War in Ukraine: the effects in Latin America
In August 2008, following the election of a pro-Western government in Georgia, Russia launched a full-scale land, air, and sea invasion of the country. It was a response to alleged aggressions against Abkhazia and, especially, South Ossetia, two Russian-backed, self-proclaimed republics lying at the border of the two nations. In what Moscow denominated a "peace enforcement" operation, the demilitarization of the Georgian armed forces ultimately took place, together with the elimination of the country’s prospects to join NATO. By replacing Georgia, Abkhazia, South Ossetia, and August 2008, respectively, with Ukraine, Luhansk, Donetsk, and February 2022, it is possible to get the entire script of the most dangerous geopolitical crisis in Europe so far in the XXI century.
While the military unfolding of this confrontation is yet unclear, its economic and financial consequences are emerging quite rapidly. For one thing, the mounting Western sanctions against Moscow signify an adverse confidence shock to world capital markets, as they deal a heavy blow to Russian assets along with the vast gamut of counterparts related to them (owners, borrowers that use these securities as collateral, custodians, etc.). Therefore, global investors must reprice their portfolios amid escalating risk aversion and uncertainty, which is seldom an orderly process. For another, there is a medium-term adverse supply shock for commodities produced in the conflagrated areas, the prime examples being fossil fuels, minerals, and grains. In this context, value creation chains should factor in a situation of excess demand that will eventually sort itself out when other producers gradually step in and restore market equilibrium.
What are the relevant facts about those singular events and how do they affect Latin America? As for the financial gyrations, it is true that episodes of escalating risk aversion cause asset prices to move in tandem and in the same direction due to herd behavior of investors. However, these phenomena typically don’t last long, and fundamental drivers ultimately prevail. Against this backdrop, a comparative analysis of Latin American countries vis-a-vis Russia is revealing. Indeed, economic policies, trade links, global investment counterparts, the regulatory framework, political systems, the rule of law and other key institutions are exceedingly different, so much so that over the long haul they lead to low correlations of interest rates, real exchange rates and several variables related to geopolitical risk (Chart I).
Because commodities account for a non-trivial percentage of the GDP, and thus of the operational results of listed companies in all these countries, the correlations of real economic growth and stock markets between Russia and Latin America are significant. But then there are rational grounds to assert that the nature of the present crisis will cause the connection to break up this time. The crashing Russian assets and the sinking economy are self-inflicted disasters that result from a reckless geopolitical gamble. To be sure, there is no deterioration in terms of trade, or an adverse shock generated elsewhere that could also be hitting Latin American nations with the same force. On the contrary, the convolution in commodity markets creates an apt environment for them to be the alternative producers that will step in and help address global supply disruption problems for many primary products.
Out of 11 commodity markets where Russia is a key supplier, with a global share of production in the double digits (Chart II), Latin American countries can step- up output to reduce distress in world value chains in no less than nine: namely, gold, oil, wheat, nickel, barley, platinum, gas, potash, and vanadium. Before this geopolitical crisis, rising prices of primary products were already a boon for Latin America; hence it is valid to argue that the new scenario will give rise to an even stronger tailwind. Conversely, economies in the consumer end, especially in more developed geographies, will face a more challenging environment. For instance, nearly a third of OECD’s total imports of oil & gas are from Russia. In the case of OECD Europe, the percentage is even higher: 39%.1 These nations should feel the pinch of higher energy costs and possible disruptions in supply until alternative suppliers move in to fill the gaps.
Admittedly, the specters of global stagflation and geopolitical conflagration in a critical geography are distressing. Still, it is better to face such upheavals on the winning side of a commodity shock, with strong external accounts, comparatively less public and private indebtedness, relatively lower fiscal deficits, and much higher interest rates to combat inflation. And this is precisely the outlook that characterizes the major economies of Latin America today, except for Argentina and Venezuela. Thus, it is no accident that international investors have been trading regional assets at a premium (Chart III). Indeed, they are doing the same with other favored areas, like Africa and the Middle East.
But what probably gives Latin America a fundamental competitive advantage is its very low geopolitical risk. Any estimation of long-term adverse shocks that resulted from military, political, religious, or ethnic conflicts is likely to find exceedingly small values associated to Latin American nations. The GPR index2, for instance, has recently detected a sharp rise in worldwide dangers that is entirely associated to the Ukrainian war (Chart IV). Furthermore, a scrutiny of the performance of individual countries over the period surveyed by the latest times series (January 1900 to February 2022) reveals that the median score of Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela concerning geopolitical disturbances is 80% smaller than in India, 89% smaller than in China and 96% smaller than in Russia, to compare only with a few large emerging economies. This paramount secular trend should also become evident over the next months.
1 As per International Energy Agency data. According to it, 61% of energy usage in the European Union depends on imports from other regions of the world.
2 Measured according to methodology presented by Caldara, D. and Matteo I. in “Measuring Geopolitical Risk,” Working Paper, Board of Governors of the Federal Reserve, November 2021.
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