South American Austerity Sets the Stage for Political Volatility

June 18, 2021

By Gabriel Brasil, Lead Analyst at Control Risks

In 2020, most countries opened their wallets to battle the social and sanitary impacts brought about by the Covid-19 pandemic. Relying on record-low global interest rates and extraordinary authorisations by their parliaments, governments printed money and got further into debt, introducing unprecedented anti-cyclical measures to help businesses and the unemployed to cope with an extremely uncertain economic panorama. These have been successful in mitigating even more dramatic contractions in economic activity in the region. The most prominent example is that of Brazil, where a large-scale cash-transfer programme has provided direct financial assistance to 63 million unemployed and self-employed workers across the country since April, temporarily reducing poverty and inequality rates.

Nonetheless, the bill for such efforts will arrive in 2021. As inflation-related concerns increase among investors, governments will be pressured to expend political capital reassuring markets about the medium-to-long-term sustainability of their debts. According to Oxford Economics, government debt as a share of GDP has increased by double digits in most of South America, including Argentina, Bolivia, Brazil, Chile, Colombia and Peru.

A bumpy road ahead

While most governments in the region acknowledge the need for more fiscal prudence in 2021, the road for such a policy shift is unlikely to be easy. Overall, we expect significant political and social challenges to hamper most austerity-related initiatives in South America in the coming year. With the notable exception of Uruguay – where President Luis Lacalle Pou enjoys positive conditions to implement his pro-business platform – most governments do not have strong legislative majorities. Some leaders – such as Chilean President Sebastian Piñera – cannot afford additional reductions in popularity.

The pandemic has also aggravated longstanding economic inequalities in the region…

In addition, the substantial increase in unemployment rates as a direct result of the pandemic means that unrest risks will remain elevated. These have already been heightened for more diverse reasons since mid-2019 – with widespread protests marking the political panorama of countries such as Chile, Colombia, Ecuador and Bolivia. There is little evidence to suggest that civil society will become any less mobilised. Occasional demonstrations will continue to be a regular feature of the operational environment on the back of persistently high social anxiety levels. The pandemic has also aggravated longstanding economic inequalities in the region, so reputational risks will remain for companies associated with controversial approaches towards social issues – a trend that will increase amid austerity discussions.

Different challenges

Although Brazilian President Jair Bolsonaro has maintained an austerity-focused rhetoric, his administration has continued, since taking office in January 2019, to face significant challenges in turning pledges into concrete reforms. The government’s erratic policymaking – marked by recurrent coordination problems – will likely continue to be compounded by his troublesome relationship with Congress, where his coalition holds a minority status. Control Risks expects the government’s fiscal initiatives, notably an administrative reform, to evolve slowly and to be diluted by legislators in the coming year. The administration’s austerity talk will continue to contrast with the lack of political will by the president to pursue such an unpopular agenda.

In Argentina, where sovereign risks remain high, the biggest challenge for the administration of president Alberto Fernández stems from its divided plan for fiscal consolidation. While Economy Minister Martín Guzmán adopts a pragmatic stance vis-à-vis investors, other members of the government – notably Vice-President Cristina Fernández and Production Minister Matías Kulfas – continue to espouse a more heterodox view towards the economy, consistently advocating for increased spending. Amid such an erratic composition, Fernández will be forced to assert the pragmatism that helped him get elected in October 2019. So far, signals have remained mixed, but the positive advancement of talks with the International Monetary Fund (IMF) – with whom Argentina is set to restructure its debt in the coming months – will likely force the president into taking a more assertive approach in 2021.

a favourable external environment should mitigate South America’s fiscal challenges in the coming year….

In Colombia, rating agencies have in the past few months downgraded the country’s sovereign risk ratings as a result of the significant deterioration of the country’s fiscal position in 2020. That has been exacerbated by violent protests that have hampered President Iván Duque’s ability to enforce much-needed fiscal reform. In Chile, the constitutional process will likely lead to a consolidation of civil society’s claims for increased social spending. While significant reversals in the country’s business-friendly environment are unlikely, increased deficits will likely become an important challenge for the public sector, ultimately hampering growth prospects for the short-to-medium-term.

In Peru a controversial and close election appears to have handed victory to Pedro Castillo, a socialist whose economic plans may well deter critical foreign investment in the country’s infrastructure programme. Ecuador is one bright spot, where the election of centre-right Guillermo Lasso as president marks a peaceful and democratic end to the correista era.

Overall, as each country faces its own challenges, we can expect more political volatility across the region for at least the 12-month outlook.

Investment opportunities

That said, while such a constrained fiscal environment will continue to limit most governments’ scope for public investment, this will also represent increased opportunities for private investment – particularly in sectors such as infrastructure, energy and sanitation. Administrations across the region – such as in Brazil, Ecuador and Colombia – will likely continue to rely on concessions to plug the gap of investment demands and to ultimately foster job generation.

Meanwhile a favourable external environment should mitigate South America’s fiscal challenges in the coming year. Overall, liquidity levels worldwide remain high, and a bullish sentiment among investors has become more prevalent against the backdrop of the early rollout for vaccines in developed countries. This will likely sustain a more positive outlook for commodities, whose prices have historically represented an important proxy for economic growth – and, hence, for governability – in the region. South American governments will also likely continue to rely on direct investments from China, which has, and will likely continue to, allocate significant sums of capital in assets across the region, particularly in infrastructure. As it is typically the case, a new age for austerity comes with challenges, but also opportunities. In both cases, the continuous monitoring of political risks will remain a top priority for businesses – in 2021 and beyond.