Oil crash puts LatAm governments in a fiscal bind: To spend or not to spend?

By Jamie McGeever

BRASILIA (Reuters) - A plunge in world oil prices and resulting market turmoil has thrust Latin American governments into the unenviable position of trying to shore up their economies without blowing a hole in their budgets or scaring off international investors.

From Mexico to Brazil, many countries in the region are major exporters of crude and other commodities, and have been hit by a triple whammy of oil's price crash, cratering import demand from major buyer China, and a precipitous fall in their exchange rates.

Economic growth forecasts for this year were already being cut due to the global spread of the novel coronavirus, but a fall in major revenue streams will tighten the squeeze on many government budgets.

The orthodox policy response, especially in emerging markets that rely heavily on capital flows from abroad, may be to tighten the fiscal belt. This gets the thumbs-up from credit rating agencies too.

But it also accelerates a vicious cycle of slowing growth and increased austerity. At a time of heightened economic, market and now public health crisis, "expansionary austerity" is a particularly risky policy.

Some countries, like Mexico, appear more open to the idea of fiscal stimulus. Some, like Peru, which recently extended the deadline for reducing its budget deficit by three years to 2024, might also have a little more fiscal room to manoeuvre.

Others, like Argentina, already in deep financial and economic trouble, have no room at all to boost spending.

Brazil, meanwhile, under the guidance of Chicago school-trained Economy Minister Paulo Guedes, is doubling down on its "fiscal zeal", as one ministry official put it on Tuesday.

"Many countries are already in deficit, so they have a choice," said Monica de Bolle, senior fellow at the Peterson Institute for International Economics in Washington.

"Have a deficit and do nothing, pushing the economy into recession. Or do something - you still have a deficit but you minimize the risk of other problems like high unemployment and social unrest," she said.

MONETARY, NOT FISCAL STIMULUS

As an indication of how wedded many Latin American countries are to budget discipline, analysts at JP Morgan reckon only Mexico, out of the region's main economies, will react to the economic damage from the coronavirus outbreak with fiscal stimulus as well as interest-rate cuts.

Brazil, Chile and Peru, on the other hand, will provide no fiscal boost, relying solely on looser monetary policy, even though exchange rates are weakening, they say.

The damage will vary from country to country, but none will emerge unscathed.

Economists at Bank of America Merrill Lynch on Wednesday slashed their 2020 Latin American GDP growth forecast to 0.7% from 1.2%, and didn't rule out a mild global recession that would bring growth in the region down to just 0.2%.

Mexico met its 1.0% of gross domestic product primary budget surplus target last year, posting a 1.1% surplus, but only because it took 40% out of a budget stabilization fund.

The major dropoff in oil revenues has now forced the finance ministry to ease up on its budget commitments and call for a fiscal splurge to kickstart an economy that had already flirted with recession last year.

Finance Minister Arturo Herrera said on Tuesday a $1.4 billion hedge program, the world's largest financial oil deal, had completely covered 2020 national oil income, so the oil price crash would not have a "direct" impact on this year's budget.

"But it is still a worrying situation," he said.

State-owned oil giant Pemex is a potential concern. If it wants to sustain its $11 billion (8.5 billion pounds) capital spending plans for this year, the government needs to provide additional support worth $13 billion, or roughly 1% of GDP, analysts at Citi estimate.

ECUADOR DEFAULT?

The Colombian government, meanwhile, issued a statement on Tuesday saying state-run oil company Ecopetrol SA is profitable with Brent crude above $30 a barrel. On Monday, the biggest one-day crash since the 1991 Gulf War pushed it as low as $31/bbl.

Finance and oil officials in Bogota would not have anticipated a 50% fall in virtually the first two months of the year, potentially pushing Ecopetrol into loss-making territory.

"God forbid that prices drop to $30 or $40 a barrel," Ecopetrol chief executive Felipe Bayon told Reuters in an interview on March 2, when Brent was around $52/bbl.

Monday's oil crash triggered a 6% plunge in the Colombian peso, its biggest one-day fall against the dollar for almost 30 years.

Colombia's government deficit last year was wider than forecast at 2.5% of GDP, and is expected to narrow slightly this year to 2.2% of GDP. While the government cut its 2020 growth forecast last month, it kept its fiscal targets unchanged.

Economists at Morgan Stanley reckon Colombia is one of the emerging economies most sensitive to oil price swings. A $10 decline over six months widens the current account deficit by around 0.4 percentage point as a share of GDP, they estimate.

The government's 2020 current account forecast, even before the latest volatility, was for a chunky deficit of 3.9% of GDP.

The hardest-hit country, however, looks like Ecuador, which is already in a $4.2 billion International Monetary Fund program.

Highly dependent on oil and fully dollarised, leaving it with no control over monetary policy and exposed to the strengthening U.S. currency, the Andean nation may be hurtling toward a sovereign debt default, according to some economists.

Analysts at Barclays estimate that every dollar decline in oil prices implies a $70 million net loss in the trade balance. An average Brent oil price of $35/bbl would be $25/bbl below what authorities had budgeted for, implying a loss for the country of approximately $1.8 billion, or 1.7% of GDP.

The impact on the central government would be smaller, closer to $800 million, but still a big loss that could make the country's financing this year too large, even if IMF payments are still made.

(Reporting by Jamie McGeever, additional reporting by Julia Symmes Cobb and Nelson Bocanegra in Bogota; Editing by Daniel Flynn and Bernadette Baum)