The Covid-19 pandemic was the quintessential global event, as it had adverse sanitary and economic effects worldwide. However, the pandemic has not affected every world region to the same extent.

Latin America has been particularly hard-hit. Despite representing only 8% of the world’s population, it accounted for 16% of global cases and 29% of diseases in 2020 and 2021. In the economic arena, distinctive characteristics made Latin America more vulnerable to the pandemic shock. The prevalence of small and medium-sized firms and the high importance of contact-intensive sectors amplified the adverse effects of lockdowns (IMF, 2020). Moreover, the region had little fiscal space (Nieto-Parra et al., 2021; OECD, 2020), so the income support was smaller than in other parts of the world. Hence, the contraction in economic activity was sharper, and the recovery was slower in Latin America (Werner et al., 2021).

Things also did not go well regarding non-resident holdings of government debt, which, as we explain below, are critical to long-term growth and economic development. Those holdings frequently diminish in Emerging Market and Developing Economies (EMDEs) during turbulent times, such as a pandemic, as risk appetite falls and investors move into less risky assets. That was the case in Latin America, where non-resident holdings fell by more than 10% in the first half of 2020. However, surprisingly, they remained 9.3% below their level of 2019 by the end of 2021 (Figure 1, panel A). Moreover, among EMDE regions, Latin America was where the non-resident holdings fell most (Figure 1, Panels A and B).

These developments are worrying since non-resident holdings are essential for long-term growth in countries that are not rich. EMDEs have lower saving rates than advanced economies (AEs) and thus rely more on foreign savings to finance investment (Blanchard and Fischer, 1989; Obstfeld and Rogoff, 1994). Furthermore, foreign investors are more prone to finance projects with high productivity and risk since their portfolios are frequently more diversified (Obstfeld, 1994; Dumas et al., 2000). In the medium-run foreign investors also contribute to macro-financial stability because they foster more liquid financial markets.

In a context where the performance of Latin America in terms of non-resident holdings was lousy, several questions arise. Was that performance only associated with the pandemic? Are the factors explaining the underperformance relative to other EMDEs only transitory -e.g., lower fiscal space and economic activity- or the decline in non-resident holdings is part of a structural adjustment?

To approach these questions, we study non-resident holdings in Latin America over a more extended period (Figure 1, panel C). The data shows that, after reaching a peak in the second quarter of 2018, those holdings started to fall long before the first case of COVID-19 appeared. This finding suggests that some of the factors explaining the underperformance of Latin America may be unrelated to the pandemic. Since COVID-19 is a transitory phenomenon, it also indicates that the reduction in holdings in 2020 and 2021 may have also been due to non-transitory (“more permanent”) factors.

Panel D of Figure 1 is consistent with this possibility. The panel decomposes non-resident holdings into transitory and permanent components. It shows that the fall in non-resident holdings that started before the pandemic in Latin America was mainly due to the permanent component. Focusing on the pandemic, Panel C confirms that the fall in non-resident holdings in 2020 and 2021 stemmed not only from transitory but also permanent factors.

Furthermore, the reduction in the permanent component of non-resident holdings has been accelerating in Latin America (Figure 2, panel D). While this component has been rising in Asia, its decline has been slowing down in emerging Europe. This finding suggests that non-resident holdings may take longer to recover in Latin America than in other EMDEs regions.

Similar conclusions arise as we take a long-run perspective and use long-term GDP growth as a benchmark. Figure 2 shows that the permanent component accelerated in all EMDEs regions in the mid and late-2000s, when global financial integration deepened and AEs adopted unconventional monetary policies for the first time (Shin, 2012; Rey, 2015; Davis and Van Wincoop, 2021). [1] Thus, the permanent component started to grow faster than long-term GDP growth in two EMDEs regions, Latin America and emerging Europe. [2] 

However, this “high” growth of non-resident holdings lasted much longer in Latin America -36 quarters-, suggesting that the period of low growth may also have to last longer in this region. This evidence again suggests that non-resident holdings may take longer to recover than in other EMDEs regions.

Hence, there are signs that the recent decline in non-resident holdings may last longer than initially expected in Latin America. This decline is partially due to permanent factors and seems related to a high accumulation in the mid and late-2000s, when AEs adopted unconventional monetary policies. Thus, the current US monetary policy normalization process may amplify the adverse effects. On the other hand, other factors may act in the opposite direction. The end of processes through which China entered government bond indexes, e.g., the WGBI index, is critical. Throughout these processes, non-residents accumulated large amounts of Chinese bonds (Figure 2, panel B), potentially reducing their appetite for Latin American assets. Hence, the end of such processes may benefit Latin America by fostering a faster recovery in non-resident holdings. In any case, the region should strive to minimize negative impacts. It should maintain investor confidence to reduce the adverse effects of negative shocks and promote an efficient allocation of government spending to mitigate the damaging effects of diminished financing.

Note: The views expressed herein are those of the authors and do not necessarily reflect the views of Banco de México. This bank shall have no liability to any person for any errors or omissions in any of the data, charts, or information contained within this paper or for any actions taken in reliance on the same, We thank Daniel Pérez for his outstanding research assistance. Please address correspondence to martintobal@hotmail.com.

1. These authors emphasize the increased importance of global factors in driving capital flows during that period and their role in fostering a surge of inflows into EMDEs. Shin (2012) emphasizes the role of high-risk appetite, represented by a low VIX index and lightly regulated global banks; Rey (2013) also emphasizes the role of high risk-appetite; and Davis and Van Wincoop (2021) identify an upturn in the global financial cycle over that period.

2. In the long run, a region’s non-resident holdings cannot grow faster than GDP since, otherwise, that region would be unable to repay its debt. Thus, we can argue that the permanent component of non-resident holdings is growing too fast if it has been growing faster than long-term GDP for a long period.

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International Monetary Fund (IMF). 2020. Regional Economic Outlook for the Western Hemisphere, October 2020. https://www.imf.org/en/Publications/REO/WH/Issues/2020/10/13/regional-economic-outlook-western-hemisphere.

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