Payoff of Fiscal Reform

Financial turmoil has economists pondering the bear market’s next target. With some justification, attention is turning to Latin America, a large market and growing producer that is starting to feel the ravages of the global downturn.

One thing is certain. The Latin countries that restructured their economies to find a niche in world markets will weather this crisis better than those that delayed. No single formula has worked for all, but governments that over the past decade have driven down inflation, slashed budget deficits, privatized state-owned companies, established banking transparency and modernized their export industries have a shield that can help absorb the blow.

There is mixed news from across Latin America, a region where stock markets have declined up to 40% over the past year. Consider the case of Mexico, which recently surpassed Japan to become the second-largest trading partner of the United States and whose economic performance deeply affects the United States. The plunging price of oil forced Mexico to revise its 1998 budget and cut spending. Interest rates soared. The peso has lost about 27% of its value, and the stock market has suffered. Instead of having the 7% economic growth expected for 1998, the country will have perhaps a 3.6% expansion, analysts say. Mexico’s close links to the United States through the North American Free Trade Agreement should help protect the country from more serious damage.

More worrisome is Brazil, which has barely restructured its economy. Its budget deficit is large, around 7% of gross domestic product, its currency is considered overvalued and capital flight is growing alarmingly, almost $8 billion in less than a month.

Argentina has lost revenue through lower prices for its oil and grains, but its true problem is its bigger neighbor, Brazil: Their economic fates will be closely linked. Slow growth in Brazil means a smaller export market for Argentina.

Of all the major Latin American countries, Venezuela is in the most precarious situation. In the early part of this decade, while most Latin American countries were busy reforming their economies, Venezuela con- tinued to rely on its fat revenues from oil. With the price of oil now at record lows, Venezuela probably will have to devalue its currency. The risks will grow even higher if, in the December presidential election, the voters elect a demagogic lieutenant colonel who promises a debt-repayment moratorium if he wins.

It is not likely that relatively small Venezuela can drag the region into a financial disaster, but the lesson is there: Latin American economies must liberalize and diversify or risk going the way of Asia.