Latin America will be the hardest hit of emerging regions as the Fed tightens

A striking feature of the latest updated forecasts from the International Monetary Fund was how sharply it cut growth estimates for Latin America. While developing Asia received upgrades and emerging Europe appears to be doing just fine, it is a different story 'south of the border': growth that was already disappointingly slow is slowing further and three of the region's six main economies are expected to be in outright contraction this year (see table).

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Two forces are at play. The first is the end of the commodity supercycle. Latin America is a big primary exporter, whether that is oil (Venezuela, Mexico, Colombia), metals (Chile, Peru) or soybeans (Argentina). Brazil produces all of those and more.

Think of economic growth as a simple sum of four components: corporate investment + net exports + government spending + private consumption. As commodity prices have plummeted they have hit all four components in turn.

Companies (both foreign and domestic) have scaled back investment. Exports have plunged. That has hit government revenues: in Mexico, 35 per cent of the state's income is generated by oil exports; for Venezuela it is more than half. And this, finally, has forced administrations across the region to tighten fiscal policy which, of course, has hurt consumer spending. Talk about a vicious circle.

The second, more recent headwind is the end of cheap money. As the US Federal Reserve prepares to raise interest rates, bond yields and hence debt service costs will rise across EMs. This constrains the ability of Latin American governments, with already battered finances, to offset slower growth with lower taxes or increased spending.

At the same time, portfolio capital will start reversing out of EMs as US yields rise too, leading to regional currency depreciation. Eventually, that will boost exports. But long before the terms of trade adjust, the pass-through from weaker exchange rates will force inflation higher, constraining local central banks from easing monetary policy to help growth. Pretty vicious here, too.

While all EMs will suffer from Fed tightening to some extent, Medley Global Advisors, a macro-policy research company owned by the FT, expects Latin America to be hit hardest. In Europe and Asia, the dominant central banks are still in easing mode. And those two regions are primarily importers of oil and metals and have benefited rather than lost from the fall in commodity prices.

Of course, all cycles turn again at some point and the apparent stabilisation of the oil price and some metals prices has raised hopes for brighter economic prospects in 2016. Coupled with a run of better news, such as Brazil's Petrobras emerging from its corruption scandal, this has sent investors scrambling back into regional equities. But another look at the IMF estimates suggests they should not get too far ahead of themselves. It will be a long time before Latin American growth recovers to even half-decent levels.

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