S&P, a global credit rating agency, recently downgraded Colombia’s credit rating to a non-investment grade, implying that Colombian government bonds are now high-risk financial assets. The downgrade hit the country amid a wave of mass unrest. For over a month, Colombians spanning all strata of society protested in large numbers. Sparked initially by opposition to a government-proposed tax reform, which President Ivan Duque soon retracted, protesters expressed diverse demands, including calling for the Duque administration to resign, a series of social and economic reforms, a thorough implementation of Colombia’s 2016 peace agreement, and an end to police brutality. Protesters thus have called for nothing less than a complete overhaul of Colombia’s political and economic system.
The protests form part of a broader protest wave that has been seen in recent years in Chile, Ecuador, Colombia, and several other Latin American countries opposing austerity policies. Government attempts to consolidate state finances through tax increases and reduction in state subsidies often implied price rises for essential and public goods, which impacted lower-income classes most heavily. Since the pandemic disproportionally hurt these classes’ living conditions, this year’s protests came as no surprise.
While the national strike committee in Colombia has agreed to temporarily suspend most protests and road blockades, it is unlikely that the Duque administration will offer meaningful concessions. Government finances provide his administration with limited flexibility. Although the influence of rating agencies on policy decisions attracts justifiable criticism, the recent downgrade shows that financial markets are becoming increasingly nervous about Colombia’s solvency.
Lessons from the past
Fears are growing that a new debt crisis—similar to the one experienced by Latin America in the early 1980s—is emerging. Back then, a continuous increase in external debt throughout the 1970s reached unsustainable levels and resulted in a spate of debilitating defaults in the 1980s.
Latin America’s ballooning debt was made possible in the 1970s by the large amount of capital that entered the global financial system due to the spiking profits from oil-exporting countries following the Yom Kippur War. The end of the Bretton Woods monetary system led to global financial deregulation and integration, further facilitating the canalization of these funds towards Latin America.
The resulting abundant availability of capital at low interest rates is very similar to what the global economy has experienced over the past years. Expansive monetary policies to foster growth and large trade surpluses by China and other countries have again created an environment of cheap and readily available credit.
During the past decade and in the 1970s, this global capital abundance met rising Latin American capital demand. In the 1970s, Latin America faced notorious trade imbalances. The oil crisis and structural changes caused a recession in industrialized countries, which, combined with global protectionist tendencies, stalled global demand for Latin American commodity exports. At the same time, the region’s focus on extractive industries implied a need to import expensive machinery and consumer goods putting pressure on foreign reserves.
Unfortunately, the current situation shows many parallels to these events. Commodities, such as oil or copper, still are the region’s most relevant exports. Skyrocketing commodity prices in the 2000s enabled governments across the region to build out their welfare states and lift millions out of poverty. When commodity prices fell after the global financial crisis, these welfare states became increasingly challenging to maintain, such that public deficits and debt levels soared.
Already before the pandemic, public finances approached critical levels. Then, in March 2020, the global lockdown let oil and other commodity prices plummet, sharply decreasing tax revenues from exports and domestic economic activities. This income drop hit public finances when government expenditure rose steeply to balance the social burden of lockdown-induced unemployment. Ecuador and Argentina thus defaulted on debt payments in April 2020; Suriname and Belize followed soon after.
In the 1980s, Latin America’s distress started with the insolvency of Mexico in 1982. The 1979 oil crisis had triggered rising oil prices and inflation in industrialized countries whose central banks responded with restrictive monetary policies. At once, interest rates bounced up. The dollar appreciated making dollar-nominated debt servicing and imports more costly.
Capital flight began as investors became increasingly nervous and shifted funds out of the region. A consequent sharp drop in credit offerings implied that several countries could no longer refinance their open debt payments, creating panic amongst investors and a further drying-out of capital supply. Ultimately, this spurred the default of most Latin American countries. The social consequences were severe—unemployment rose, real wages declined, and governments had to cut down their budgets.
Recent events, unfortunately, give rise to similar concerns. Like in the early 1980s, inflation rates around the globe are on the rise. U.S. Treasury Secretary Janet Yellen recently remarked that central banks might need to respond by lifting interest rates. Such a tilt could come too early for many Latin American countries. A slower vaccine roll-out has prevented some countries in the region from wholly restarting their economies. Large public deficits in Europe could add additional anxiety to financial markets.
The coming months will show whether Latin American is indeed entering such tumultuous waters once again. While Colombia’s credit downgrade provided a clear warning, there are also signs of hope. The economic rebound in large parts of the world, an unimpaired Chinese economy hungry for Latin American natural resources, and recovering commodity prices should all translate into increasing Latin American export and tax revenues.
It would be desirable that such relief materializes before rising pressure from financial markets push governments to further budget cuts. Otherwise, the region’s governments can inevitably expect determined citizen opposition.
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