Argentina Crisis Adds to Neighboring Economies' Headwinds


Thursday, October 17, 2019   /03:20 PM  / By Fitch Ratings / Header Image Credit: Daily Express


Argentina's economic crisis will have negative effects on neighboring economies, adding to an already challenging external backdrop for the region, says Fitch Ratings. Reduced trade and financial exposures should help to limit broad-based regional effects from a prolonged Argentinian recession, but smaller economies with higher direct exposures to Argentina are likely to be affected more.


Fitch forecasts the Argentinian economy to contract by 3% in 2019 and 1.7% in 2020. The scope for destabilizing regional contagion should be limited by a substantial reduction in trade linkages over the past two decades, limited direct financial exposures and low financial market contagion risk. Positively, direct goods trade exposures to Argentina for Brazil, Chile and Uruguay have fallen substantially since the 2001-2002 crisis, largely due to trade diversification into markets such as China. Exports to Argentina have risen for Paraguay and Bolivia, although the concentration in certain goods less directly exposed to Argentinian demand (soybeans) or based on pre-agreed contractual terms (natural gas) should mitigate the economic effects.


Thus far, the region has also seen no substantive signal of market contagion risk to neighboring countries since the onset of heightened volatility in Argentina in August. Bond and CDS spreads for neighboring countries have remained roughly stable even as Argentinian spreads rose significantly. The confluence of challenges facing the country including low policy credibility, a substantially increased and highly dollarized government debt burden, high inflation, a sharp recession, acute financing constraints amid large financing needs and reduced international reserves, makes it an outlier. Additionally, the severe political shock and elevated policy uncertainty that have exacerbated these challenges in Argentina are not shared by other countries.


Although we believe that Argentina's crisis will unlikely have a severe or destabilizing effect for the rest of the region, it will pose headwinds of varying magnitude among individual countries. Smaller economies, including Uruguay, Paraguay and Bolivia, are likely to see the greatest economic growth effects owing to a range of exposures including trade, tourism, reduced competitiveness owing to real exchange rate appreciation and remittances.


Fitch's outlook on Bolivia and Uruguay's ratings are already Negative. For the latter, we specifically highlighted persistent growth underperformance and fiscal deterioration as contributing to the Negative Rating Outlook in our rating affirmation in May, which primarily reflect homegrown issues that will be amplified by headwinds from Argentina namely via the key tourism sector. Bolivia's Negative Rating Outlook also reflects rising macroeconomic vulnerability from the rapid decline in international reserves due to adverse developments in the gas sector and highly expansive policies. Further erosion in competitiveness vis-a-vis Argentina could exacerbate these trends.


Paraguay will see a substantial growth slowdown with growth now forecast at zero this year, partly due to the Argentinian crisis. That said, Paraguay has a stronger fiscal position relative to Bolivia and Uruguay, with the lowest debt burden in Latin America at 17% of GDP in 2018, offering greater scope to cushion the impact with countercyclical fiscal policy


While less vulnerable, risks related to Argentina will still add to a challenging macroeconomic backdrop for larger neighbors such as Brazil and Chile. The addition of the Argentina crisis to an already challenging set of external risks and domestic demand challenges confronting Brazil will further constrain recovery potential and add to difficulties in addressing rising general government debt and the large deficit. Chile stands out as being in a stronger fiscal position and likely with the least vulnerabilities directly linked to Argentina.


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