Argentina and Venezuela: The weakest link

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This post is a guest contribution by Daniel Volberg of Morgan Stanley.

Faced with the risk of a global downturn, we have argued that starting points matter and that Latin America is for the most part better prepared for a downturn than in the past. But the improvements in the region’s balance sheets have not been uniform; indeed, two economies in the region, Argentina and Venezuela, stand out as most vulnerable to a severe external shock. A track record of policy heterodoxy, relatively weak balance sheets and high reliance on elevated commodity prices mean that Argentina and Venezuela are likely to be Latin America’s weakest link. However, while neither is well equipped to weather a prolonged slowdown in global growth, we are concerned that Venezuela is far more vulnerable than Argentina. We highlight three concerns:

First, the balance of payments in Argentina and Venezuela may be vulnerable to deteriorating global macro dynamics. At first glance, it may seem that the starting points for both Argentina and Venezuela are strong. After all, in the four quarters through June both countries ran current account surpluses, putting them in an exclusive club with only Chile as the other regional economy with a current account surplus. Argentina posted a 0.3% of GDP current account surplus while Venezuela’s surplus was a massive 8.4%. But this image of a strong starting point belies very challenging dynamics.

If commodity prices were to simply remain flat at the levels reached in mid-2011, both Argentina and Venezuela could face balance of payments reversals. Whether we use twelve- or six-month growth trends in import and export volume to project forward the current account balance, we find that Argentina’s and Venezuela’s balance of payments could reach unsustainable levels within a year. For Argentina, using the six-month trend results in the current account balance falling from 0.3% of GDP surplus in the four quarters through June to a 3.9% deficit by December next year. For Venezuela, a similar calculation results in the current account slipping from an 8.4% of GDP surplus to a 6.4% deficit. And while this exercise for the rest of the region suggests that Argentina’s current account dynamics are in line with the regional average (Venezuela, though, is one of the worst performers), we suspect that both Argentina and Venezuela may be more vulnerable than the rest of Latin America to a reversal in the current account. After all, in both countries, foreign direct investment – which tends to be the most sustainable form of financing current account deficits – has been limited (and in Venezuela’s case negative). This suggests an important vulnerability since both countries appear to be reliant on steadily rising commodity prices in a global economy where downside risks to commodities have risen sharply.

Second, the fiscal accounts appear stretched and vulnerable to a downturn. In contrast to the current account balances, on the fiscal side both Argentina and Venezuela are starting from a position of weakness.

Argentina’s fiscal balance is already in the red, although admittedly it is difficult to be too alarmed about a consolidated fiscal deficit which we estimate reached 0.5% of GDP through August: the federal budget balance posted a deficit of roughly 0.3% of GDP in the 12 months through August and we estimate that the provincial fiscal deficit was likely at least -0.2%. After all, many developed and emerging economies are facing double-digit shortfalls. But it is worth noting that the deficit comes despite what had been a very favourable global environment that had prevailed in the first half of this year. And for a country with no access to international capital markets, managing any deficit may be challenging.

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