Latin America and Covid-19: Conditions for a Sustained Recovery

Luis Miguel Castilla, The InterAmerican Dialogue, 14 de abril de 2020

The Covid-19 pandemic, already impacting two million people globally, represents one of the worst shocks ever to affect Latin America and the Caribbean. Governments, firms, and workers are coping with a severe economic crisis with yet unknown human losses and potential for social disarray. The region is being hit by large demand shocks from sharp commodity price falls due to a slump in external demand, external capital flight, financial sector volatility, and a collapse in tourist flows due to border closures and immobility measures. These shocks have been exacerbated by output disruptions associated with mandatory social distancing which have paralyzed all non-essential economic sectors, with a high toll on the spending capacity of millions of firms and consumers. In view of this situation, there is an urgent need to build more resilient societies, with buffers to mitigate shocks and adequate delivery of public goods and services. This will test the capacity and determination of all relevant actors in the region.

Economic recession and potential social disarray

According to the IMF, global output is expected to decline by three percent in 2020. In contrast to the situation faced in the aftermath of the global financial crisis in 2008, with a quick V-shaped recovery, there are some fundamental differences this time around: it is unlikely that China will be able to pull the world into a quick recovery as it did a decade ago; aggressive stimulus packages in most industrialized countries are set in a context of political uncertainty driven by US presidential elections and fragmentation in Europe; there may be lasting supply chain disruptions; confidence will only be restored to the extent that the pandemic is kept under control (with no vaccines developed any time soon).

Most Latin American countries are in a more fragile position than a decade ago. Growth has been stagnant for the past five years (with growing social unrest) and macroeconomic fundamentals are weaker. IMF estimates that regional economic output will decrease by 5.2 percent this year and a 3.4 percent growth recovery in 2021 hinges upon several external and domestic assumptions. Job losses are one of the main concerns, as the Inter-American Development Bank forecasts around 18 million job losses and informal employment potentially affecting three out of five workers. The UN Economic Commission for Latin America and the Caribbean projects that 24 million Latin American citizens may fall back into poverty (and 15 million into extreme poverty). In light of this situation, opinion polls are placing economic concerns on top of citizen priorities. According to recent Ipsos research, around 60 percent of Brazilians and Mexicans think that Covid-19 poses a high threat to their jobs and businesses.

Economic stimulus might be insufficient

Although the next months will be very challenging for Latin America, the crisis is today very much underway. As of April 13, close to 70,000 people have tested positive, a third coming from Brazil, with still very limited testing in most countries. Health care officials are actively trying to contain the pandemic through strict quarantines and social distancing policies, while economic policymakers are pursuing measures to mitigate the ensuing economic crisis. The response has been swift so far, as most central banks have aggressively reduced interest rates and extended liquidity facilities. In turn, finance ministries are tapping into a broad range of available tools, including boosting public health sector expenditures, providing non-conditional cash transfers to vulnerable groups, and granting payroll subsidies, tax and financial support to small and medium-sized enterprises. Other policies being adopted include tapping into unemployment insurance schemes, pension funds and flexible labor regulations to provide sufficient cash flow to firms and workers to reduce the risk of bankruptcies and massive layoffs.

Starting from a more limited public finance stance, the scale and impact of expansionary fiscal policies will vary depending on country-specific public indebtedness levels, access to external financing (both official and private) and availability of public saving and asset pools. On the one hand, strong macroeconomic fundamentals are paying-off. Countries such as Chile and Peru have been able to implement aggressive stimulus packages. In contrast, there is a very limited room of maneuver in nations such as Argentina (in the midst of a debt restructuring process), or Haiti and Venezuela which face humanitarian emergencies and political unrest.

Overall, most countries confront important fiscal challenges due to high fiscal deficits and debt overhang. Oil exporters, for example, such as Colombia and Ecuador, face tight fiscal revenues due to much lower oil prices. Brazil and Mexico, in turn, are stuck in low-growth equilibria with halted or no structural reform processes underway. Central American economies have a weak fiscal stance in spite of recent institutional improvements. Caribbean island states have almost no fiscal space due to vulnerabilities associated with climate change and natural disasters.

Mobilizing external financing becomes critical

Having the capability to pursue expansionary policies will make a difference in mitigating the crisis. The IMF will be critical in providing liquidity loans to several countries, as it has a global lending envelope close to $1 trillion. Nonetheless, even the best credit-rated economies will eventually be constrained by limited available resources and capital markets that become increasingly more risk-averse. So far this year, external capital outflows from emerging markets have reached $100 billion.

Multilateral development financing, which prior to the coronavirus pandemic channeled annual financing around $30 billion into Latin America and the Caribbean, needs to be boosted. This will demand replenishing capital contributions from shareholders, leveraging additional resources, both official and private sources, into the region. Although concessional resources will be heavily demanded to finance social investment needs and create blended facilities to mobilize risk-averse institutional investors, fiscal constraints and global competition for donor money will be a daunting challenge. In this context, the US International Development Corporation, with a recent $60 billion mandate, has a great opportunity to lead the recovery effort throughout the region.

Effective public good delivery will help recovery and build resilience

Beyond financing needs, effective and adequate policy deployment will hinge on overcoming a series of internal constraints that existed before the pandemic. Progress is needed to deal with diverse public policy challenges, such as incomplete information to manage extensive targeted transfer programs, opaque procurement policies, inefficient tax administration, and political economy considerations to phase out temporary stimulus measures. A very comprehensive agenda needs to be pursued to go beyond crisis containment and establish enabling conditions to sustain economic recovery and boost resilience. The pre-coronavirus scenario in most Latin American countries was characterized by growing citizen disenfranchisement, stagnated private investment, social unrest and growing populism.

Boosting quality healthcare is critical

Moreover, the pandemic has made some longstanding structural gaps more evident and a growing sense of urgency to fill them. An example is the inadequacy of public health systems. Although Latin America has increased its health sector expenditures, average annual per capita spending is $1,076, three times less than in the European Union, according to the World Health Organization. Brazil with the largest health care sector in the region, only spends four percent of GDP in comparison to ten percent in France or Germany. There is insufficient service delivery due to infrastructure gaps and scarce medical personnel and equipment. For example, Ecuador only has seven Intensive Care Unit beds per 100,000 inhabitants (Mexico three and Peru one) in comparison to 30 in the United States or 10 in South Korea. Recession-induced quarantines have been implemented in many countries for governments to gain additional time to build sufficient treatment capacities for large numbers of sick people in already overburdened health facilities.

Public health systems are under extreme stress and there is an urgent need to boost their capability to address extreme circumstances. In addition to increasing budgetary allocations, innovative initiatives should be pursued, such as IT technology Smart Health Care. Moreover, new public-private ventures should also be implemented through long-term service delivery contracts. There is a need for policymakers, private corporations, and civil society to think out of the box to deliver quality public goods and services during normal times, and adequately prepare to address shocks when they occur.

In sum, Latin America and the Caribbean is confronting a severe recession with uncertain prospects. Although the recovery will primarily depend on external factors, three key components will determine whether the region is capable of sustaining its path of economic prosperity and social cohesion: sound economic management, access to external finance, and delivery of quality public goods and services to all its citizens. Covid-19 introduces a sense of urgency as well as an opportunity to continue making real progress.