Even before the COVID-19 pandemic, economists from the World Bank, the IMF and credit rating agencies had warned that many Latin American countries faced difficult fiscal problems after borrowing and debt-to-GDP ratios rose sharply following unusually slow economic growth between 2012 and 2019.
Deteriorating debt and interest burdens Governments are under-equipped to adapt to new shocks. Unless economic growth accelerates significantly, fiscal restraint is justified in almost all countries. Structural reforms of government spending are essential to bring about meaningful and lasting change. and I needed a source of income.
But then the pandemic arrived, and to support the economy and public health, most governments increased spending despite falling revenues, further widening deficits, which in turn led to further borrowing and a rise in the debt burden. The region’s overall deficit widened from 3.8% of GDP in 2019 to 8.3% of GDP in 2020, although one-third of that increase occurred at a time when the region’s GDP contracted by 7%.
Fearing that future access to international capital markets might be jeopardized, most governments in Latin America and the Caribbean cut spending as revenues and GDP recovered, resulting in significantly narrower budget deficits, averaging around 3.5% of GDP, in 2021 and 2022. Forecasts in late 2022 predicted continued fiscal prudence and therefore that budget imbalances would not widen again in 2023-24.
Still, the region’s budget deficits widened again last year to 5.1% of GDP and are unlikely to shrink much this year, except in Argentina, where a shocking austerity experiment is underway. The region’s deterioration was skewed by Brazil, which nearly tripled its budget deficit to 7.9% in 2023. There were also a few exceptions, with Colombia seeing a sharp decline in its deficit and Mexico’s remaining unchanged.
The weak fiscal outlook for this year is raising new concerns among policymakers and financial markets, as governments face slowing revenue growth and rising borrowing costs. The IMF’s credible forecast for Latin American countries is for a total budget deficit of 4.7 percent of GDP, slightly lower than last year, mainly due to expected improvement in Brazil and a possible narrowing of Argentina’s deficit equivalent to 4 percentage points of GDP.
Big country, big challenges
In Argentina, the challenge for the government is to move from emergency spending cuts and deferrals enacted by presidential decree to permanent spending cuts and revenue-raising measures approved by Congress, which are more legitimate and more likely to prove sustainable, as well as improved monetary, capital control and exchange rate policies, and deregulation and other efforts to improve the investment climate.
Brazil’s challenge is to slow government spending growth, as its public debt, equivalent to 86% of GDP, is the most burdensome of any emerging market. Such restraints contradict President Luiz Inacio Lula da Silva’s election pledges to increase welfare spending and expand the role of government. From April to June, financial markets sounded the alarm over the country’s fiscal generosity because it was preventing inflation expectations from converging to the central bank’s 3% target, forcing interest rates to remain higher than usual. Fortunately, Lula softened his stance earlier this month and agreed to some spending cuts, sparking a rally in struggling stocks, bonds and the currency.
Mexico’s next president, Claudia Scheinbaum, faces the unenviable task of fulfilling campaign promises to expand the social security system after her predecessor’s big spending spree in an election year. The budget deficit is expected to reach 6% of GDP in 2024, up from 4.3% in 2023 and the largest deficit since the early 1980s.
Mexico’s government spending is now equivalent to 30% of GDP, up from 25% pre-COVID. Spending on investment projects with low social returns, rising pension and interest payments, and large transfers to the struggling state oil company Pemex are of growing concern. Since 2019, the outgoing administration has provided more than $50 billion to Pemex, the equivalent of almost 4% of average annual GDP. The company’s tax burden has been reduced, and this year the government is due to cover almost the entirety of its large, coming due debt.
Other countries disappoint
There are also fiscal concerns in medium- and small-sized countries. The pace of economic growth is slowing sharply in the Andean countries, falling from 2.1% in 2022 to 0.2% in 2023 in Chile, from 7.3% to 0.6% in Colombia, from 6.2% to 2.3% in Ecuador, and from 2.7% to -0.6% in Peru. This slowdown, mainly due to investment-unfavorable policies and political instability, is weakening governments’ revenue bases and jeopardizing fiscal outcomes. A meaningful turnaround is unlikely this year.
Panama’s relative success from 2000 to 2020 has raised concerns because it is at risk of succumbing to the economic problems that have plagued many other Latin American countries, including fiscal distress. It ran a budget deficit of 3% of GDP last year and authorities plan to cut it further this year, but risks are mainly on the downside: Drought has hurt shipping, and revenues from the Panama Canal and from giant copper mines that were forced to close. In March, Fitch Ratings revoked the Panamanian government’s investment-grade rating, but Moody’s and S&P have so far not followed suit.
Implications
There are two main reasons why fiscal issues have taken centre stage in policymaking and financial circles: this trend is also true for many high-income countries, which now have higher budget deficits and public debt than projected pre-pandemic, due to slower economic growth (and therefore government revenues) and rising domestic and international interest rates (and therefore higher borrowing costs).
Latin America’s annual economic growth averaged 3% between 2006 and 2015, falling to just 0.5% between 2016 and 2019 and experiencing pandemic-related fluctuations between 2020 and 2022. GDP growth in the region is expected to average 2.3% between 2023 and 2025, with government revenue growth correspondingly slower than in 2006-2015. This alone justifies fiscal prudence.
But rising borrowing costs are a factor: they will rise by a few percentage points in almost all regions of the world in 2022-23, before falling slightly this year. Moreover, interest rates in 2025-27 are unlikely to return to the unusually low levels that prevailed before and during the pandemic. Many Latin American governments are likely to have to continue making large payments to finance new deficits, whether in domestic or international markets. In countries such as Brazil and Mexico, where more than a fifth of their debt comes due each year, these high costs are increasingly being locked in for each short-term or long-term debt refinancing.
Policymakers and investors should place increased emphasis on the region’s medium-term fiscal sustainability, especially as sovereign debt trends are unfavorable among Latin American countries, some of which are the slowest growing, most indebted, and most deficit-prone.
The opinions expressed in this article are not necessarily those of American Quarter Or its publisher.
