The U.S. Financial Crisis Affects Latin America: The Colombian Context

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The world economy is facing a strong recession due to the explosion of the financial crisis in the U.S. market, which was not widely anticipated. Global growth is expected to stay close to zero for months, as happened during the 2001 world recession. The economies of the United States, Western Europe, and Japan are most likely going to experience economic contractions in the near future. However, it will be much more difficult for less developed countries such as those in Latin America to come through this global economic breakdown.

Latin America’s banking systems may be strong enough to weather the storm because many have not invested significantly in the U.S. market, and their domestic financial markets are not as developed as those of other Western countries. However, restrictions on credit may prove to be the most immediate risk for the region. In addition, the fact that the region’s financial markets are small to begin with suggests a significant reduction in domestic investment can be anticipated for next year.

Latin American countries have reacted differently to the current world financial crisis, with some calling for support from developed nations and others taking active measures to protect their financial standards against repercussions of the crisis. It is interesting to note that Latin American leaders have in few days gone from preoccupation with the phenomenon happening elsewhere in the world to abject fear. Despite strong economic growth this decade and aggressive efforts on the part of some Latin American nations to disconnect from the U.S. economic sphere of influence, in order to immunize their institutions from a contraction. There is a growing nervousness that once again Latin America cannot escape the consequences of the globalized financial connections that run through the United States.

It is becoming clear that in Colombia the crisis is starting to affect the investment climate, and will do so in a major way, especially now that the U.S. banks have announced that they will restrict loans in emerging economies. The Colombian government issued measures to ensure the country’s banks can survive, and have taken measures to protect their foreign currency system from facing a collapse. The Finance Ministry announced the creation of a special credit option at Colombia’s Bank of Foreign Trade, in an attempt to encourage loans, most of which come from abroad.

The Colombian government also has prepared a comprehensive plan to deal with the financial crisis, declaring that the economy of the country will be strong enough to reduce the risk of recession. President Álvaro Uribe announced that the plan will primarily seek to secure the financial resources needed by the State, to maintain the level of foreign investment that has been very important for economic growth, thus preventing a deterioration of the local market. The government will also approach the global banks to fund projects for the coming three years and will try to strengthen economic ties with Arab and Asian markets that have not been affected by the crisis as much as the United States and Europe. But is this a real plan rather than whimsical posturing? It must be taken into account that every other Latin America economies will be looking towards the same sources of relief, which cannot possibly secure all of their economies.

In the end, it is now clear that the stagnation of growth in the G7 countries and sharp deceleration in emerging Asia will have a negative impact on Latin American growth. In particular, growth in the region inexorably will decline from 5.6% in 2007 to 4.7% in 2008 and to between 2.8% and 3.8% in 2009. This deceleration will occur from a relatively high regional growth trend achieved in recent years.

However, Latin America has remained relatively stable during the credit crisis that has affected the U.S. financial system. Despite rising fears and forecasts predicting an economic slowdown in the region, most Latin American economies have shown resilience amid the U.S. market convulsions. There are warning signs, of course. Inflation is creeping up, energy and commodity prices have descended from the stratospheric highs of earlier this year, and increasing imports are menacing exports, threatening current account surpluses. Poverty, unemployment and underemployment also remain
persistently high.

Many factors have helped Latin America and Caribbean countries weather the storm, at least so far. Stronger economies fortified by government spending, heftier foreign reserves, record exports and steady consumer spending all mean the region is less dependent on global financing than in the past.

Since Eastern Europe and Asia have been the favoured destinations of global foreign investment in recent years, hot money did not pour into Latin America and therefore was not suddenly withdrawn when the market panic overtook financial markets to the North. The region also is less economically dependent on the United States, which is currently more linked with other areas of the world. Latin America’s exports to the United States, for example, have dropped from 57 percent of the region’s total exports in 2000 to 40 percent in 2007. Trade with Asia now counts for almost 10 percent of the region’s foreign sales, compared with 4 percent in 2000. Still, the region is not immune from the strains on its financial markets as stocks plummet, borrowing costs rise and foreign reserves drop as governments try to shore up their currencies.

The situation in Colombia is in line with the majority of the other Latin America nations. Foreign capital restrictions already have been lifted on local bonds to defend financing for the next three years. Colombia is an exporter of oil, coffee, nickel and coal, and earlier this year has imposed restrictions such as a special deposit requirement on portfolio capital to curb the soaring peso currency. However, it lifted restrictions on equity investments in September. Bogota expects economic growth of around 4% this year after its economy soared more than 7% last year. President Uribe wants the central bank to lower interest rates to foster economic growth, but most of the banks’ boards have resisted. Furthermore, endemic corruption within Colombia’s political and financial world is almost in proportion with the U.S.

Countries that are tightly linked to the U.S. economy such as Mexico and Central American countries, will be more negatively affected than those that are more diversified. Nations that are relatively more linked to other regions, like Argentina, Peru, and Brazil, will see a delayed impact, as long as China’s growth remains robust. Moreover, the ability of Latin American countries to regain a high growth trend after this global crisis runs its course may prove surprisingly easy to achieve. The countries that are likely to perform better will be those that have in the past years managed to reduce macro-financial vulnerabilities, increase investment rates, diversify export markets, and restore productivity growth. In this scenario, Colombia faces good prospects.