The debt trap

No easy answers for LatAm’s debt vs expenditure conundrum.

In few other regions of the world are debt-to-GDP ratios quite as high as they are in Latin America. A toxic cocktail of soaring inflation and disgruntled citizens calling for greater expenditure on public services is making difficult fiscal choices even harder.

This issue is particularly evident in Argentina, as one of the region’s leading macroeconomic specialists explained, “Argentina immediately comes to mind when one thinks about the region’s difficulties of balancing the financing of public debt and the need to finance sound public policies. Buenos Aires has reduced external debt primarily through payments made to the IMF and modest GDP growth but external debt is still around 70% of GDP.”

“Argentina immediately comes to mind when one thinks about the region’s difficulties of balancing the financing of public debt and the need to finance sound public policies.”

Leading macroeconomic specialist, Argentina

Governments across the region are certainly aware of the need to make meaningful reforms in tax and social security – doing so will provide much needed fiscal breathing space – but these decisions are difficult politically. Presidential elections and slow growth across the region this year means that progress will be slow.

In Argentina, the Ministry of Economy is at a crossroads. On the one hand, it must lower public spending to comply with the IMF agreement, by reducing energy and social subsidies, for example. But on the other hand, the now former Minister of Economy had a major confrontation with Vice President Cristina Fernández de Kirchner, who was asking for the minister to be removed. With the appointment of Silvina Batakis as the new Minister of Economy, there is still little hope things will move in the right direction.

Fiscal flexibility would be a good start and administrations have little option to cut back on public spending or at least prioritise those areas where it is more important. From Costa Rica to Argentina, governments across the region have loans with the IMF and are compelled by these agreements to rein in expenditure and costly housing and energy subsidies – doing so, see Argentina, has led tensions and political infighting between fiscal hawks and doves.

A university professor, columnist and former public sector official explained, “Administrations across the region have show little meaningful interest in getting public accounts in order, this is also a deficit of leadership. There is a persistent fear that major reforms cannot be implemented without sacrificing economic growth.”

“Administrations across the region have show little meaningful interest in getting public accounts in order, this is also a deficit of leadership.”

University professor, Colombia

The challenge is that if a government begins to overspend and begins to put much more cash in circulation at a time of high inflation, like now, what is going to end up happening is that the Central Bank is going to have to raise interest rates.

Economic growth is paramount right now given inflation and soaring unemployment rates. Tax revenues will increase as employment levels improve but governments need to tighten up tax collection systems at the same time. Investors and rating agencies alike will be keeping a keen eye on such reforms.

Across much of the region, the key challenge lies in reining in inflation – doing so will make it easier to balance the books. To this end, interest rates have been raised by central banks throughout much of Latin America, and where central banks have been less inclined to follow this path, it has exerted a negative impact on the productive capacity of the economy.

“When considering inflation we must also think about economic growth, the presence of oil and the ability to pass reforms to increase revenue,” explained a former economic adviser to the government of Colombia, “it’s not just about interest rates.”

With this in mind, it is important to remember that each country is different: the political landscape is different, the relationship between the executive and legislative branches is different, etc. This local complexity is truly critical and investors must get a handle on it. The macroeconomic specialist concludes, “There are no broad concepts or generalisations that work in Latin American: a country like Panama is totally different from a country like Ecuador or a country like Colombia. They are very different countries that are going through very different times. President Lasso is very different from a Gustavo Petro.”

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