In the largest economies in Latin America, governments have increased their spending in recent years without simultaneously increasing their production or tax collection. What began as an extraordinary measure to help the most vulnerable during the pandemic is becoming a delicate new fiscal normal at a time of economic slowdown and an increasingly complex global environment.
Recently, the Government of Brazil surprised analysts and investors with a larger than anticipated fiscal deficit, with an estimate for the end of the year of 6.8% of the Gross Domestic Product (GDP). Although the figure only includes the first two months of the year, if the spending trend continues, it could close 2024 with a greater increase than in 2023. For its part, Mexico also increased its deficit, estimated at 5.9% of GDP for this year. year, with the highest debt level since 1988. Colombia and Chile have deepened their public debts and Peru is poised to exceed its fiscal rule this year for the second consecutive time. Taken together, this paints a picture of a deterioration in public finances in the region.
“There are more fiscal imbalances now than there were 8 or 10 years ago and that is bad,” says Tim Kehoe, professor at the University of Minnesota and co-author of the book Monetary and Fiscal History of Latin America, 1960 – 2017. “This will promote more instability, especially with today’s high interest rates… but it is not unique to our region. There is a lot of populist pressure in the world right now. We are seeing it in many places, and now even in Europe. “People vote for left-wing or right-wing populists when they are upset with the establishment and populists tend to be fiscally irresponsible,” he added.
In a report by the Economic Commission for Latin America and the Caribbean (ECLAC) published in February, the organization warns that this evolution of public finances has occurred in a climate of lower economic growth worldwide, high interest rates and a reduction of capital flows to emerging markets. At the regional level, the low growth trend that has characterized the last decade continued. In other words: it’s a dangerous cocktail.
“In Latin America, fiscal deficits increased and the primary result became deficient,” the report says. “This is explained by the slowdown in aggregate demand and the decrease in prices of non-renewable natural resources that negatively impacted public income, while the level of public spending stabilized after two years of cuts,” the specialists wrote. of ECLAC. A greater deficit raises interest rates on sovereign bonds listed on international markets, which increases financing costs.
The trade war between China and the United States could bring great business opportunities to the region. nearshoring, or business relocation, but it is negatively impacting the demand for raw materials that China buys from South American countries. A slowdown in China could also reduce levels of external financing and investment in recipient countries, many of them in Latin America.
“We are seeing a diverse set of forces at play,” Kehoe adds. “Populism is a common thread, but otherwise, each country has a different story of why it has large deficits.” The increase in spending began with the pandemic, since Latin American economies have high levels of informality and, therefore, a large part of their population lacks social guarantees.
The region’s largest economy, Brazil reported a deficit of $293 million in March, surprising analysts. This was higher than expected, in part, due to the increase in social security expenses that will require greater monitoring, the Treasury Secretary reported at the end of April. “Countries like Brazil and Peru reacted strongly to Covid and that was good. It was an unprecedented shock!” says the academic, “then there is Colombia, where they elected what is, in essence, their first left-wing president and they had to respond to social demands.”
In fact, the winter of discontent generated by the health crisis in Colombia led to a massive social outbreak in 2021. Resources for social protection and health coverage took the largest share and, given the urgency, it was agreed to make the limits of the fiscal rule. The election of President Gustavo Petro was largely based on those mobilizations and his Government inherited a complex and tight fiscal horizon from former conservative president Iván Duque (2104-2018). “The majority of the spending was made with debt and Petro receives a country with many commitments to international creditors,” recalls economics professor at the Universidad de los Andes Oskar Nupia.
Two years later, in the middle of his mandate, the fiscal deficit has become a kind of nightmare for the execution of the social reforms proposed by progressivism. The collection projections for 2024, in addition, have fallen short and the Government reported last week that the projected deficit for this year will rise from 4.2% of the 2023 GDP to 5.6%. “Petro promised all kinds of expenses and projects without having the money to spend on hand,” continues Nupia, “and with a gap of 3,984 million dollars that must be paid to Ecopetrol. [la estatal petrolera]due to a subsidy that has already been eliminated, leaves a scenario with many pressures on spending.”
The Fiscal Observatory of the Javeriana University has calculated in this context that the State will have to disburse 24 of every 100 Colombian pesos next year to pay off the debt. That is why the risk rating agency Moody’s warned two weeks ago that Colombia’s credit profile, which is in the same range as that of Mexico, could suffer a downgrade. Everything depends on the efforts of the Government, which has already cut its budget by 4% of the total, to balance the macroeconomic framework.
“The situation in Brazil and Mexico is different from that of Colombia because the markets have a different perception of risk,” says Mauricio Cárdenas, former Minister of Finance (2012-2018) who has been critical of the Petro Government. Brazil is on track to meet its goal of increasing oil production towards the end of the decade, while Mexico became the United States’ main trading partner last year. This gives investors confidence that there will be resources, both external and fiscal, to cover their gap in public finances.
“Colombia does not even have oil because, on the contrary, the Government has taken it upon itself to demonize the industry… nor does it have the nearshoring because it has not been able to take advantage of the advantages of its location or the fact that it also has a free trade agreement with the United States,” adds Cárdenas, an economist and researcher at the school of public policy at Columbia University, SIPA, in New York. York.
In Mexico, the increase in the deficit did not occur until the last year and a half of the Andrés Manuel López Obrador Administration, when resources were channeled to its infrastructure projects and social transfers were advanced before the June 2 elections. President-elect Claudia Sheinbaum has said she will reduce spending to 3% of GDP in 2025 and the Treasury Department has already taken some initial steps to make finances more flexible. However, without tax reform, analysts say it will be difficult to achieve the goal.
Cárdenas and Kehoe reach the same conclusion: this is about the populisms that afflict the world and, in particular, the region. “There is a populism of the character of what is now called identity politics, which is separating society between good and bad, between the elites and the people, dividing society,” laments Cárdenas. “To that type of populism is now added the traditional, legendary version of Latin America, which is very deteriorated public finances, excess spending. We are entering the hybrid phase, a mixture of traditional Latin American populism and that based on the division of societies,” says the specialist.
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