Can Latin American Central Banks do ‘whatever it takes’?
When it comes to systemic risk, governments are required to do ‘whatever it takes’ — but even that is a privilege developing and emerging economies cannot afford.
by Sebastián Carvajal, a heterodox economist interested in monetary theory and policy & María Gabriela Palacio, a political economist interested in development studies and social policy
As we grapple with the extent and severity of the COVID-19 outbreak, we are coming to terms with the idea that this crisis is not comparable to the 2008’s financial crisis nor to the Great Depression of the 1930s, some analysts have referred to this period as one of a war economy. We are required to (self)isolate and contemplate the imminent cessation of economic activities and payments, breakages of supply chains and the inability to move labour around. The collapse of trade, FDI, banking and credit, insurance and merchandising are taking place concurrently and everywhere. We are all in uncharted territory. Collective efforts to flatten the curve have become urgent to mitigate a crisis full of unknowns but required to adapt to the limited capacity of healthcare systems — a result of years of underfunding. Economic policies devised to mitigate the cessation of economic activity around the world, are unable to subdue the elitist, gendered, racialised, ableist and ageist workings of the stratified systems that are in place. Policymakers did not anticipate a worldwide shutdown like this.
Economic, political, and social forces mediate a crisis like COVID-19. While advanced economies are injecting liquidity in the system, in what resembles quantitative easing to the state, developing economies seem unable to contain the negative multiplier effect of this crisis. Global markets will take a while to recover. Even when the lockdown measures cease it might be impossible to return to a November 2019 scenario. Further, this crisis intersects with aspects of precarity that were brewing in Latin American economies. The region had witnessed an increase in informal activities, mostly own-account work — usually at the lower-tier of the income distribution, to pick up the slack left by cost-cutting strategies and limited formal employment creation. The stark reality of informal workers has become evident through the implementation of mitigation measures, as they lack economic security to take sick leave or cope with unexpected emergencies, including unemployment, sickness, or loss of income. Social (or rather, physical) distancing and lockdown, two of the critical containment measures implemented in March 2020, remain privileges for formal workers covered by social security. Note that 53 per cent of Latin American workers operate in the informal sector. Informal and unpaid work, particularly care work, and the lower-tier of frontline health work where women are overrepresented has intensified. Workers in the formal sector also have less protection, as the increased risk and uncertainty for employers make them unwilling to take any costs, including the protection of wages and observance of labour regulation. The debts of many workers, formal and informal, might not be repaid because operations have ceased. Informal dwellers, homeless migrants, own-account and casual workers, small businesses cannot afford to be idle nor stay home. Migrants are not allowed to move across and within countries, and as a result, many have lost their livelihoods. Entire populations are left to their means to navigate the harshness of markets without state-provided social protection or distrusting a state that is associated with violence instead of protection.
Given the interconnectedness of Latin American economies with global markets, the impacts of this crisis are manifold. Lockdown measures have disrupted global value chains, both goods and services. The volumes and values traded globally have severely decreased, also affecting merchandising and insurance. Given its production structure, Latin America is particularly affected by the slump in commodity prices. In the first month of lockdown measures, UNCTAD estimated that energy prices fell by 55 per cent — and are likely to stay low. ECLAC estimates that the value of Latin American exports to China, strategic partner for many countries in the region, could drop by as much as 10.7 per cent. Finance has reacted more intensively and rapidly. FDI has come to a halt. However, despite the decline in new flows of capital to the region, we have seen a surge in capital outflows next to a tightening of financial conditions, as financial markets adapt to increased uncertainty and fragility, returning to safety. At the same time, the increase in the yield of bonds from emerging markets has made borrowing more expensive, next to currency depreciations that have increased debt costs that are denominated in foreign currencies. For Latin American governments to buffer the effects of external transmission of this crisis and ensure social protection for their population, coordinated efforts are needed to lift some of the financial constraints, including debt-resolution strategies. This crisis requires a change in global architecture to increase liquidity: the IMF suggested that 2.5 trillion dollars in extra liquidity would be needed to safeguard emerging economies. Although such a figure would appear unimaginable, it has been done before, the reason why UN frames the recovery needed as a Global Marshall Plan. The severity of this crisis not only calls for debt restructuring but the introduction of capital controls to contain the haemorrhage of capital that developing economies have experienced amid this pandemic.
Considering the levels of volatility and external vulnerability exacerbated by this crisis, it would seem as if the region is headed towards another ‘lost decade’, with severe consequences in terms of poverty and inequality: ECLAC anticipates an increase in the number of people living in poverty to jump from 186 to 220 million in 2020. As Latin American labour markets are largely informal, discussions on basic income have gained prominence — note that in the global North, Spain is considering a permanent universal income while more radical proposals include the nationalisation of the payroll. The provision of a basic income would not necessarily act as an equalising instrument but is merely intended to provide own-account and casual workers with some income support. Yet, this crisis has made evident the limited policy space of Latin American economies. With reduced financial flows, balance of payments problems, and other foreign constraints, severe fiscal problems will emerge, and alternatives such as basic income seem unattainable. Considering these limitations and urgency of the response, it is time to think about unprecedented policy instruments. There is no possibility for the economies in the region to carry on without fiscal stimulus given the negative multiplier effect of lockdown measures. A bold response would be a helicopter drop: either printing money or creating digital currencies, to give cash to people — no strings attached. To pre-empt concerns that this measure would be inflationary, it should be noted that at the moment there is a slump in labour income and thus on demand. Inflation might come from production, but that has also come to a standstill and it is uncertain when it would pick up. As of now, printing money is necessary to have not only the economy but the people who depend on it, survive. But then again, the possibility to do so is mediated not only by economic but political forces, both domestic and global actors.
Urgent and unprecedented alternatives are especially important for Ecuador. As the government struggles to bury the dead as bodies are left in the streets of Guayaquil — not all attributable to COVID-19 as tests are not widely available — it also faces the daunting task of keeping a resource-based economy afloat. While the government failed to make USD 200 million in bond interest payments due to the urgency of the public health crisis, it still made a USD 325 million principal payment on its 2020 bond due in March. As a dollarised economy, Ecuador is hamstrung in terms of conventional monetary policy. With energy prices at a historical minimum and damage to the oil pipeline, by traditional methods, the only influence it has over the money supply is through preventing outflows, hence the urgency for a debt moratorium and capital controls. While the government deals with external pressures and resolves debates of whether a default would backfire, the possibility of major social and political unrest demands the use of exceptional monetary policy tools to provide some form of support to its population.
One such tool is that the Central Bank of Ecuador (Banco Central del Ecuador, or BCE) to expand its fractional reserve banking modality and create accounts for any household on its balance sheet while keeping only a fraction of its deposits as liquid reserves, just as any commercial bank mobilises financial resources through credit. Through this expanded balance sheet, the BCE could allocate direct cash transfers to households. The BCE already has such a tool in place, known as electronic money (dinero electrónico), which has the advantage of using mobile technology, e.g. text messaging, as a payment medium. Given the widespread access to mobile phones in the country, this medium could reach most of the population. Nevertheless, international reserves might be affected in the medium- and long-term. To prevent the risk associated with international reserves, it is crucial to restrict (or postpone) convertibility next to imposing capital controls during the emergency response. Once the dust settles, it would be necessary to design instruments to capture the potential excess of liquidity resulting from this response. Monetary financing of extraordinary cash flows appears unavoidable. Meanwhile, questions as to who and for how long should receive basic income remain open to debate. Even if COVID-19 measures affect disproportionately the poor, the erosion of social and economic rights has shown the levels of vulnerability that low- and middle-income families experience, as they are left to their own means in a context of marketised and stratified provisioning of health services and social protection. In a region with a long pedigree of targeted social programmes and laboratory of the popular conditional cash transfer scheme, reintroducing universal provisioning might be met with resistance. Yet, in the face of major health and economic crises, the administrative costs of surveying and selecting beneficiaries would add unnecessary pressure to an already overwhelmed system — let alone the socially divisive effects of targeting. And even if the response leans towards a universal basic income (UBI) delivered to all without means-test or conditions, accompanying fiscal resources are needed to expand public health coverage as the system is substantially commodified, with Ecuador exhibiting one the highest out-of-pocket (OOP) health expenditure shares in South America.
When it comes to systemic risk, governments are required to do ‘whatever it takes’ — but even that is a privilege developing and emerging economies cannot afford. It is not necessarily the virus but the measures adopted which have uneven consequences on human lives, resulting in a system of make live or let die. When we eventually step out of this crisis, we would have learned about the global architecture, our governments and their priorities.
