By Nora Lustig, Professor of Latin American Economics, Department of Economics, Tulane University and Jorge Mariscal, Adjunct Professor of International and Public Affairs, School of International and Public Affairs (SIPA), Columbia University
This blog is part of a series on tackling COVID-19 in developing countries. Visit the OECD dedicated page to access the OECD’s data, analysis and recommendations on the health, economic, financial and societal impacts of COVID-19 worldwide.
COVID-19 has hit Latin America hard on two fronts. The pandemic and the lockdowns to contain the spread of the virus have shut down significant portions of the region’s economies. However, even if the pandemic were to miraculously disappear from the region, falling demand for exports and tourism, declining commodity prices, interruptions in the supply chain of inputs, shrinking remittances and unprecedented capital outflows are significantly affecting countries’ growth prospects.
The International Monetary Fund (IMF) in its recent World Economic Outlook (April 2020), predicts that the world economy could fall by 3% in 2020 and in Latin America by 5.2% – higher than that observed during the 2008-09 global financial crisis. Still, the IMF’s growth forecasts for Latin America compared to those for advanced countries seem overly optimistic and will likely be subject to downward revisions. Based on data for 48 countries, the OECD has estimated that each month of containment measures translates to an approximate decline in annual GDP growth of up to 2 percentage points. Considering the extent to which the region’s economies depend on trade, foreign direct investment (FDI), commodities, tourism and remittances, in the absence of strong policy responses, we would add an additional decline equivalent to one-third of the total shock. Latin American economies could thus face GDP contractions of 9-10%.
To avoid even worse outcomes and face the pandemic in its multiple dimensions, governments, multilateral organizations, the private sector, and society in general must take bold and unprecedented action (Lustig and Mariscal, 2020). Priorities on the health front include hospital capacity, protective gear, diagnostic tests, tracing capabilities, and so on. The salient economic priority is first to curb the decline in economic activity, whilst also ensuring the functioning of key sectors (food, banking, telecommunications, electricity). On the social front, the priorities are minimizing the destruction of employment sources and, very importantly, implementing adequate social protection measures. The latter are of two main kinds: measures to compensate those who cannot work or lost their jobs because of lockdowns, and measures to cover the basic needs of the poor and vulnerable, severely affected by the combined internal (lockdowns) and external shocks.
All these necessary measures come at a high cost. So, how will they be paid for?
The IMF’s Fiscal Monitor (April 2020) calculates that combined, the world’s fiscal packages amount to 9.5% of global GDP. Latin America, however, lags behind. Brazil, Chile and Peru have announced the largest packages in the region of around 4-5%, half the global average. In other countries, fiscal packages are outright meager: 1.5% for Colombia and 1.2% for Mexico. These packages are unlikely to be enough. Excessive fiscal prudence that may be well received in normal times does not have its place today. While governments should label the measures taken as temporary, increases in debt/GDP of 10 or more percentage points of GDP may be necessary in the region. This would be within the range expected by the IMF´s Fiscal Monitor for April which contends that global public debt/GDP will rise by 13 percentage points of GDP because of the pandemic. Concerns with a stable or decreasing trajectory of debt/GDP (and with credit rating agencies) should be left for the years after the pandemic.
The use of traditional monetary policy in Latin America is limited by the low level of interest rates in real terms prevailing in most countries. Several countries have created short-term lines of credit from central banks to banks and companies. These are useful, but not sufficient if the crisis extends over time. Liquidity problems will become solvency problems, confronting us with a financial crisis whose consequences will be even more devastating and lasting. This calls for innovation in monetary policy. In particular, central banks in Latin America should explore using unconventional monetary policy more aggressively. For example, central banks could channel long-term funds to the banking system with the appropriate incentives (and monitoring) for banks to turn these funds into long-term loans to consumers and companies (ideally, from 10 to 20 years with a 3 to 5 year grace period, and concessional interest rates) to prevent the deterioration of consumer and corporate balance sheets. These lending programmes must be large (multiple fiscal packages) and the loans should be available to all economic agents (individuals and corporations), matching the extent of their needs and the duration of the crisis. Central banks should then buy these assets from private banks. Since these transactions do not increase national debt, this tool can significantly increase the countercyclical effort and lessen the burden on fiscal policy.
Even if all fiscal and monetary tools are deployed, many countries will not be able to cope alone. The IMF, multilateral development banks, and international donors will need to provide resources in larger amounts than in the past. Crucially, financial support should not be conditional on short-term fiscal or inflation targets, but on the effectiveness in using resources in accordance with the health, economic and social priorities stated above. Credits should be long-term (10 to 30 years), with concessionary interest rates and a grace period for interest and principal of at least 3 years. Finally, and for the most extreme cases of countries with permanent damage to their productive structures, granting partial or full debt forgiveness should be considered. Lee Buchheit and others have proposed a global “stand still” for the hard currency debt of emerging and low-income countries. G20 countries should be ready to refill the “tank” of these international financial institutions. In a recent petition, a group of former Presidents of Latin America advocate for an additional USD 1 trillion for IMF capitalization to the available USD 1 trillion.
The pandemic also makes us consider social protection schemes that go beyond what governments can do: that is, people-to-people social protection (Lustig and Birdsall). Examples include, continuing to pay for domestic services, even without using them. Managers in nonprofits, small businesses, or cooperatives, can negotiate transitional pay cuts or reduced working hours to keep sources of work intact for everyone, or at least for lower-income employees. Similarly, landlords who have tenants who lost their jobs might relax repayment terms and even consider giving them an interest-free loan. Young people could offer their help in doing shopping for the elderly. Those who have extra time on their hands could offer to virtually mentor children in other households. In cities, people might leave nonperishable foods at their doors for people living in the street. Those who have extra protective gear can give it to people who deliver packages, to the postman and to those who pick up the trash.
The top “1%” in Latin America should also consider increasing and refocusing their philanthropic donations and sustainable investments in extraordinary ways. New philanthropic funds can help, for example, to ensure foodbanks are stocked up, diagnostic tests for those who cannot afford it and connectivity for the disadvantaged. Governments can help by creating incentives to facilitate the channeling of these private resources. In addition, governments should contemplate a pandemic-relief wealth tax. In doing this, the government should be careful not to appear confiscatory because this could increase already significant capital outflows. Given the great negative impact this crisis will have on the living standards of many of the world’s poor and middle classes, it is fully justified to expect that those at the top of the wealth pyramid will co-operate in a meaningful way. Many have already started.