|
 |
 |
|
Finance ministers and economists around Latin America have been expecting the economies of Brazil, Argentina and Chile — the three major ones in the region’s Southern Cone, with Brazil by far the largest in all of South America — to march together towards a rebound, following recession and slow growth last year. But the increase two weeks ago of the basic interest rate by the U.S. Federal Reserve raises serious doubts about the viability of this scenario, because Latin American economies remain highly dependent on foreign funds for financing their growth.
It is not so much the half-a-point increase on May 17, moving up the Fed funds rate to 6.5 percent, that causes concern, even though there’s enough to worry about the Fed’s decision to abandon the policy of one-quarter-point increases it had been following. The biggest worry is that there is a strong opinion shaping up in Wall Street that we are going to see the Fed raise rates by a three-quarters of a percent in June and another 75 basic points in August. Furthermore, although usually in a presidential election year the Fed doesn’t touch rates in its September meeting — the last one before Americans go the polls — so that rising borrowing costs do not become an issue in the election, there are those who believe this tradition may be abandoned if previous actions have not cooled the economy enough.
It is virtually inevitable that, influenced by the increase in the United States, rates will go up in the world’s other major economies. An increase in the basic inflation rate has already led to expectations of a rate increase in the Eurozone; the cycle of increases may not have ended in the United Kingdom; and the Bank of Japan has again suggested that the end of its “zero interest” policy is not far away.
Key to the direction the world economy will follow is the nature of the process by which the overheated U.S. economy cools down. If the Federal Reserve achieves its objective of a soft landing, the impact upon most of the world would not be great — although some regions, such as Asia, that trade heavily with the United States, will suffer a decline in its exports. A harder landing might have wider and more serious consequences for the world economy.
But for Latin America the end of the process, either with a soft or a hard landing, is not as relevant as it might be for other regions, because it is already suffering the effects of foreign investors’ flight to safety as risk aversion is increasing in financial markets. U.S. funds for investment in the region are becoming scarce and, with U.S. mortgage rates creeping up to two-digit figures, those willing to take the chance of investing in Latin America are demanding rates exponentially higher. Investors from other major financial sources are following a similar pattern.
Economies in the Southern Cone with floating exchange rates, such as Brazil and Chile — as well as Mexico in North America—can partially offset higher U.S. rates by allowing their currencies to drift lower, which also helps boost exports. Even though its currency has been up to now mostly stable, Brazil reported last week its highest-ever monthly budget surplus, but there is still great concern about the effect upon the economy of the global turbulence trigged by the Federal Reserve rate increases. Chile also reduced a key capital control, making it easier for investors to move in and out.
Argentina, however, is more vulnerable to the U.S-interest rise because nearly a decade ago it pegged its currency firmly to the dollar in a successful effort to end hyperinflation, so U.S, rate increases translate directly into higher rates locally. A change in “convertibility”, as the system is known, is scarcely viable politically, as it would destroy the key element in public confidence that inflation will not return.
Argentina’s center-left Alliance government — more center than left — headed by president Fernando de la Rua came to office in December convinced it could make rapid progress on reducing the fiscal deficit and boosting investor confidence. Instead bond and share prices have slumped and unrest has intensified in the poorer provinces, where the authorities are making their own fiscal adjustments. In addition, tax increases have not raised the hoped-for revenues, while consumer confidence has stayed stubbornly low.
Also, under the terms of its $7.2 billion standby loan agreement with the International Monetary Fund, Argentina is committed to cutting its fiscal deficit from last year’s $7.1 billion to $4.7 billion. The gathering pace of economic recovery was expected to ease Argentina’s chronic social tensions, fueled in part by high unemployment. But the poor revenue figures have forced the government to cut spending in poverty reduction and better education and healthcare in an effort to meet second-quarter deficit targets — and even so the goal remains elusive. On the brighter side, through an aggressive borrowing campaign carried out mostly before the Fed’s rate increase, Argentina has already secured over 50 per cent of its $17.5 billion financing needs for this year.
Claudio Campuzano (claudio-campuzano@hotmail.com) is U.S, correspondent for the Latin American newsweekly Tiempos del Mundo and editorial page editor of the New York daily Noticias del Mundo. He writes weekly for World Tribune.com