Following are excerpts, reprinted with permission, of a report published in Deloitte Insights in January 2023. Authors are Daniel Zaga, Economic Analysis Director, Deloitte Spanish LATAM; Alejandro Mina, Manager, Deloitte Spanish Latin America; Daniel Gonzalez Sesmas, Senior Manager, Deloitte Spanish Latin America; Federico Di Yenno, Economic Analysis Manager, Deloitte LATAM; and Alessandra Ortiz, Senior Economist, Deloitte Mexico.
The far-reaching impacts of the ongoing war in Ukraine, such as persistently high energy and food costs, have further weakened a global economy already reeling under the lingering economic challenges of the COVID-19 pandemic. Most economic forecasts in recent months have reflected this sentiment. Such weakening economic activity is bound to dampen growth prospects in Latin America (Latam). Consequently, we at Econosignal (the economics unit at Deloitte Spanish-Latin America) have revised our forecast for the region’s growth in 2023 from 2.0% to 1.7%.
In this article, we take a closer look at these issues and try to answer two questions: Is Latam heading toward a recession? And how likely is Latam to face a debt crisis? We will also discuss the potential growth opportunities on the horizon for Latam economies that could help the region withstand a global economic downturn.
In 2021, Latam rebounded from a pandemic-induced economic contraction. The region benefited from a surge in commodity prices driven by strong demand when the global economy reopened. The result: The region grew by 6.8% in 2021,3 with GDP of half of its countries surpassing pre-pandemic levels. Then, in 2022, the war in Ukraine broke out, which has decelerated this recovery.
However, we still forecast an economic expansion of 3.4% for Latam in 2022.4 Highlights of this overall recovery include countries such as Chile, Colombia, Costa Rica, and the Dominican Republic, which witnessed better post-pandemic recovery than the rest of the world. Conversely, economic growth in the three largest Latam economies—Argentina, Brazil, and Mexico—lag the rest of the globe.
Prospects for 2023 are less rosy than those for 2022, as several headwinds cloud the regional outlook.
There is an increasing belief that a recession (or a larger slowdown) is set to hit the U.S. economy within the next 12 months: A survey by Bloomberg in October pins the odds of a downturn in the United States at 60%. This has tapered global demand, which in turn has depressed the prices of oil and other commodities. For example, compared to 2022 peaks, oil is down 27%, copper 24%, zinc 28%, nickel 33%, silver 25%, gold 14%, wheat 29%, soybeans 10%, and maize 10%. The conspicuous exception is gas, whose price has soared since the start of the war in Ukraine—up 79% in the US market and 109% in Europe.
A drop in commodity prices is usually a harbinger of economic hardship in Latam because commodities are the region’s main exports and constitute a crucial source for incoming international reserves and government revenue. Nevertheless, are these factors enough to lead to a recession in Latam? Not necessarily. In fact, Chile is the only Latam country where a slight contraction of GDP is forecasted.
Is a Debt Crisis Likely?
The region had seen a period of considerable borrowing in the 1970s, because of low interest rates and liquidity excesses worldwide. According to the World Bank, the external-debt-to-GDP ratio increased from 22.6% in 1975 to 42.9% in 1982. Then, in the aftermath of the 1981–1982 recession, economic growth rates of indebted Latam countries slowed down and international interest rates rose. Interest payments on external debt rose from 15% of exports in 1975 to 33% in 1982 for Latam.
What became known as the debt crisis was triggered in 1982, after Mexico announced it could no longer service its debt and several sovereign defaults ensued. All in all, 16 Latin American countries had to restructure their debts, including the four largest debtors, Mexico, Brazil, Venezuela, and Argentina. Consequently, loans to the region decreased by more than 20%, and sharp devaluations followed.
Fast forward to the present: Latam’s debt has risen over the past decade as global interest rates have dropped since the 2008 financial crisis. The government-debt-to-GDP ratio increased from 47% in 2012 to 69% in 2021, peaking at 74% in 2020. However, Latam’s policy framework is different this time around, thanks to the changes that the 1980s crisis brought about, especially for the independence of central banks.
The 1990s saw a wave of reforms that modernized central banks. Most notably, most Latam countries passed laws aimed at reducing central banks’ financing to governments and adopted new policy regimes, such as inflation targeting. In general, the results proved satisfactory as countries achieved price stability, and inflation rates converged to a single digit within a decade.
The strain on global production chains over the pandemic exposed the risks of the offshoring strategy. The prime example of such risks is the delays and suspension of exports after China implemented stringent lockdowns in January 2020. Since then, companies have internalized these risks and adjusted accordingly, for example, by moving their global value chains closer to end markets—in other words, by adopting the “nearshoring” strategy. The result is a reshaping of global economic activity around three regional production hubs: North America, Europe, and East and Southeast Asia.
Geographical proximity to any of the three hubs is of prime importance in nearshoring. Naturally, among Latam countries, Mexico stands to gain the most from this new development, because of its vicinity to the United States. In fact, it has already started to reap the benefits, reflected in high foreign direct investment (FDI) inflows into Mexican states bordering the United States.
While Mexico as a whole reported a 4% decrease in FDI in 2021 against the average from 2015 to 2019, its northern states of Baja California, Chihuahua, and Nuevo León recorded increases of 54%, 6%, and 4%, respectively. The Inter-American Development Bank estimates that nearshoring could add US$78 billion to Latam’s exports every year, from which US$35 billion would go to Mexico and US$7.8 billion to Brazil. Industries such as automobile, textiles, pharmaceuticals, and renewable energy could benefit the most.
Digital nomads are remote (and mostly self-employed) workers whose flexibility allows them to work from different cities and countries. They work on their laptops or phones and use wireless networks in places such as coffee shops, libraries, or coworking spaces. Such a lifestyle was already trending before the pandemic, but it has exploded since then. There are an estimated 35 million digital nomads worldwide, and half of them come from the United States alone, where their numbers doubled from 7.3 million in 2019 to 15.5 million 2021. They are seen as a potential source of additional income to the economy because they stay longer and spend more money than regular tourists.
Ever since the number of international tourists dropped because of pandemic-related restrictions, countries have been actively targeting digital nomads. There were 21 countries with digital nomad visa programs in February 2021—the number is now 49. Argentina is the latest country in the Latam region to introduce such visa programs, joining six other nations—Costa Rica, Mexico, Panama, Brazil, Ecuador, and Colombia. The migration office in Argentina estimates that a digital nomad spends US$3,000 per month—twice as much as the average tourist.
Latam offers several advantages to digital nomads, such as proximity to the United States, low cost of living, and warmer weather during winters in the northern hemisphere. Four Latin American countries, according to website Two Tickets Anywhere, feature in the list of top 10 destinations for digital nomads in the world: Mexico (no. 1), Colombia (no. 4), Costa Rica (no. 8), and Brazil (no. 9). As for cities, Mexico City (no. 3), Medellin (no. 5), and Buenos Aires (no. 9) are among the top ten destinations. There is room for expansion in the other countries that are yet to implement digital nomad visa programs, but international competition is steep.
Lithium-ion batteries are a key part of the world’s clean-energy transition, particularly in the electric car and consumer product industries. An estimated 106,000 metric tons of lithium was mined in 2021 alone—an all-time high and a 258% increase from 2015. And almost half of the world’s lithium comes from a region in the Andes Mountains known as the “Lithium Triangle,” jointly governed by Argentina, Bolivia, and Chile.
Latin America with a focus on the Lithium Triangle.
Photo: Getty Images
Global lithium production is expected to grow up to 420,000 tons by 2031. Chile and China will more than double their outputs, and Argentina’s production will rise nine-fold to 57,000 tons, making it the second-largest global producer between 2027 and 2028. If these projections materialize for Argentina, the credit will go to increased foreign investment in the sector and better economic policies compared to its neighboring countries.
In the short term, the main challenge for Latam countries is coordinating public policies to ensure inflation subsides. Central banks have already done their part, but the external lag of monetary policy means that price increases will remain above the inflation targets, even though most countries may have already experienced their inflation peaks. Going forward, policymakers should continue policy tightening until inflation is brought under control. Governments, meanwhile, will benefit from fiscal discipline, to keep inflation expectations down and to keep debt ratios under check. At the same time, it is crucial to avoid an extreme contraction of monetary and fiscal policies to prevent Latam from entering a deep economic slowdown.
Nonetheless, there are glimmers of hope in the form of unexpected opportunities. A reconfiguration of the global economy could: first, help Latam increase its manufacturing exports to the United States; second, generate additional sources of revenue by attracting digital nomads (although not as sizable as the first one); and third, increase oil and gas exports to the world, as well as inputs associated with the world’s transition to clean energy.