All Roads Lead to Recession for Biggest Latin American Economies

(Bloomberg) — Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast

Most Read from Bloomberg

They got there in starkly contrasting ways, but Latin America’s two biggest economies have found themselves in a similar and unenviable place two years into the pandemic: Back in recession.

Mexican output shrank 0.1% in the three months through December, the government’s statistics institute said today, after a 0.4% contraction in the previous period. Brazil’s $1.6 trillion economy, the only one in the region that’s larger, fell into recession in the second quarter of 2021 and is forecast to flatline all through this year.

Pandemic policy in the two countries could hardly have been more different. Brazil shelled out more cash than other emerging economies, and many rich ones. Its stimulus measures added up to about 12% of gross domestic product, according to the International Monetary Fund, translating into a historically large budget deficit.

Mexico kept the purse-strings so tight that even Wall Street economists -– who typically cheer fiscal prudence in developing nations — called for them to be loosened. Excluding interest payments, the government came close to balancing its budget in both 2020 and 2021.

Yet they’ve both ended up with stalled economies and little sign of much growth in the near future — a familiar outcome in Latin America, already a global laggard in the pre-pandemic decades and now hit harder than most by Covid-19.

‘Synchronized Recession’

“Both economies face now a synchronized recession, which reflects a combination of supply-chain issues, local rate hikes, policy uncertainties and their own structural problems,” says Adriana Dupita of Bloomberg Economics.

Story continues

That’s not to say there are no differences.

Brazil’s hefty spending did trigger a much quicker recovery. The economy shrank a relatively manageable 3.9% in 2020 and had more than recouped that loss by March last year. Meanwhile the government’s pandemic programs, including cash transfers to low-income households, succeeded in briefly reducing poverty close to record lows.

By contrast, Mexico -– which contracted more than 8% in 2020 — isn’t forecast to climb back to pre-pandemic output until 2023. And it now has some 4 million more people living in poverty than it did in 2018.

But Brazil’s growth tailed off as fiscal stimulus was withdrawn last year while the central bank embarked on the world’s most aggressive monetary tightening. It raised the benchmark rate by 725 basis points to curb inflation — which surged past 10%, partly driven by the public spending. Another 150-point hike is expected this week.

President Jair Bolsonaro, up for re-election in October, has begun another round of cash transfers. But with monetary policy now pushing in the opposite direction, those measures aren’t expected to nudge growth much above zero for the rest of this year.

Some analysts say the spending is aimed at securing political support rather than shoring up the economy’s potential by addressing its long-run weaknesses.

‘Political Survival’

“It’s political survival, or populism,” said Barbara Fritz, an economics professor at the Latin America Institute of Berlin’s Free University. “There’s no policy like doing industrial policies, fostering investment, like streamlining administration.”

Mexico’s President Andres Manuel Lopez Obrador, who daily decries neoliberalism at his morning press conferences, says his pandemic austerity will eventually pay off. Keeping the country’s debt burden down, the argument goes, will ensure Mexico avoids diverting too many resources to interest payments instead of social programs.

The national debt is around 60% of GDP, according to IMF numbers, compared with roughly 90% for Brazil. Mexico’s central bank hasn’t had to raise interest rates quite as aggressively as Brazil’s, because inflation hasn’t spiked quite as sharply.

Still, the jury’s out on whether there’ll be much of a growth dividend. The IMF expects Mexico’s economy to expand 2.8% this year, well below the 4.8% average for emerging markets.

‘Extremely Weak’

What’s striking, too, is that both economies are relying on drivers of growth that are exactly the opposite of what their politicians promised.

Bolsonaro hired Paulo Guedes –- an economist from a school of thought associated with the University of Chicago that’s famous for its hostility to public spending –- to run things. He presided over a massive fiscal splurge, smashing budget rules that were supposed to constrain outlays.

Lopez Obrador came to power promising to reduce dependence on his giant northern neighbor. But the biggest boost that Mexico’s economy got over the past couple of years was the indirect result of U.S. fiscal largesse in the pandemic, which triggered a boom in demand for Mexican exports as well as a wave of remittances sent home by migrants who received stimulus checks.

It’s “worrisome,” says Goldman Sachs Group Inc. Chief Latin America economist Alberto Ramos, that Mexico only got that far by piggy-backing on U.S. policy. He’s not confident of the outlook in Brazil either: “Both of them have extremely weak engines of growth.”

Another ‘Lost Decade’?

Which country, if either, manages to rev up those engines first is an open question.

For growth-oriented economists like Arturo Huerta of Mexico’s National Autonomous University, Brazil’s pandemic policy of running the economy hot and alleviating poverty via cash transfers offers better prospects.

Analysts who worry more about fiscal risks, especially with the Federal Reserve poised to start hiking U.S. interest rates, can see benefits in Mexico’s caution — and risks for Brazil.

The latter’s own central bank chief, Roberto Campos Neto, sounded like he might be in that camp in November, when he warned that Brazil’s combination of low growth, high debt, and soaring inflation and interest rates suggest an outlook that’s “no longer sustainable, but explosive.”

Neither country appears close to achieving what’s been elusive for the region’s economy in recent times.

Latin America needs “long-term and inclusive growth,” says Ernesto Revilla, head of Latin America economics at Citigroup Inc. and former chief economist at Mexico’s Finance Ministry. “Another decade lost is not something that we’ve written in the books yet. But the risk is there.”

Most Read from Bloomberg Businessweek

©2022 Bloomberg L.P.