Fitch: China and Commodities Test Latin American Sovereigns

NEW YORK

Slower Chinese growth and weaker commodity prices will add to the challenges facing Latin America’s commodity exporters and test their external and fiscal buffers, Fitch Ratings says. Each sovereign’s credit impact will be a function of the size of these buffers and the effectiveness of authorities’ policy responses.

We forecast Chinese real GDP growth to slow to 6.8% this year from 7.4% last year. Chile (‘A+’/Stable), Uruguay (‘BBB-‘/Stable), Peru (‘BBB+’/Stable), Venezuela (‘CCC’) and Brazil (‘BBB’/Negative) have the largest direct export exposure to China, but export volumes in these countries have mostly been stable or only declined moderately. Slower Chinese growth is being felt mostly through its contribution to lower commodity prices and weaker confidence. This has had a negative effect on investment, both in commodities sectors and more broadly by reducing confidence and weakening local currencies (making capital imports more expensive). Foreign direct investment inflows and fixed capital formation have shrunk in several of Latin America’s commodity-dependent economies in 2015. Energy importers like Chile and Uruguay have seen the impact somewhat offset by the decline in oil prices.

As China rebalances, private consumption will emerge as a more important driver of growth. This could be more supportive for agricultural exporters (e.g. Argentina, Paraguay and Uruguay) relative to metals exporters.

Chile and Peru are the region’s economies most exposed to a China slowdown (directly through trade and indirectly through its impact on copper prices), but they are also the best prepared. In the past decade, they have built policy buffers to weather a commodity downturn, including low public debt and fiscal rainy day funds. Peru’s proposed 2016 budget targets a 15% increase in public investment. Chile’s 2015 budget included a capital spending-based stimulus, although this is unlikely to be repeated in 2016 to preserve fiscal buffers.

Click here to view chart showing Latin American countries’ export exposure to China by type.
https://www.fitchratings.com/web_content/images/fw/fw-chart-20150918.htm

Higher debt, low fiscal savings and widening fiscal deficits in Brazil, Colombia (‘BBB’/Stable) and Uruguay limit the scope for their governments to support growth via stimulus packages to offset their varying commodity dependence and direct exposure to China.

All of the investment-grade economies benefit from strengthened external buffers thanks to their large international reserve holdings and flexible exchange rates. Considerable currency depreciation is containing external imbalances, primarily by reducing imports, but has yet to boost non-commodity exports, suggesting underlying competitiveness issues and similar depreciations throughout emerging markets could hinder takeoff of manufacturing and diversification in the near term. Rising inflation has narrowed the scope for maintaining accommodative monetary policy in these countries. Especially high inflation in Brazil and Uruguay has led central banks to adopt tight monetary policy stances, which could weigh further on growth.

Venezuela and Argentina (‘RD’) have the least scope for counter-cyclical policies to mitigate lower commodities prices, lacking flexible exchange rates, fiscal buffers and financing flexibility. Bilateral loans from China have been particularly important for Venezuela and Ecuador (‘B’/Stable). These have remained forthcoming in 2015, preventing more drastic fiscal adjustments to lower oil prices. Chinese lending to Latin America totaled approximately USD90bn from 2010-2014, according to Inter-American Dialogue, more than reported disbursements from the World Bank and Inter-American Development Bank.

China’s slowdown has different implications for the region’s less commodity-dependent economies. While lower oil prices will hurt Mexico’s (‘BBB+/Stable’) fiscal income, the broader impact on the economy is likely to be more moderate as a weaker peso, a U.S. recovery and some structural reforms should boost prospects for manufacturing. For the energy-dependent economies of Central America and the Caribbean, cheaper oil can have a beneficial impact, supporting growth, reducing current account deficits and, in some cases, lowering energy subsidy costs.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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