The COVID-19 pandemic has ravaged Latin America and the Caribbean, causing a heavy human toll and inflicting massive economic damages. Although most countries implemented early and strict containment measures, the region has become an epicenter of the pandemic and now has one of the world’s highest per capita mortality rates. The health crisis has been accompanied by an economic downturn of historic proportions, which followed several years of disappointing growth. Real GDP is estimated to have declined by 8% in 2020 as prolonged national lockdowns, weaker merchandise exports and a collapse in tourism undermined economic activities.
Amid a drastic contraction in employment, an estimated 45 million people in the region have been pushed into poverty, wiping out all progress made over the past 15 years (United Nations Economic Commission for Latin America and the Caribbean -ECLAC-). Additionally, the crisis has been responsible for further setbacks to achievement of the sustainable development goals by exacerbating deep-rooted structural inequalities, for example, between formal and informal workers and gender. Despite severe fiscal constraints, many of the region’s governments have adopted substantial stimulus packages in response to the pandemic. This support, along with monetary easing, a gradual lifting of restrictions and a pickup in global economic activity, has prompted a modest recovery starting in the second half of 2020. Regional growth is forecast at 3.8% in 2021, before easing again to 2.6% in 2022, while aggregate output is expected to reach its pre-crisis level only by the end of 2023. The recovery will likely remain fragile and uneven, with outlook risks tilted towards the downside. Indeed, a resurgence of infection rates could lead to a renewed tightening of containment measures. At the same time, several countries in the region face significant political risks and the possibility of a debt crisis. The pandemic disrupted economic activities in Latin America and the Caribbean at a time when many countries were already engaged in a struggle against severe economic difficulties. Stagnant growth, weak investment and limited macroeconomic policy space made the region highly vulnerable to a global shock. National lockdowns and movement restrictions have led to massive employment and income losses, aggravating long-standing disparities. According to estimates of ECLAC and the International Labor Organization (ILO), 47 million workers in Latin America and the Caribbean lost their jobs in the first half of 2020. Working hours dropped by about 21% during the first nine months, while labor income fell by 19%, also according to ILO. Job losses have been particularly severe in the informal sector, where most occupations are contact-intensive; and women, young people and workers with low education, who make up the bulk of employment in sectors such as retail and hospitality, were disproportionately affected. Countries where informal work is widespread and where governments implemented stringent and lengthy lockdowns have experienced the largest employment shocks.
In Peru, for example, the employment rate declined by a staggering 38% in the second quarter of 2020, as the country experienced one of the region’s largest output contractions. The job and income losses have caused sharp declines in household spending, with private consumption expenditure estimated to have contracted by about 9% at the regional level in 2020. As movement restrictions are gradually easing, labor markets have started to improve and this trend is expected to continue in 2021. Amid falling consumer demand, temporary business closures and heightened uncertainties, firms have rolled back planned investment. Gross fixed capital formation declined by an estimated 13 per cent in 2020, dwarfing the drop experienced in 2009. According to estimates of the United Nations Conference on Trade and Development (UNCTAD), foreign direct investment flows to the region may have fallen by up to 50%, with the travel and leisure and oil sectors recording the largest losses. While investment bounced back quickly following the global financial crisis, a fast recovery seems unlikely this time around. Uncertainties over the regional and global outlook, coupled with lingering effects of the crisis such as elevated unemployment and increased fiscal pressures, are expected to weigh on capital spending over the coming year. According to the baseline projections, gross fixed capital formation in the region will increase by about 7% in 2021 and by only 3% in 2022. The domestic shock from the undermining of economic activities has been compounded by a rapidly deteriorating external environment as the global economy fell into recession. Many of the region’s economies are highly dependent on external inflows, most notably from commodity exports, personal remittances and tourism.
Merchandise exports and commodity prices plummeted in the first half of 2020 but have since been recovering, which can be attributed mostly to a strong rebound in industrial activity and import demand from China. During the first eight months of 2020, the level of exports of Latin America and the Caribbean was about 6% lower than one year ago. Unlike oil prices, which remain well below the pre-pandemic level, prices of metals and agricultural commodities have recouped their losses. Further moderate gains are expected for 2021, which should support the recovery in major commodity exporters. Brazil, Chile and Peru appear to be best positioned to gain from a continued rebound in China. Remittance flows to the region have also pulled back from the lows during the second quarter and are likely to be at a level for the year similar to that in 2019, which has helped to mitigate the shock experienced by remittance-dependent Central American countries. Tourism flows, by contrast, have remained at a standstill, leading to sharp contractions in economic activities in Caribbean countries; but given a gradual improvement in international tourism flows in the coming years, most Caribbean countries should expect a recovery from a low base. Across the region, Governments have responded forcefully to limit the socioeconomic fallout from the crisis, preserve financial stability and boost recovery. Central banks have eased monetary policy and provided liquidity to the financial system; and in many countries, policy rates have been cut to record low levels. These measures have supported credit flows to the private sector, reduced market stress and contributed to a general improvement in financial conditions. After a spike in risk aversion triggered massive capital outflows from the region in early 2020, the situation improved in the subsequent quarters. However, given considerable global uncertainties and the subdued outlook for Latin America and the Caribbean, capital flows will likely have a rocky period ahead. In view of subdued inflationary pressures-mainly due to the persistence of economic slack-monetary policy is set to remain extraordinarily accommodative in the coming years. Large-scale fiscal policy stimulus has been critical in strengthening health-care systems and providing lifelines to firms and households. Although many countries entered the pandemic with sizeable fiscal deficits and high public debt levels, Governments deployed considerable resources to combat the economic shock. Brazil, Chile and Peru introduced the largest packages in the region in terms of direct support through additional expenditure and forgone revenue. The total fiscal stimulus packages in these three countries, including loans, equity injections and government guarantees, are estimated to have amounted to 10–15% of GDP.
In this regard, Brazil’s fiscal response stands out, as it provided sizeable support for households and workers, which helped boost the country’s recovery during the second half of 2020. By contrast, Mexico’s fiscal response has been relatively timid, as the Government focused on public finance sustainability even as economic activity collapsed; and in many Caribbean economies, government responses were constrained by a lack of fiscal space. Going forward, Governments must balance the need for further fiscal support to buttress a fragile recovery against increased pressure for fiscal consolidation. Although Latin America and the Caribbean is projected to see a moderate recovery in 2021 and 2022, the danger of another lost decade-in terms of both economic growth and development progress-is looming large. Judging by the experience of previous crises, there are likely to be significant long-term damages to potential output. Prolonged school closures, challenges associated with remote learning activities and persistently high unemployment are expected to have a negative effect on human capital accumulation. This could exacerbate skills shortages, which have been a severe constraint in many countries. In addition, corporate and public investment will likely be hampered by heightened uncertainties, sluggish household demand and needs for fiscal consolidation, which could, in turn, further stifle innovation and productivity growth. In this context, an increasingly fragmented and uncertain global trade environment could generate external headwinds to exports and growth. Against this challenging backdrop, ECLAC has called for a new development model which centers on a radical transformation of production and consumption patterns, with investment redirected towards productivity, environmental stewardship, employment and social inclusion.
In light of the current situation, how would that translate to investors interested in this region? Latin America has been hit very hard by the Covid crisis. As long as the Federal reserve does not raise interest rates, good opportunities are still present, especially in commodity rich countries such as Mexico and Peru. The fixed income market was hard hit in 2020 but the worst is, most likely to be over as industries recover and default probabilities decline.
As per the equity markets, the region was also a big underperformer, but for investors with a risk appetite, Latin America is the areas to look for good opportunities, with the constructions sector being a good candidate for a strong recovery.
That said, we very well know that Latin America is always the world’s sleeping giant, and it might never really wake up.
Marcello Tedeschi, July 13, 2021
