Already facing sluggish economic growth, the spread of the coronavirus means that Latin America must now confront the additional challenge of pouring resources into its healthcare systems. Given the new reality, Maurício Cárdenas, Colombia’s finance minister from 2012 to 2018 and a longtime specialist in fiscal policy, says now is the time for stimulus.
“Greater fiscal space is needed to accommodate additional health expenditures to contain the spread of Covid-19,” he told AQ.
But those measures “need to be complemented with a reform agenda” to
guarantee regional economies will stay healthy in the medium term,
Cárdenas said. He spoke with AQ this week about the broad
economic challenges facing the region in light of the coronavirus
pandemic. A transcript of the conversation is below, lightly edited for
clarity and length.
Americas Quarterly: What do you expect to be the economic impact from the coronavirus crisis?
Mauricio Cárdenas: There will be a clear reduction of economic output. The extent is very hard to assess, but across the board countries in Latin America will have to revise their growth projections downward for this year.
In Brazil, Latin America’s largest economy, the effects of the shock are already becoming apparent and the Central Bank is forecast to further cut interest rates.
On the supply side, the effect from the reduction of social interactions and travel, quarantines, and on inputs for certain supply chains will be particularly severe for countries that source a lot of their inputs from China, such as Brazil and Mexico.
On the demand side, countries like Mexico, where exports make up 34% of GDP, are very vulnerable. Then there is the shock to Latin American commodities. China accounts for close to 50% of global demand in copper and nickel. So the shock to external demand will be pretty severe. And on the domestic demand side, there is less optimism, and less demand for a number of services including in education and the tourism industry. Caribbean countries are especially prone to this and will suffer job losses.
AQ: Is anyone equipped to handle the economic shock?
Cárdenas: All countries are going to be affected. And countries dealing with another shock, the decrease in oil prices, will be affected the most. Oil production will be significantly larger than oil demand for a while, so Latin America needs to be prepared for much lower oil prices.
There is also a third shock that could arise. Foreign capital flows have been very important for the region, but now capital is going back to gold and dollars in what is called a “flight to quality.” The effects of this shock will depend on how economies manage the first two shocks – the coronavirus and the reduction in oil prices.
AQ: What can countries do to mitigate the shocks from the coronavirus and low oil prices, and prevent capital outflows?
Cárdenas: Latin America doesn’t have too many instruments to respond to the first two shocks. There is not much fiscal space to respond with a large fiscal stimulus. However, the need for additional fiscal expenditure is unavoidable. So how can the region think about fiscal stimulus if in the long-term economic growth is compromised by lower oil prices?
The response has to combine two things. These countries need fiscal stimulus today. They need government expenditure to combat coronavirus. But the only way to accommodate greater fiscal expenditure today is if governments introduce reforms that improve medium-term fiscal sustainability at the same time. This is the right time for governments to spend political capital and introduce legislation that is about pension reform, tax reform and downsizing some areas of the government, depending on the country.
We need to combine the short-term response to increase government
expenditure with a structural reform agenda that is targeted towards
strengthening the fiscal accounts in the near long term. The good news
is that, politically, it’s much harder to enact these reforms in normal
times than it is in stressful times like today. So governments can
benefit from the fact that societies are less divided when there are
crises like this that affect everyone and require immediate action.
AQ: You have outlined the necessity of complementing short term increase in expenditure with medium-term structural reforms. What happens if governments only focus on the short term?
Cárdenas: If the fiscal numbers deteriorate and
there are no future improvements planned, the ratings agencies will
respond with downgrades. The idea is that the short-term fiscal stimulus
has to be combined with measures that calm investors. Because what we
really want to avoid is shock three, the capital outflows. Although
these medium-term reforms are unpopular fiscal measures, they are
necessary. With these two measures together, the ratings agencies will
understand. What they care about is long term fiscal sustainability, not
necessarily this year’s fiscal deficit.
AQ: What role do multilaterals like the IMF have? What can they do to cushion some of these economic shocks?
Cárdenas: The IMF is in a decisive position to articulate this strategy of short-term expenditures and medium-term reforms. If these two responses become the dominant view supported by the IMF, then markets will become more accepting of this reality. The IMF should take the lead on a country-by-country basis to implement this view I’ve outlined. In the specific cases of Ecuador and Argentina, where there are IMF programs in place, the fund must be flexible in its implementation of these programs. In Argentina, the key element is a renegotiation of less strict fiscal targets in the next two years, with the hope that this will improve growth numbers. The IMF must incorporate this new reality of coronavirus and be flexible with their policies.
Rauls is an editorial intern for AQ