Country Report El Salvador 1st Quarter 2015

Update Country Report El Salvador 30 Dec 2014

Falling oil prices: winners and losers in Latin America

In the short run, Latin America as a whole will benefit from the recent plunge in global oil prices, but some economies may be hit hard by the market rout. Lower energy costs will have a favourable impact, principally on net oil importers in the region, but falling oil exports and fiscal revenue will hurt the external and public accounts of net exporters, principally those with weaker macroeconomic fundamentals. The Economist Intelligence Unit assumes that the market will stabilise and international prices will rebound in the months to come, with the Brent crude price expected to average US$80/barrel in 2015, down from US$100/b in 2014.

Although world oil prices plummeted by nearly 50% in the second half of 2014, this decline is lower than that experienced in the second half of 2008-at the brink of the world financial crisis-when they plunged by 77%. The global economy is not in its best shape at present, but it is certainly not in the critical condition that marked the start of the recent great recession. This fact confirms our view that the ongoing oil-market rout chiefly responds to a global oversupply of crude, and, to a lesser extent, to demand factors.

Venezuela the most vulnerable

Lower oil prices will have a particularly negative effect on the ailing Venezuelan economy. The country's dependence on the oil industry is extremely high, as it accounts for about 95% of export revenue, nearly 40% of fiscal income and about one-third of total GDP. The government of the Venezuelan president, Nicolás Maduro, assumed a price of US$120/b in the 2015 budget, while it is estimated that prices below US$100/b will make Venezuela's huge government-subsidised programmes unsustainable. Prices close to US$50/b (the level that the Venezuelan crude basket reached at some point in December) severely increase the risk of sovereign default. This risk comes directly from the financial vulnerability of Petróleos de Venezuela (PDVSA, the state-controlled oil company).

In this context, Mr Maduro will probably have to take harsh measures to prevent balance-of-payments and fiscal crises. These measures will likely include devaluation of the currency and some budget cuts, but Mr Maduro will seek to avoid more drastic fiscal adjustment, a rise in petrol prices, or the floating of the exchange rate. Any measures taken will be unpopular and will further undermine Mr Maduro's popular and political standing, already damaged by an economic recession, high inflation and widespread goods scarcity.

Mixed impact on other economies

Other net oil exporters affected by the current oil rout include Colombia, Ecuador and Mexico. Although the Colombian economy has traditionally been well managed and this reduces risks, oil dependence is high, with this commodity accounting for 55% of export revenue, around one-quarter of total fiscal income and more than one-third of foreign direct investment (FDI). Falling oil prices (in tandem with market jitters on account of expected changes in US monetary policy) have already sparked drastic currency depreciation, led to a significant depreciation of the stock value of Ecopetrol (the oil company owned in majority by the state, although with shares floating on the local stock exchange, held by more than 500,000 individuals) and forced the government to revise upwards its fiscal-deficit and public-debt goals for 2015.

Although lower oil prices, together with a recent hike in taxes, reduce the attractiveness of the oil industry to investors, Colombia's free-floating foreign-exchange regime will provide for an adequate adjustment of external imbalances, while a relatively strong fiscal position will enable the implementation of a pro-cyclical fiscal policy. Policy options are more limited in the case of Ecuador, which requires an oil price of around US$120/b to maintain fiscal stability and which already has a high fiscal deficit, of nearly 5% of GDP in 2014.

Mexico's economic vulnerability to falling oil prices principally comes from the fact that the industry provides about one-third of total fiscal income. However, the country has hedged part of its oil-price risks for 2015 and has saved a portion of the oil bonanza in a stabilisation fund, thereby reducing the need for drastic public-spending cuts. Further, it is expected that lower oil prices can help to reduce electricity costs, boosting the competitiveness of Mexico's manufacturing exports at a time of rising demand from a stronger US economy, their main destination. It remains to be seen, however, how lower world oil prices will affect expectations for an increased stream of foreign investment, following the comprehensive energy-sector reform currently being implemented.

Some short-term winners

Indeed, sustained lower crude prices will deter investment in the oil industry throughout the region, but mostly in high-cost shale and offshore projects. This could have particularly negative effects for the development of new key projects in Argentina and Brazil in the medium-to-long run. Nevertheless, in the short term, the impact of the ongoing oil rout will be beneficial to these and other net oil importers as energy costs fall. These include Chile, Peru, Panama and other Central American and Caribbean nations.

While this impact will most likely materialise in improved terms of trade and lower inflationary pressures, it may also help to boost domestic demand as households use their savings on petrol bills to increase consumption and governments (as in the case of Brazil) to reduce subsidies and, consequently, potentially adopt expansionary fiscal policies. In all, however, consumer and investor confidence in the region will benefit if the current uncertainty regarding the future of oil prices, as well as the movements in US monetary policy, subside sooner rather than later.

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