Like most of the world, Latin America felt the economic fallout from Covid-19 most acutely in the second quarter of 2020: GDP contracted by 15.5% year on year in Colombia, 13.7% in Chile and over 30% in Peru. While economic activity has since rebounded to some extent, Peru is still expected to suffer a double-digit decline in economic activity for the year as a whole, and Chile and Colombia are likely to see milder contractions of around 6% and 8%, respectively.
Covid is not the only culprit
The challenges created by the pandemic are not solely to blame for the massive economic disruption to the region – a crash in commodity prices added fuel to the fire. First, oil prices sank to historic lows on the back of weaker Chinese demand and supply issues in the OPEC+ group of countries – severely impacting the finances of oil-producing nations across Latin America. Second, the price of copper plummeted as metals took a virus hit. As the world’s leading producers of copper, Chile and Peru have keenly felt the economic pain of this slump in demand.
Governments around the world have, of course, rolled out unprecedented fiscal packages running to trillions of dollars to shore up economies hard hit by the corona crisis. However, there is a mixed picture across Latin America in terms of the level of monetary and fiscal support provided in individual nations – reflecting a combination of budget constraints and domestic market conditions: Only those countries with low inflation and a strong currency market have the capacity to cut interest rates – and only those with adequate fiscal flexibility have been able to deploy expansive fiscal policies. If we turn the spotlight on the three Andean nations of Colombia, Chile and Peru, some interesting patterns emerge.
Central banks to the rescue
Colombia’s central bank responded swiftly to the pandemic – slashing interest rates and supplying liquidity and credit facilities to businesses in a bid to shore up the economy. In fact, from March to October 2020, the central bank cut interest rates no fewer than seven times. Interestingly, in March, Colombia also became the first Latin American country to resort to quantitative easing (QE) – purchasing billions of dollars of government bonds and demonstrating that this tool can be deployed by emerging markets too.
Meanwhile, Chile – which began 2020 with the lowest interest rates in the region at 1.75% – announced two further rate cuts in the spring following the Covid-19 outbreak. In June, with rates already close to zero and little room for manoeuvre, Chile’s central bank then decided to follow Colombia’s example and announced the launch of a QE program of up to USD 8 billion.
In Peru, inflation was already below 2% at the start of the pandemic following two sets of interest rate cuts in 2019. This allowed the country’s central bank to move quickly – providing the necessary economic stimulus by pushing through two further rate cuts in March and April. The central bank also reduced reserve requirements for the country’s commercial banks and offered new liquidity and guarantee facilities to bolster the corporate sector.
Focus on fiscal stimulus
That sets the scene in term of monetary policy – but what about fiscal measures? Peru is arguably one of the countries to have offered the greatest fiscal support, unveiling a package worth more than 15% of GDP according to the IMF. The fiscal packages in Chile and Colombia account for 10.7% and 5.3% of GDP, respectively. Interestingly, Peru and Chile already had relatively low financing costs and debt-to-GDP ratios of 27% and 28%, respectively, at the start of 2020 – creating scope for both governments to increase debt without threatening long-term stability. Their debt-to-GDP ratios are expected to reach 40% and 33%, respectively, by end-2020.
In stark contrast, the limited fiscal support offered by Colombia’s government reflects the worsening economic conditions in the country in recent years, with a debt-to-GDP ratio that had escalated to 50% even before pandemic struck. Add to this a sharp drop in government revenues due to the corona-induced economic downturn and the collapse in oil prices and we can see why the government’s hands were tied.
A glimmer of hope?
As the end of 2020 approaches, there finally appears to be some light on the horizon: All three Andean nations are expected to see a further recovery in GDP in 2021, driven in part by a rebound in commodity prices that will give a much-needed boost to exports. According to IMF estimates, GDP growth is likely to reach 4% in Colombia, 4.5% in Chile and 7% in Peru next year – surpassing the 3.3% average predicted for Latin America as a whole.
In a region severely hit by Covid-19, Andean economies thus appear comparatively well positioned to benefit from a cyclical rebound in the near future – giving reason for hope. At the same time, however, it is impossible to overlook the significant challenges that lie ahead for these three countries. In particular, the measures that they have taken to mitigate the effects of the pandemic come at a high cost – in the form of larger fiscal deficits and higher debt levels. The spectre of future pension shortfalls also looms large – exacerbated by the substantial withdrawals from private pension funds permitted by Peru and Chile during the crisis, which could have severe consequences for the population in the medium to longer term. The road to full recovery may be long.
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