The Asian Crisis's Effect on Latin America
by Carlos Lozada, economic analyst
inancial shocks can ripple quickly through countries within the same region, as the Mexican peso crisis of 1994-95 demonstrated. But the current financial crisis in Asia is proving a regional crisis can threaten geographically distant economies in developing areas and touch even advanced economies like the United States.
The effects of the Asian crisis began to be felt in Latin America in October 1997, when Asia's currency devaluations began pressuring other markets, threatening to transform the regional crisis into a broader crisis of emerging economies. Developments in Asia have affected Latin America through two main channels of contagion: finance and trade.
Latin American Stock Indexes
Note: Daily stock market closings normalized to 100 as of Oct. 1, 1997.
Source: Federal Reserve Bank of Atlanta
Several Latin American countries suffered immediate financial setbacks because of investor perception that they shared some of Asia's economic imbalances.
Brazil's sizable current account deficit and what some perceive as an overvalued currency made the country a target for a speculative attack, forcing the central bank to spend an estimated U.S.$7 billion (about 12 percent of total reserves) in late 1997 in defense of the Brazilian real. To bolster confidence in the currency, the central bank raised its overnight borrowing rate from about 20 percent to over 40 percent. This move contributed to an annualized 4.3 percent decline in real gross domestic product (GDP) in the first quarter of 1998.
The government also proposed some fiscal cutbacks. But these measures have encountered political obstacles, and the budget deficit remains high at over 6 percent of GDP. Most forecasts estimate that Brazilian GDP growth will decelerate to between 1.5 and 2 percent in 1998 after reaching 3.1 percent last year. By mid-1998, interest rates had fallen to nearly precrisis levels.
The sharp decline of capital flows into Latin America in late 1997 appear to have been associated with Asia's financial difficulties. According to the U.N. Economic Commission on Latin America, international bond issues from Latin America declined to less than $4 billion in the fourth quarter of 1997 compared to U.S.$20 billion during the previous quarter. Similarly, stock indexes throughout the region have lost ground since the fourth quarter of 1997, ending the second quarter of 1998 well below their pre-Asian crisis levels (see the chart). Brazilian equities declined because of investor concern over the country's "managed float" exchange regime, which is pressured by Brazil's large fiscal and current account deficits. Argentina's market has suffered from perceptions that it is doubly vulnerable through its fixed exchange rate regime and its dependence on Brazil as a trading partner.
While the financial effects on Latin America were evident in the aftermath of the Asian devaluations, trade effects have taken longer to appear. Weakened currencies and the beginning of recessionary periods in Asian economies are forcing those countries to curtail imports. As a result, Latin American trade balances with Asia are starting to deteriorate.
The prices of primary goods such as copper and petroleum — key Latin American exports — have declined significantly in 1998 due in no small measure to reduced Asian demand. South Korea and Japan, for example, are among the world's largest copper consumers. Chile, Peru and Brazil are especially exposed to Asia (including Japan), with over 30 percent, 16 percent and 13 percent, respectively, of their 1997 exports going to that region.
Though not as directly exposed to Asia, oil exporters like Ecuador, Mexico and Venezuela are suffering from the overall slump in petroleum prices. Given declining government revenue associated with lower export earnings, several countries in the region have been obliged to make significant cuts in 1998 spending plans. Some countries, such as Mexico, are even considering raising prices on publicly provided goods and services — in particular, gasoline and electricity — to meet budget shortfalls. Some oil-exporting nations' efforts to raise prices by curtailing production have met with limited success.
Current account imbalances, already aggravated by the impact of El Niño on agriculture and fishing, are deteriorating in several Latin American countries and may reach deficits near 6 percent of GDP in Colombia, Chile and Peru in 1998. Overall economic growth in Latin America is expected to decelerate to about 3 percent in 1998 after reaching a 5.1 percent rate in 1997.
These trade and financial repercussions underscore Latin America's continued vulnerability to external shocks, highlighting in particular the region's limited export base and continued reliance on primary commodities as a source of foreign exchange. Moreover, the risk of further financial contagion in Latin America — merited or otherwise — remains, especially in light of the ongoing difficulties in Russia, Japan and other parts of Asia.
So far, Latin America has been able to weather the Asian crisis. Policymakers responded forcefully to external pressures, though in some cases like Brazil there is still much to be done in the area of fiscal reform. The economic reforms in Latin America over the last decade have placed the region in a stronger position to mitigate the impact of adverse international trends. Based on domestic economic fundamentals, the long-term outlook for the region remains one of tempered optimism.
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