Channels of contagion: How the European crisis is hurting Latin America

June 8, 2012

If anything positive can be said to have come out of the global financial crisis of 2008-2009, it may be that the theory arguing major economies could “decouple” from one another in times of stress was roundly disproved. Now that Europe is the world’s troublesome epicenter, economists are already on the lookout for how ructions there will reverberate elsewhere.

Luis Oganes and his team of Latin America economists at JP Morgan say Europe’s slowdown is already affecting the region – and may continue to do so for some time. The bank this week downgraded its forecasts for Brazilian economic growth this year to 2.1 percent from 2.9 percent, and it sees Colombia’s expansion softening as well. More broadly, it outlined some key ways in which Latin American economies stand to lose from a prolonged crisis in Europe.

Latin America has exhibited an above-unit beta to growth shocks in the U.S. and the euro area over the past decade; resilient U.S. growth until now had offset some of the pressure coming from lower Euro area growth, but U.S. activity is now weakening too.

The European Union is the destination for around 15% of Latin America’s exports – half of the share of exports to the US but more than those to China – but the share varies widely across individual countries.

Ongoing pressure that European banks are facing to shed assets in order to improve their capital ratios is a potential channel of contagion to Latin America that still warrants close monitoring.

Beyond the direct links between Latin America and Europe related to bilateral trade and bank deleveraging, perhaps the most important channel of contagion in the end will be the impact of the European woes on capital flows – both FDI and portfolio inflows.

The increased economic links between Latin America and China also complicates things, since the latter is showing many signs of sputtering as well:

The influence of China on growth dynamics of Latin America has increased significantly in recent years; a 1 percentage-point lower yearly expansion in China is estimated to reduce Latin America’s full-year GDP growth by around 0.2 percentage point, but the beta is much higher for commodity exporters, particularly Brazil.

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