Development & Aid, Economy & Trade, Financial Crisis, Headlines, Latin America & the Caribbean

ECONOMY-SOUTH AMERICA: Day-to-Day Impact of Crisis Not Yet Felt

Mario Osava*

RIO DE JANEIRO, Oct 13 2008 (IPS) - The financial crisis that originated in the United States demonstrates, more clearly than any previous such event, the distance between capital markets and ordinary citizens, especially in developing countries.

Most people in South America have not yet felt the effects of the panic sweeping those with investments in the stock markets, big companies or abroad. But the newscasts are frightening everyone, because of the size of the figures being bandied about, and due to memories of previous economic crises.

In Brazil, the value of the local currency, the real, has dropped by 31.6 percent against the dollar since August, and the Sao Paulo Stock Exchange (BOVESPA) has fallen by 20 percent so far this month, and 44.2 percent since the beginning of the year. The day will come, experts say, when these indices will produce inflation, unemployment and the exacerbation of social ills.

The enormous volatility seen in previous crises is being repeated in Brazil. Part of the downturn in the stock market is due to speculation by industrial companies in other markets, particularly the foreign exchange market.

Three large industrial firms posted losses of 4.9 billion reals (2.2 billion dollars) due to betting on the continued overvaluation of the real. It is feared that the solidity of other companies will also be undermined by these damaging transactions.

The Central Bank’s exchange policy was largely responsible for this misadventure, because it supported heavy overvaluation of the local currency, which hurt the competitiveness of Brazilian industries.

In mid-2002, when markets were jittery over the imminent triumph of leftwing presidential candidate Luis Inácio Lula da Silva, the exchange rate stood at nearly four reals to the dollar, but it strengthened to 1.56 per dollar by Aug. 1 of this year. Since then, however, the real has plunged to 2.31 against the dollar.

Such volatility is due to “excessive previous overvaluation,” and to excessively high interest rates set by the Central Bank, which attracted large amounts of speculative capital to the country, former Central Bank director Carlos Thadeu de Freitas told IPS.

The devaluation of the real against the dollar in the last couple of months, a “correction” according to many economists, shores up the competitiveness of local industry, but will drive up inflation, which at an annual 6.25 percent is already high with respect to the target set by the government.

Therefore the Central Bank is expected to continue raising the interest rate, which at present stands at 13.75 percent, one of the highest in the world, and so accentuate the economic slowdown. In spite of this, experts forecast gross domestic product (GDP) growth of three to 3.5 percent in 2009, compared to the five percent projected for this year.

The deepening of the crisis throughout the industrialised world led President Lula finally to recognise that Brazil will suffer from its effects, after initially dismissing its possible impact on the country. Venezuelan President Hugo Chávez, after celebrating the decline of capitalism, has also admitted that “we are not immune.”

Crisis contagion in Latin American countries may occur in a number of ways. Mexico, the Caribbean and Central America are obviously vulnerable because they are highly dependent on the United States, either through trade or through rapidly diminishing remittances sent home by migrants.

Venezuela’s Achilles’ heel is oil. “If the price of crude does not stabilise at around at least 80 dollars a barrel, its foreign exchange inflows will be seriously affected,” economist Pedro Palma, the head of MetroEconómica, a consultancy firm, told IPS.

But it will take longer for the crisis to have an impact on day-to-day life in Venezuela than in other countries, because of the powerful presence of the state in the economy. In the medium term, when the impact occurs, it will be serious, however, because crude exports, worth 44 billion dollars a year, account for 20 percent of GDP.

At that point, scarcity of foreign exchange will force “companies, savers and consumers to buy more expensive black market dollars, which will fuel inflation,” Palma predicted.

Inflation in Venezuela is currently 30 percent a year, the highest in the Americas, and on the black market the dollar costs close to five bolivars, compared to the official exchange rate of 2.15 bolivars.

Venezuela’s difficulties could also spread the effects of the crisis to some 15 countries that receive Venezuelan oil aid, amounting to 200,000 barrels a day at favourable prices. If the crisis reaches the dimensions that have been predicted, “many of the government’s aid and cooperation programmes will fall by the wayside,” warned former Venezuelan energy minister Álvaro Silva.

In Argentina, chain reactions are what most concern local entrepreneurs. This country will be hit hard by potential economic slowdown in Brazil, its main trading partner and fellow member of the Southern Common Market (Mercosur), to which Paraguay and Uruguay also belong and Venezuela is in the process of joining.

A flood of cheaper Brazilian industrial goods, like the ones that have created conflicts in the past, could happen again if the real depreciates more than the Argentine peso.

This would exacerbate the imbalance in bilateral trade, which was already growing. From January to August of this year, Brazil had a trade surplus of 3.57 billion dollars in its trade with Argentina, 40 percent higher than for the same period in 2007.

But “Argentina does not appear to be one of the countries directly affected” by the global financial crisis, since there is no adverse information on its “real economy,” said Mariano Lamothe of abeceb.com, an economic consultancy in Buenos Aires. “Brazil devalued (its currency), but it isn’t going to stop buying from us, nor will it stop growing overnight,” he told IPS.

Lamothe acknowledged that there were “negative expectations and great uncertainty,” with raised interest rates, depreciation of the peso, and more expensive credit that will reduce consumption and exports. However, he said he was convinced that there was “no risk of a run on the banks, nor of the feared flood of imported products.”

He admitted that in the field of theory, this crisis “has contradicted all logic,” and that “financial engineering failed, and economic orthodoxy is not coming up with solutions.” “There is a great deal of confusion,” he concluded.

*With additional reporting by Marcela Valente in Argentina and Humberto Márquez in Venezuela