Latin America has historically been characterized by constant political, economic and social shifts. The turn of the Century signaled a rise in left leaning governments dubbed the ‘pink tide’, but it appears this pivot towards 21st Century Socialism has reached a stop and is, in fact, showing signs of reversal. For example, center-right governments with business-friendly and open macroeconomic policies have been elected in Argentina and Peru. This volatile nature leaves the region vulnerable to external agitations in the global financial environment, the last of them being the United Kingdom’s decision to leave the European Union.
Overall, regime changes in Latin America have coincided with major economic stress. Namely, the end of the commodity super cycle, especially the drastic drop in oil prices, has led to anemic growth and pessimistic output predictions for 2016 and 2017. Beyond economic effects, current political shifts leave most of the region vulnerable to additional financial pressures.
The Brexit vote on June 24 strained the economic capabilities of many faltering countries in Latin America. The results exhibited the triumph of nationalistic sentiment in the UK as 52% of voters preferred to leave the EU. In an increasingly interconnected world however, the consequences of this vote were felt immediately across global markets. The pound sterling dropped, global stock markets fell, and the recovery in commodity prices halted abruptly. Latin America is not immune to the UK’s decision, which will impact the region’s economic future in several ways.
Short-term effects
The eventual separation between the UK and the EU trade bloc will affect economic relations between Latin American countries and Europe. Pre-existing trade negotiations and treaties with the UK will have to be revised and re-negotiated. This process can possibly take up to two years and, as Colombian President Juan Manuel Santos stated in an interview with Bloomberg News, will be quite a ‘headache’ for Latin American leaders.
Currently, 19 percent of Costa Rica’s exports go to the EU. The same goes for 17 percent of Colombia’s, 16 percent of both Brazil and Peru’s, and 14 percent of Argentina and Ecuador’s. These percentages will decrease as trade flows between the EU and Latin America drop. Thus, export revenues in most Latin American countries will decrease until new trade agreements with the UK are consolidated.
Aside from the bureaucratic costs of re-negotiating trade accords with the UK and the temporary dip in trade flows with the EU, financial shock effects of the Brexit vote have already incurred costs for Latin America. Sentiment-driven shifts in currency and commodity prices represent the biggest threats to regional economies in the short term.
Latin American markets will continue to experience currency volatility as a response to instability, and central banks will need to determine the appropriate intervention to stabilize financial and currency markets. In the aftermath of the Brexit vote, the Mexican peso, which is a preferred emerging-market currency because of its stability, has become the world’s second-worst performer after the British pound. This highlights the important ripple effects of the Brexit on Latin American currency markets.
Capital flight to safety will appreciate the dollar beyond expectations from future interest rate hikes by the Fed. This weakens the competitiveness in exports of dollarized economies such as El Salvador, Panama, or Ecuador. Also, the dollar’s appreciation will worsen the situation for countries with large debt in dollars like Brazil. Moreover, countries with hard pegs to the dollar throughout the region will also be strained.
Commodity prices will be affected as well, which implies heightened instability for commodity exporting countries such as Mexico, Colombia, Ecuador, Venezuela, and Brazil. The end of the commodity super cycle has been one of the main drivers for recent feeble growth in the region, and the Brexit vote will only worsen this situation.
According to a recent Inter-American Development Bank investigation, Bolivia depends on commodities for 97 percent of its export income, Venezuela for 96, Ecuador for 94, Peru for 87, Chile for 88, Colombia for 83, Argentina for 69 and Brazil for 67 percent. These countries will suffer the most from the slowdown in commodity price recovery. Countries that have commodity-backed debt in oil, mining, or gas future contracts will have an even harder time dealing with the fall in commodity prices.
Long-term effects
The short-term effects of the Brexit vote will reach every country in Latin America. However, long-term outcomes of the vote will depend on the regulatory capabilities and financial stability of each country. The EU is Latin America’s top source of foreign investment, representing a third of FDI in the region. As investing capital tends to look for safe havens during volatile periods, the instability created by the Brexit will result in reduced foreign investment in Latin America as a whole.
The Brexit vote has fueled anxiety among investors. A weakening pound and slower growth in Europe will also add to the drop in total foreign investment. This systematic uncertainty could create a capital flight to low-risk economies. Consequently, investors will increasingly avoid investing in high-risk assets, such as Argentinian and Ecuadorian government bonds, without asking for higher returns. At the same time, countries with steady markets and fiscal systems, such as Chile, will receive a bigger piece of the investment pie.
Political stability will play a key role in attracting foreign capital despite uncertainty. For instance, recent elections in Peru strengthened expectations for an increase in FDI through lower regulation, which propped up the Nuevo Sol and protected it against negative fluctuations from the Brexit. On the other hand, Venezuela’s ongoing political crisis and the likelihood of default on the country’s $65 billion debt with China point to a steep increase in capital flight after the Brexit Vote.
The UK´s departure from the EU will also affect the economic relationship between China and Latin America. As described in The Economist, “A weaker European economy will certainly hurt Chinese exports (…) as Europe’s currencies weaken, [this] might put renewed downward pressure on the yuan”. This would strengthen the deceleration of the Chinese economy, plus incentive further yuan depreciation, therefore decreasing the aggregate Latin American trade balance.
Conclusion
In whole, significant changes in international politics such as the Brexit vote bolster volatility and uncertainty. This hits unstable regions the hardest. The important economic and political shifts that Latin America is undergoing at present make the Brexit vote’s timing problematic for its already-faltering countries. Pre-existing differences within the region will be further accentuated by the short-term uncertainty. Investors will rush to countries with solid institutions and clear economic norms that provide much-needed confidence.
Regional growth pockets such as Chile, Peru, and Panama will stand with greater ease throughout the negative shock. On the other hand, countries with ample current account deficits will remain vulnerable to external shocks from the Brexit vote. Economies with large deficits such as Colombia, Mexico, or Venezuela will feel a stronger impact in their currencies while risking capital outflows. Should protracted and messy Brexit negotiations prolong uncertainty, a further fall in investor confidence will prevent the stabilization of the region’s weakest economies by impacting the foreign exchange, commodities, and equity markets.