Latin America Advisor

A Daily Publication of The Dialogue

How Does the Yuan’s Fall Affect Latin America?

China allowed its currency to fall more than 4 percent against the U.S. dollar in mid-August, making the country’s exports cheaper and imports more expensive, generally. The move roiled global markets as investors grew increasingly concerned about the slowdown of the world’s second-largest economy. What does the devaluation of the yuan mean for Latin American economies, capital markets and currencies? Which countries in the region are particularly at risk? What actions should governments in the region be taking in light of China’s changing role in the global economy?

Pablo F.G. Bréard, vice president and head of international economics at Scotiabank in Toronto: “Increasing scrutiny about the pace of economic activity in China has prompted both market adjustments and substantial policy shifts. The Chinese government has intervened intensively in both currency and securities markets as a way of stimulating its economy and deescalating tension in equity markets. A clear bias toward fostering a weakening renminbi (as a means of reviving export sector activity) has exacerbated a bearish tone already present in emerging markets. Intensifying concerns about growth deceleration and corporate indebtedness in China have fueled bearish momentum in virtually all commodities. The U.S. dollar remains in high demand, supported by attractive growth and interest rate differentials versus major peer currencies. The Latin American region has been subject to adverse headwinds due to the triple shock of dollar strength, China’s growth deceleration and collapsing commodity prices. The destabilizing effect of erratic U.S. monetary policy will continue to stoke fi nancial market tensions over the coming months. Mexico will benefi t from the improving economic outlook in the United States (real GDP growth will likely be 3.1 percent in 2016) and may outperform both its NAFTA partners once structural reforms are fully implemented. The economies of the other Pacifi c Alliance countries (Colombia, Peru and Chile) will be driven by infrastructure investment, with China likely serving an important fi nancing role. Mexico and China are both global leaders in emerging market corporate debt issuance, and each remain vulnerable to contagion from the other. Brazil has suffered the most acute impact of China’s weakening momentum in both its real and fi nancial markets. At the same time, terms of trade and lower export volumes may affect the outlook in the South Pacifi c region. Chile and Peru are vulnerable to further market/ economic stress if base metal prices remain depressed and Chinese growth decelerates more than anticipated.”

Carlos Casanova, economist at BBVA Research in Hong Kong: ”Many Latin American economies are commodity exporters to China and so have already been feeling the impact of a slowdown in China; namely weaker demand for commodity exports as well as lower commodity prices. For countries with large current account defi cits, living in the shadow of China’s rebalancing will not be easy as they have not built up enough buffers on the fi scal and external sides during the ‘plush’ years. The situation could be even worse if a large proportion of this debt is denominated in U.S. dollars. A weaker yuan means that exports to China, which has already overtaken the United States as the largest trade partner for many countries in the region, become less competitive. Weakening terms of trade, in combination with a prospective interest rate hike by the Fed, will most likely exert further downward pressure on currencies in Latin America. This will not affect all countries equally, but those with a bigger exposure to shifts in Chinese demand, namely Colombia, Uruguay, Venezuela, Brazil, Peru, Panama, Chile and Argentina, need to brace themselves for a ‘new normal’ of slower growth. In addition, depreciation of Latin American currencies could expert signifi cant upward pressure on infl ation, which has remained obstinately high compared to offi cial targets. Finally, whereas trade fl ows will continue to dominate economic relations between China and Latin America, there have been discussions lately about shifting away from trade and towards investments. FDI can defi nitely help Latin America develop crucial manufacturing, particularly in the high-tech, new energy and telecommunications sectors where China has comparative advantages. But in order for this shift to take place, Latin American governments will have to leverage their strategic proximity to North American markets more effectively. Ongoing FTA negotiations are a good starting point. Ideally, the region should strive to achieve a multilateral agreement on the lines of the ‘One Belt, One Road’ initiative to lock-in support for necessary transport links and infrastructure.”

Gary Hufbauer, senior fellow at the Peterson Institute for International Economics: “China’s devaluation was small, so it won’t have much direct impact on China’s own trade or the exports of its trading partners. The big impact comes as a signal — but a signal of what? In the immediate aftermath, fi nancial markets saw the weaker renminbi as a signal that China’s growth was decidedly slower than the advertised 7 percent, with ominous implications for the entire world economy. Later, the fi nancial markets reconsidered this bleak interpretation and recovered part of the losses. The devaluation seems more a signal that the Chinese authorities will give market forces greater sway in determining the exchange value of the renminbi. Whether Chinese growth is 5 percent or 7 percent doesn’t make much difference to Latin America. Whatever the true number within that range, given that the composition of Chinese growth is swinging toward services and away from hard infrastructure and heavy industry, Chinese demand alone will not revive commodity prices. For that to happen, India and other parts of Asia must sparkle. In the meantime, Latin America needs to nourish domestic growth: build infrastructure (fi nanced by user-pay projects), liberalize a wide array of services and free imports. Brazil could start the ball rolling with a one-two-three package: make wage indexation illegal, sharply reduce interest rates and slash applied tariffs.”

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