More evidence of major fiscal damage - Capital Economics
Latin America Economics

More evidence of major fiscal damage

Latin America Economics Update
Written by Quinn Markwith

After blowing out in April, budget deficits in Latin America remained wide in May. And while a pick-up in economic activity should help tax revenues to recover and social welfare spending to ease over the second half of the year, the slow pace of the region’s economic recovery relative to other EMs suggests that the overall fiscal cost of the crisis will be larger.

  • After blowing out in April, budget deficits in Latin America remained wide in May. And while a pick-up in economic activity should help tax revenues to recover and social welfare spending to ease over the second half of the year, the slow pace of the region’s economic recovery relative to other EMs suggests that the overall fiscal cost of the crisis will be larger.
  • May fiscal figures for Latin American economies have been released in dribs and drabs over the past few weeks. These data can be difficult to interpret as they are typically volatile from month-to-month and are seasonal. They also tend to capture only the central government’s finances, not the whole public sector.
  • That said, we can seasonally adjust the figures in order to give a more reliable read of the state of public finances. As we noted in our Weekly, data for April suggested that fiscal deficits in Latin America blew out to around 10-20% on average, and more recently released May figures suggest that deficits remained wide.
  • Chart 1 shows the combined April and May seasonally adjusted budget deficits, expressed as a share of our estimate of the equivalent months’ GDP so they can be interpreted as an “annualised” figure. While these two months of fiscal data may not accurately capture the hit to public finances due to the different timings of lockdowns and stimulus measures, they suggest that Latin American budget deficits were among the widest in the EM world in the first two months of Q2. They have blown out to around 6.5% of GDP in Mexico, 10-12% in Chile, Argentina, and Peru, and around 20% in Brazil. (See Chart 1.)
  • Three further points are worth noting. First, the deterioration in budget balances has been due to both a collapse in revenues and higher expenditures. Brazil, Peru and Chile saw the steepest declines in nominal receipts. (See Chart 2.) And while nominal revenues grew in Argentina, they fell sharply in real terms. Expenditures have risen across the region, but to a lesser extent in Mexico, which is mainly due to the limited scale of its fiscal measures.
  • Second, while stimulus packages are generally not as large in Latin America as in many other EMs, budget deficits in the region are set to be wider than elsewhere. For one thing, most of the major Latin American economies (most notably Brazil) entered this crisis with weaker public finances than elsewhere in the emerging world. What’s more, a weak recovery in the region means that tax receipts are likely to remain depressed for longer. While a recovery in activity over the second half of the year should support the public finances, data for May and June show activity is improving at a slower pace than elsewhere. (See here.) That reflects the continued rapid spread of the virus and the slower lifting of containment measures. Chile’s government finances look most vulnerable on this front as activity has not even started to rebound there.
  • Third, large budget deficits, especially in Brazil, reinforce our view that policymakers there will turn to austerity and financial repression once the crisis is over. (See our Update.) Leaning on private sectors to hold more government debt would help to reduce borrowing costs and prevent public debt ratios from spiralling out of control. But this will come at the cost of a misallocation of resources and may require capital controls to sustain artificially lower bond yields, both of which would weigh on potential growth.

Chart 1: Government Budget Balances for
April-May 2020 (Seasonally Adjusted, % of GDP)

Chart 2: April & May Gov’t Revenues
& Expenditure (% y/y, Avg.)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


Quinn Markwith, Latin America Economist, quinn.markwith@capitaleconomics.com