China’s Expected Deceleration Presents Threat To Colombian & Other Latin American Economies, Says Fitch
Heavy commodity dependence and direct trade exposures represent significant vulnerabilities for Latin American economies if China’s slowdown is sharper than expected, says Fitch Ratings. Large commodity exporters such as Chile, Brazil, Peru and Colombia are likely to be among the most exposed, although Mexico would also be affected. The recent escalation of trade tensions between the U.S. and China, including the imposition of additional tariffs on imports from both sides, has escalated the likelihood of a prolonged bilateral trade war. This will likely have implications for growth in both countries.
Slower Chinese growth could particularly have an adverse effect on major Latin American economies given the rapid deepening of trade and investment ties over the past decade as well as their high commodity exposure. While Fitch’s base case for Chinese growth is for a gradual deceleration to 6% in 2020 and 5.8%in 2021, they conducted a hypothetical severe slowdown scenario to assess how a more significant deceleration would affect Latin America. The scenario, which was developed using Oxford Economics’ Global Economic Model, includes two major assumptions: first, the imposition of 25% tariffs by the U.S. on $300 billion of Chinese imports and, secondly, a sharp downturn in China’s business investment. Together, this would pull Chinese growth to average just 4.1% from 2019-2021 versus Fitch’s 6% base case. The scenario assumes a monetary but not a fiscal policy response as well as commodity and global equity price shocks.
Chile would be the most affected, with real GDP growth diverging from Fitch’s base case by 1 percentage point in 2020 and 5 percentage points in 2021. Brazil, Mexico, Peru and Colombia would also see a growth drag of over 1 percentage point in 2021. Larger exposures to trade in specific commodities, particularly crude petroleum, iron and copper, account for the vulnerabilities in most of these countries, with falling global prices weighing on export values and investment. In the cases of Chile, Peru and Brazil, a large direct trade volume effect would also be expected given that China is their single largest export destination. Adding to these challenges, Latin American countries are generally not in a strong position to respond to a Chinese slowdown. Several major economies are experiencing a cyclical deceleration this year following years of tepid growth.
The potential for fiscal stimulus is also likely to be highly constrained by ongoing consolidation challenges and increased or high debt levels. A monetary easing cycle has begun in several countries in the region, but the policy space to dramatically cut rates is also limited. This is especially so given that a sharp China slowdown would also likely include depreciating pressure on Latin American currencies and broader asset price volatility.
Additional information on how a severe China slowdown scenario could affect major Latin American economies and further detail on trade and investment linkages, see the Fitch Wire + report published today available to subscribers through this link.