blockade, while opponents blame gross mismanagement. 

The Cuban government responded by eliminating customs duties on food and medicine coming into the country, but they are short-term measures. Cuba is developing the region’s first two Covid-19 vaccines. 

Next steps  

Despite the dramatic declines in GDP and spikes in unemployment and poverty, the crisis has affected Latin American and the Caribbean differently than in the debt crisis of the 1980s and the financial meltdown of the 2000s. Governments and central banks have responded with an array of measures that were unavailable less than a decade ago. Chile led the region with monetary and fiscal stimulus, reaching 25.7% and 8.2% of GDP, respectively, according to a March 2021 report by Fitch. Peru’s fiscal stimulus was 5.4% of GDP, while its monetary stimulus came in at 8.1%.

shetty

Shelly Shetty, Fitch Ratings

Ms Shetty says the stimulus programmes pose a new challenge as economies open fully and vaccination campaigns gain steam in the second half of 2021. “Governments need to start fine-tuning monetary policies as they think about withdrawing stimulus programmes that were applied to preserve balance sheets,” she says. 

Countries are already starting to slowly unwind these policies. In June, Brazil and Mexico raised benchmark interest rates to keep inflationary pressure from increasing. Chile followed suit on July 14, with the central bank upping the benchmark rate 25 basis points to 0.75%. Inflation remains low in Chile, within the central bank’s 2–4% target band. 

The eyes of regional policy-makers are on the US, where inflation is increasing faster than anticipated and the Federal Reserve could consider an interest rate hike sooner rather than later, although this seems unlikely in the near term. A Fed hike would lead to most countries in the region following suit. 

It would mean an increase in borrowing costs. The region has broken records this year with corporate and sovereign bonds; issuances will likely continue as costs remain low. Capital flows to the region were $65.5bn in the first four months of 2021. 

Ms Shetty says Fitch does not see US rates going up in the short term, but changes could still happen as countries get ready. “We still think the US rate hike is going to happen sometime in 2023, but it is being talked about and we could begin to see a tightening with borrowing [which] might become more expensive,” she says. “On the positive side, I think the region’s current account imbalances are much smaller this time around, compared to 2013 when we had the last Fed tapering.” 

Banks across the region took a big hit to the bottom line during the pandemic, but have generally remained solid. One of the more notable changes for banks in the pandemic was the increase in savings, as consumers reduced spending, keeping money in their accounts, and demand for loans fell off. 

Ms Rojas-Suarez says that initial concerns about banks were wrong. She says analysts were worried that banks would be slammed by companies going under, but that has not happened. “Large banks are in good standing, with significant provisions. They will be ready if some loans [will] never be paid back,” she says. 

“Banks are in a position to start making loans,” Mr Trettenero adds, “but this will depend on a sustainable recovery of households and companies.”

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