Roundup: Financial cooperation with China can buffer LatAm against external economic shocks

Latin America is in a position to weather the potential economic impacts of a tighter monetary policy the United States has adopted. In particular, the region's financial cooperation with China has served to further cushion any economic blows, a Chinese economist has said.

In an exclusive interview with Xinhua, Chai Yu, director of economic affairs at the Chinese Academy of Social Sciences' Institute of Latin American Studies, said that the current situation offers both China and Latin America a good opportunity to boost cooperation by promoting the circulation of the Chinese currency renminbi (RMB), or the yuan, in the region, which would offset the outflow of the U.S. dollar.

BREAKING CYCLE OF ECONOMIC CRISES

On Dec. 16, for the first time since 2006, the U.S. Federal Reserve announced it would raise its benchmark interest rate by a quarter of a percentage, launching a new cycle of a tight monetary policy expected to stem the supply of dollars in circulation, but which could potentially spark capital flight out of the region.

As a result, the central banks of Mexico, Chile and Colombia raised their respective interest rates by 0.25 percent, in a bid to prevent major capital flight and greater volatility in the regional financial market.

Historically, Latin America has been highly vulnerable to the Fed's interest rate hikes, which were largely seen as the straw that broke the camel's back, triggering economic crises many times throughout the region.

These recurring crises -- including the Latin American debt crisis in the 1980s, Mexico's 1994 peso crisis, the 1998 Brazilian crisis and the 2001 Argentina crisis -- all erupted when the Fed raised rates, sparking a dollar scarcity in local markets that eventually led to defaults on those countries' massive foreign debts and steep devaluations of their national currencies.

This time, however, "the situation has changed," said Chai, not least because regional countries have implemented sound fiscal policies, including adopting inflation and fiscal deficit targets, and more flexible exchange rates.

Today many Latin American countries have succeeded in keeping their public debt at lower levels while accumulating sufficient international reserves.

According to the data released by the Economic Commission for Latin America and the Caribbean (ECLAC), the region's public debt amounted on average to 34.3 percent of its GDP in 2015, well under the 60 percent limit established by the European Union.

At the same time, gross international reserves took up 15.3 percent of the region's GDP in 2015, rising from 14.8 percent in 2014. As of October, the figure stood at 824.795 billion U.S. dollars, almost five times larger than the total registered in 2000.

"The macroeconomic foundations of the whole region remain relatively stable, displaying a greater capacity to weather the headwinds generated by the Fed's interest rate hike," said Chai.

NEW CHALLENGES

Still, the region is not a monolithic bloc, but a diverse collection of states. Each reacted differently to the four hikes of a quarter point the Fed has in store to gradually reach a one-percent hike in the interest rate.

"An increasingly stronger dollar could lead to a fall in international prices for raw materials and damage the current account surplus of some South American economies that had benefited from the supercycle in raw materials during the last decade," said Chai.

According to ECLAC, South American economies went from an average growth of 0.6 percent in 2014 to a 1.6 percent contraction in 2015, amid a sharp drop in raw material prices and slow growth in aggregate global demand.

Regional exports also shrank by about 14 percent, dragged down by Venezuela (41 percent), Bolivia (30 percent), Colombia (29 percent) and Ecuador (25 percent), among other countries.

South American economies are expected to shrink by 0.8 percent in 2016, mainly due to a 2 percent contraction in Brazil and 7 percent contraction in Venezuela, ECLAC estimates.

The political upheaval swirling around both Brazil and Venezuela is also expected to erode confidence in the regional market and further cause capital flight toward the United States.

Ecuador, according to Chai, could become another concern due to the dollarization of its currency, as a stronger dollar will make its exports less competitive and raise the cost of financing.

"2016 will be a difficult year for South American countries given the adverse situation, but at the same time, it will be a perfect opportunity to boost financial cooperation between China and the region," said Chai.

INTERNATIONALIZATION OF THE YUAN

Financial cooperation between China and Latin America has developed rapidly in recent years, thanks to Chinese President Xi Jinping's three-pronged initiative to use trade, investment and financial cooperation to bolster bilateral ties for mutual benefits.

In 2014, China lent Latin America 22.1 billion U.S. dollars, more than the 20 billion provided by the World Bank and the Inter-American Development Bank together, according to a study by the Washington-based Inter-American Dialogue, a center for policy analysis.

Chai believes financial cooperation with China helps the region to diversify both its models and channels of financing, which not only brings greater stability and predictability, but also allows long-term planning.

China has signed agreements with Argentina, Brazil and Chile to use each other's national currencies to do business, and to open the first RMB bank in the region. Such cooperation has been regarded as firm steps toward the internationalization of China's currency in Latin America, Chai said.

"Faced with the revaluation of the dollar and the rise in financing costs, Latin American countries would have a greater need for the RMB as a cushion," said Chai.

The increasing use of the RMB, within the framework of the currency accords, would cut the cost of commercial exchanges by eliminating the need to use the currently bullish dollar, according to the economist.

In addition, Latin American countries could exchange RMB for dollars, as Argentina has recently done, to build up their foreign currency reserves at critical times and reduce the risk of default.

Chai is optimistic that the RMB will gain circulation in the region in the near future. He called on the Chinese government to give priority to building such a mechanism so that Latin American investors can purchase Chinese financial instruments using the RMB. Endi