Economic slowdown driving new generation of reforms in Latin America

It is not often that the diagnosis on what a region needs is as unanimous as this.

Still, “generalizing about a region with such vast differences as Latin America is risky business,” notes Carlos Malamud, a researcher specializing in the region at Spain’s Real Instituto Elcano think tank and a history professor at the UNED distance university .

But a majority of experts supports the theory that Latin America needs to adopt a bold, credible agenda of structural reforms focusing on improved education, infrastructure and the business climate.

These would essentially be second-generation reforms, adapted to economies that no longer rank last in development yet still fail to meet the demands of their growing middle classes.

Complacency stemming from a job well done during the 2008 shock may become the greatest risk of all” BBVA chief economist Jorge Sicilia

This, despite the fact that Latin America gets top grades for the way it handled the biggest financial crisis since the Great Depression. At the time, the region’s economies benefited greatly from strong Asian demand for raw materials and basic industrial goods, and from significant foreign capital inflows as a result of the zero-interest policies of all the main central banks.

“Now, complacency stemming from a job well done during the 2008 shock may become the greatest risk of all,” says Jorge Sicilia, chief economist at BBVA Group.

In fact, according to BBVA Research figures, the Latin American economy will grow only 0.9 percent this year and 1.8 percent in 2015, due to slower domestic demand and a less favorable foreign scenario – China’s own economy has lost speed and global demand for raw materials is down.

Bank researchers say that on average, the worst of the economic downturn is probably over, and that there is a growing gap between the Pacific Alliance nations – Mexico, Colombia, Peru and Chile – which will post growth of 2.8% in 2014 and 3.8% in 2015, and their Mercosur counterparts – Argentina, Brazil, Uruguay, Paraguay, Venezuela and Bolivia – whose GDP will contract 0.5% this year and grow a mere 0.4% next year.

Even so, regional growth will still be a far cry from the average recorded between 2003 and 2011 – 4.5%, according to the International Monetary Fund (IMF) – and from other economies with similar income levels in Asia, which will grow at an average rate of more than 7% this year.

“The slowdown in economies like Brazil’s and the drag effect of the situation in Europe and China forces Latin American governments to adopt adjustment measures as well as reforms in order to face the coming times in good shape,” says Javier Santacruz, an economist and researcher at the University of Essex in the UK.

Governments will have to address those reforms in a much less favorable setting, say international financial sources.

IMF economists underscore how important it is for the region to have “prudent fiscal policies in place, low inflation and flexible exchange rates to improve its response capacity to eventual shocks.”

But besides the macroeconomic policies, they also admit that the time has come to introduce other reforms aimed at raising the low productivity levels in the region, addressing the shortage of transport infrastructure, and improving the business climate.

“It is necessary to move from reforms aimed at increasing growth and macroeconomic stability to those that require investing in physical and human capital and reducing the informal economy,” says Sicilia. “The problem is not the diagnosis, it is whether the will and the ability are there to implement these reforms.”

The first cracks are already starting to show. Mexico has passed a sweeping set of structural reforms, and only violence and the state’s weakness to fight crime could possibly endanger this reformist agenda. But this kind of attitude is nowhere on display in Argentina, where the fiscal deficit keeps growing and monetary policy is used to fund public spending.

“Often enough, it is political change that drives the new reform initiatives, as witnessed in India or in Mexico with the election of Enrique Peña Nieto in 2012,” explains Geoff Dennis, a strategist at UBS.

This is not what has happened in the region for the most part, but according to Malamud, “there are already signs that the economic slowdown is affecting politics. The latest elections did not produce great changes in government, but they did yield very tight results that are no longer as comfortable to government officials as they once were.”

But political consequences depend greatly on each country. “In places where institutions play a bigger role, like Chile or even Brazil, the political agenda is changing due to the current situation. But this is not the case in Argentina or Venezuela.”

“Recessions never help political or social stability too much,” wrote the Swiss investment bank Lombard Odier in a recent statement to its clients. “It is not surprising that capital flows to emerging markets are already turning their backs on South America in favor of Asia.”