Janet Yellen, nominated by President Obama last week to be the new chairwoman of the U.S. Federal Reserve, might not know it yet, but she has friends in high places in Latin America.
This is because many in the region rightly believe that Yellen’s forecasted doveishness will give Latin America time to make the necessary adjustments while U.S. monetary tightening slowly winds its way through global markets.
Even in Brazil, where there aren’t many kind words being said about the U.S. these days, Central Bank Governor Alexandre Tombini has been buttering up markets with measured comments about the Fed’s tightening policy.
But Latin America is watching the aftermath of this appointment closely because there is an ominous feeling that, despite the region’s growing monetary autonomy, tightening U.S. policy will have important consequences for the region—such as creating more expensive imports, pricier debt payments, and higher local interest rates.
Past crises in the region have happened around moments of decisive Fed action—think 1982 and the 1994 Tequila Crisis, without even mentioning the trail of broken exchange rate pegs. But what is remarkable about the last few years is the contrast between Latin American governments having their economic houses in relative order and the chaotic, then sclerotic macro-environment amongst the world’s wealthiest countries.
This is a much different reality than Argentina in 2001 or Mexico in 1994. Only ten or twenty years ago, sovereign, dollar-denominated debt would have been the biggest part of any Fed monetary tightening problem, followed by fixed currency values. These days, after remarkable growth and a decade of responsible policy, much of the region can keep a full-blown crisis at bay. Instead, Latin Americans can now expect mild recessions, hampered growth, and a reckoning for low levels of invested in the good times.
Loose policy in the U.S. and elsewhere over the past few years has given Latin America a relatively favorable environment to conduct its own responsible monetary policy. At the same time that money was cheap in the U.S. and Europe, the relative high returns in Latin America drove capital their way, which provided a boon to economies in a strong phase of growth. China was still growing quickly and South American commodities were fueling that growth. But that new Latin American normal has evaporated relatively quickly with the specter of a developed world recovery and monetary tightening.
Officials from Lima to Brasilia are worried that a fast taper could create an important macroeconomic crunch for much of Latin America at a fragile time for many of the region’s economies.
Nobody is more worried than the Brazilians.
Brazil in particular has experienced enormous demand from inward capital flows given the important mismatch of global rates to local rates. Over time, the real appreciated and these returns became less favorable. Rates also went down over time, and the Sistema Especial de Liquidação e de Custódia (Base Interest Rate—SELIC) was almost halved over the last several years.
This has been a double-edged sword though. It made the once-nonexistent corporate lending markets more competitive and eased the inflow of hot money the country witnessed in the immediate aftermath of the financial crisis.
The appreciation of the real also made imports cheaper. But now faced with depreciation, the country’s reliance on consumption vis-à-vis cheap imports combined with the debt hangover of the country’s new consumer class, are a ticking time bomb. This could have major consequences on continued growth and inflation, which have both deteriorated very quickly in a short period of time. Specifically, uncompetitive industries have suffered alongside productivity gaps and the high exchange rate, causing industrial production to shrink.
Peru is a distant second worry. The country has a high amount of dollar-denominated debt, both consumer- and corporate-based. In the case of a strengthening dollar, even with the banner growth numbers seen over the past several years, markets could see a credit crunch and an increasing number of consumer and corporate defaults.
The only country in the region sitting pretty in the midst of all the uncertainty is Mexico. And, in a way, the country is in a win-win position. More aggressive monetary tightening would put downward pressure on the value of the peso, facilitating exports at a time when major sectors are becoming competitive against Asia, all while keeping the country’s lending rate far below Brazil’s. It would also coincide with greater U.S. economic activity, which is always a boon across the Rio Grande.
In a dovish environment, Mexico still has the benefit of American growth and an attractive rate environment for international capital.
Simply put, this is an important juncture for the entire region. It is one where structural weaknesses will come to light more quickly, and the relative autonomy that each country has enjoyed in its monetary policy will be challenged. No doubt that once Janet Yellen’s appointment is confirmed, there will be a lot of kind words for both her and the Latin America-friendly policies she is likely to deliver.