Brazil's economic recession may end up affecting all other Latin American countries, especially its closest neighbors: Argentina, Uruguay and Paraguay. The negative effects of this situation will be mostly felt on trade but they will also impact tourism, foreign direct investment (FDI), and fund flows, among others. However, according to BBVA Research, the general effect of Brazil's negative circumstances is not strong enough to bring a crisis situation to other countries in the region.
According to a report by BBVA Research on the extent to which Brazil's problems will affect other countries in the region, Argentina may suffer the most. This is mostly due to Argentina's export volume to Brazil. "After six quarters of one standard-deviation shock to Brazil's GDP (2.5 percentage points), the accumulated impact is approximately 0.8 p.p. in Argentina, just over 0.6 p.p. in Uruguay and around 0.4 p.p. in Paraguay." Among Andean countries, only Peru could be impacted because of reduced FDI; the effect on all other economies, including Mexico, is very low.[DS,E1]
Economic recession: main channels for contagion
According to BBVA Research's report, the general effect of Brazil's negative circumstances is not strong enough general to bring a crisis situation to other countries in the region. Nevertheless, it could contribute to this scenario in some specific cases.
One of the main channels for contagion of Brazil's economic crisis is trade. Argentina (around 6%) is the biggest exporter to Brazil, followed by Mexico and Chile (approximately 2% each). However, Argentina would suffer the most from a sudden decrease in Brazil's demand since most of Argentina's exports are manufactured goods. Although Uruguay and Paraguay export 22% and 12% of their goods to Brazil respectively, the impact of the current recession is mitigated by the fact that agricultural raw materials account for a high percentage of these exports.
On the other hand, Brazil's FDI has increased significantly in the last few years. This investment plays a major role in the GDP of some countries in the region such as Uruguay (around 6%), Paraguay and Peru (around 2%) and, to a lesser extent, Argentina (1%). And these countries would suffer the most from the reduced FDI of Latin America's largest economy.
In terms of fund flows and property investments, the greatest beneficiaries have been Argentina and Chile, especially in relation to equity. However, according to BBVA Research's analysis, the overall weight of these investments is not significant: they represent 0.6% of GDP in Uruguay and Paraguay and only 0.1% in all other countries. However, financial investments in Latin American assets are influenced by the performance of Brazilian shares; consequently, a pronounced drop in Brazil's financial assets could spread to all other countries in the area.
Another channel for contagion is tourism. A high number of Brazilian tourists visit Mercosur countries; nevertheless, this type of tourism has reduced importance in the countries' economy – it accounts for only 0.5 of Uruguay's GDP, 0.3% in the case of Paraguay and 0.2% in the case of Argentina.
Lastly, Brazilian banks have expanded significantly in the region, and reached high market share in some countries: in Paraguay they represent 20% of the banking market; in Uruguay, over 10%; in Colombia and Chile, around 6% once mergers/acquisitions are approved; and in Argentina, approximately 4%. BBVA Research believes that there is risk of contagion through this channel. However, the fact that branch offices –rather than subsidiaries– are predominant helps to restrict the shock effects.