In 2015, Latin America’s dominant extractive industries will have to deal with lower prices and lower international demand. But with political and economic challenges building, many governments may find themselves unable to fix matters while assailed on all fronts.
The first quarter of 2015 will most likely be less than optimal for many Latin American markets because of various interconnected negative externalities such as the slowdown of the Chinese economy, a contracting primary sector, proliferation of social unrest, and surge of the U.S. dollar.
The economic success of the region for the remainder of 2015 depends on how governments react to these externalities. For now, the international financial community and Latin American governments are treating the coming year with cautious optimism.
On December 5th, IMF President Christine Lagarde met with political leaders in Santiago to discuss long term economic expectations for the region. Lagarde mentioned that much has been achieved in the post-2008 crisis years, but also tacitly warned that the economic well-being of Latin America was contingent on “quality growth”.
In the context of Latin America, quality growth can be interpreted as a diversified economic system not dependent on commodity exports. Unfortunately, it has not yet arrived in Latin America. During the past decade, the region’s governments have managed positive account balances mainly because of high commodity prices.
But with no economic restructuring, Latin American economies in 2015 will remain dependent on the global demand for its commodities, namely oil, copper, iron, gold, natural gas, and to a lesser extent agricultural products.
With this said, Lagarde’s warning comes at an opportune time—prices of dominant commodities dipped in 2014 and there is fear that they will continue dipping in 2015 because of lower demand triggered by slower growth from the Chinese construction sector, a fragile Eurozone, and unstable emerging markets.
Mexico, which relies on oil exports for one third of its budget, will have to make fiscal adjustments in 2015 if the price of oil does not climb above 80 dollars a barrel.
The same stands for Venezuela, whose national budget derives almost entirely from oil exports. Colombia is also feeling the effects of cheap oil—its national oil company, ECOPETROL (NYSE: EC), has lost more than half its value in the past three months.
Copper, the main commodity in Chile and Peru, has fallen to multi-year lows in the second half of 2014. Peruvian President Ollanta Humala and Chilean President Michelle Bachelet have taken different approaches to lower government revenues from commodity exports—Humala has traveled extensively to seek foreign investment, while Bachelet has faced the sobering economic truth and acknowledged that 2015 might not be a high growth year for the Chilean economy.
Although gold has made a slight comeback the past month and leveled off at 1,220 an ounce, prices are still far below 2011 prices, which hovered at 1,795 an ounce.
Additionally, rapidly depreciating currencies indicate that markets across the region are already losing investor confidence. The Mexican Peso has reached a 6-year low, while the Colombian Peso has depreciated more than 20% against the greenback. Every currency in the region has depreciated markedly against the dollar, except the pegged Bolivian Boliviano (El Salvador, Panama, and Ecuador use the dollar).
In theory, this region-wide currency depreciation should be good news for export-oriented sectors. However, with lower world prices for the aforementioned commodities extractive industries are not able to take advantage of the favorable terms.
Coupled with unpredictable currency fluctuations, investors are opting for more stable markets, such as the U.S. A strong dollar and the possibility of the Fed increasing interest rates is also driving capital away from markets such as Mexico or Colombia.
To make matters worse, governments in the region are coping with mass protests and social instability, which may lead political parties to place economic growth in the back-burner. President Bachelet’s approval rating has decreased during the past months to 42%, over the government’s slow response to education reform. President Santos in Colombia is also hurting from a weak approval rating, despite being elected this same year.
In Mexico, President Peña Nieto only attends international functions and has avoided facing the nation over the disappearances of 43 students. Protests have grown by the day and have held Mexico’s capital at a standstill for weeks. Not surprisingly, the timing of the protests correlates with the Peso’s slide.
The popularity of Venezuelan President Nicolas Maduro has dropped to 30% for his inability to bring macroeconomic reforms and manage a Venezuelan economic recovery.
Coincidentally, legislative elections will take place in Mexico and Venezuela, the most vulnerable economies at the moment. Considering Mr. Peña Nieto’s fall from grace, the ruling PRI party is not expected to win a majority of seats in each legislative chamber, but neither is the leftist PRD or right leaning PAN. The most likely outcome will be a governing coalition between the PRI and smaller parties.
In Venezuela, the socialist ruling party (PSUV) could take a bigger hit, and there is a possibility it could lose a majority of seats if the situation continues deteriorating. The elections, however, have not been scheduled—they are usually scheduled at the most convenient time for the ruling party.
Although 2015 is likely to be a sour year for Latin American markets, governments should see the state of the global economy as an opportunity. Emerging markets in all regions are expected to face tough times ahead because of the anticipated resurgence of the U.S. economy.
This so-called resurgence, however, has not yet materialized and the American economy is far from booming—there is still a degree of uncertainty about the path that the U.S. economy will take the coming year.
With the Eurozone yet to show robust growth and most of Asia cooling off, this global scenario, paired with lower commodity prices, poses an opportunity for Latin American governments going into 2015 to restructure and follow Lagarde’s advice about quality, diversified growth.
