South America: Low Energy Prices Weigh on Economic Prospects

18266036015_65585e454d_zThe future of the world economy has made headlines so far in 2016, as a recent Barron’s piece, concerned with the growth prospects of the global economy focused on the uncertain fortunes of  South America for 2016 shows. Brazil is the centre of attention, where the economy declined 4% in 2015 and is expected to contract a further 2.5% this year. The slowdown in China, low energy prices,and a precarious debt load are the three main reasons that South American economies will not fare particularly well in 2016 and likely remain weak in 2017.

China’s slowing economy is a paradoxical anomaly in the economic orthodoxy of the last 30 years, where central planning coexisted with  the idea of economic rationalism of scarce resources into infinite time for several decades. While Deng Xiaoping was the initializing force behind his country’s remarkable experiment over the last generation, China is in a different stage, where its double digit economic growth is unsustainable. In relation to the global economy, high Chinese growth not only drives internal demand for imported goods and materials, but also stimulates Chinese investment abroad  South America, while home to high-technology and advanced industries depends on a large part on resource exports (e.g. oil in Brazil and Venezuela, copper in Chile) to China, and any downturn in the east Asian economy will find systematic reflection for South American countries.

A significant connection to the above is the recent information that China plans to lay off up to 6 million industrial workers over the next several years, citing production overcapacity. The implications here is declining exports and imports, and growing inventory that has no place to go. In economic terms, this move will not affect the workers alone; the multiplier effect, a measure of the indirect impacts of a decision, negatively impacts an entire substratum of suppliers and customers that depend on the materials industrial clients take and the output they move. In this respect, South American economies will be among the sufferers.

As per Barron’s publication, low energy prices have reverberated around the world since their decline began in the summer of 2014, and the hardest hit are the flagship producers – OPEC, Russia, Canada and the emergent US suppliers, in no particular order. In the past year, we have seen Saudi Arabia begin to battle with substantial deficits that have put pressure on the petro-monarchy’s generous welfare system and ability to finance an expensive foreign policy, massive economic difficulties in Venezuela, which has been battling inflation and market supply problems, and Brazil’s flagship energy company, Petrobras, is dealing not only with the collapse in revenues, but debt and extensive corruption probes that in turn put political pressure on the Roussef administration resulting from increased risk of recession. Additionally, overleveraged shale companies in the United States might well set off a junk bonds default boom worth several hundred billion dollars, should the energy market malaise continue. The link between these cases is that energy risk is very complex, because of the interconnectedness that exists between supplies and producers in a globalized economy, which in turns allows for the fast dissemination of the multiplier effect when problems crop up in one or more locales.

When we talk about debt, we refer to the fact that today’s world is leveraged towards obligations to a level that is unknown in recorded history – when we begin from sovereign debt, then move to its corporate cousin, consumer debt, and derivatives, among others – the overall picture reveals that we are amidst a very uncertain time in global history, in the context of a stagnant and declining economy. While there are some bright spots – such as Argentina’s recent settlement after a 14-year battle to sort out its 2001 $82 billion default, the largest in history prior to that point – the rest of South America does not look very promising. The problems are especially acute in Brazil, where the decline of the Rial over 2015 combines with the fact that most debt is denominated in the appreciating USD, meaning that paying it back is going to reflect in higher inflation in Brazil, amid declining economic prospects. Along these lines, corporate debt in Brazil stands at $188 billion, where Petrobras alone owes $52 billion of that amount.

South America is facing significant problems, but as we can see, it is not alone in these difficulties. Rather, the trouble on the continent is part and parcel of our greater global economic problems, where issues in one place lead to large reverberations somewhere else. South America finds itself in a difficult situation, not just from the choices and policies of the resident countries, but also because it is highly dependent on the larger world market for many of its transactions. Today’s reality forces leaders to take a hard look at short-term benefits, the volatility of commodities, exogenous economics and the utility of debt in a local and global perspective. It is the global implication that makes economic policy so difficult today, but better understanding of its consequences could make South America’s emerging markets more resilient to the world’s economic volatility.  

Georgi Ivanov (7 Posts)

Georgi Ivanov is a political scientist specializing in the geopolitical questions of the Arctic region. He obtained his B.A. in Political Science from the University of Western Ontario and his M.A. in Political Science from Carleton University in Ottawa. Ivanov's interests include international political economy, currency politics, the Middle and East Asia. He is fluent in English and Bulgarian, and currently works with the Atlantic Council of Canada, the Atlantic Community in Berlin, and does occasional consulting for Wikistrat.


 

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