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Latin America's 2 largest economies are reeling -- and they don't know what comes next

In Latin America, falling commodity prices and uncertainty in some of the world’s most important economies appear to have hit the region’s two biggest economies hard.

These economic struggles, when coupled with political instability, indicate that the region will likely limp to the finish line of 2015 as its powerhouse economies face an uncertain future.

Brazil’s fraught politics and deteriorating outlook

The largest economy in Latin America is a husk of its former self. Economic activity is estimated to be shrinking at 5% per year, with a 2.06% contraction is expected this year.

If that estimate holds true, it will be seven straight years of zero or negative growth for the region’s dominant economy.

At the beginning of August, the real was trading against the dollar at the lowest level in years, and inflation has been predicted to hit 9%, which prompted a half-percentage-point hike in interest rates at the end of July — the largest rate hike in nine years.

Activity in the services sector was at its lowest point since the financial crisis, and the unemployment rate grew to 8.3% in the second quarter of 2015, as 8.4 million of the country’s 204 million people became jobless.

Consumer confidence has fallen to its lowest level since 2005 — when measurements began — and Moody’s downgraded the country’s bond rating to Baa3 with a negative outlook.

“The combined output of the manufacturing and service sectors suffered the largest fall since early-2009,” according to analysis from Markit Economics. “Weak demand, high interest rates, fiscal tightening, strong inflation and rising unemployment are expected to continue to hamper activity.”

This downturn would on its own likely be enough to imperil any politician’s prospects.

But there’s also a wide-ranging corruption scandal involving the state-owned oil company Petrobras has ensnared many leading politicians, including President Dilma Rousseff, and has led to a wave of resignations and indictments.

Rousseff, who was head of Petrobras when the alleged kickback scheme arose, has said she never saw any signs of corruption, even though the scandal has sparked investigations of at least 70 politicians and executives.

Amid the ongoing controversy, Rousseff’s popularity has shrunk to single digits, while almost three-quarters of the country viewed her administration negatively.

A vocal movement has been calling for her resignation. According to polls released in early August, almost 70% of Brazilians believed she should have been impeached, and many legislators were leaning toward a call for the same.

Nevertheless, there may be reason for optimist amid the crisis. Federal anticorruption investigators have not shied from pursuing powerful figures. And opposition legislators have pushed back against members of their own parties who called for impeachment without evidence of wrongdoing.

“So far it doesn’t seem that Rousseff has committed an impeachable offence. … It could undermine their future leaders and parties, as well as the president’s, if impeachment became too politicized,” Shannon O’Neil, the senor fellow for Latin American Studies at the Council on Foreign Relations, told Business Insider.

The resiliency of Brazil’s democratic institutions signals that the country may muddle through, and perhaps eventually emerge from this contentious political atmosphere in better shape.

“The independence of the judiciary and continued investigations suggest that in the end it may strengthen the quality of Brazil’s democracy, forcing it to open up and become more accountable,” O’Neil told Business Insider.

As for the economy, we’ll have to wait and see.

Mexico’s ailing economy and withering crime problem

Latin America’s second-largest economy faces its own broad set of challenges.

Mexico opened 2015 with a GDP growth forecast that reached as high as 4.2%.

Since then, growth estimates have shed percentage points, with the most recent number predicting just 1.75% to 2.5% growth.

The downgraded growth forecast, according to O’Neil, indicates “some overall slowing, but more likely the continued bifurcation of the Mexican economy.”

Some Mexican states, ones with trade links to the US, have continued to grow, while others — ones with energy-focused economies, in particular — have slowed faster than expected.

Other national trends have stoked concern. The Mexico peso reached a value of 17 to the dollar in late August, a new historical low signalling a 15% depreciation so far this year.

Many Mexicans blamed the government for the tumble, and a majority, when polled, doubted it would recover.

Some observers have suggested a cheaper peso could boost exports, but depreciation in other national currencies appears to have stalled that increase, according to Carlos Petersen, a Latin America associate at the Eurasia Group.

“The Central Bank (Banxico) has argued that given the orderly depreciation of the peso, prices have not been affected, but this cannot be discarded from happening in the future,” cautioned Petersen, though he doubted that trade and access to goods would see a major disruption.

Others have cautioned, however, that a weakening peso at a time of stagnant or negligible economic growth could trigger a debt crisis as “the dollar-denominated debt held by Mexican corporations with peso-denominated operating income becomes increasingly difficult to service.”

The oil privatization reforms of President Enrique Peña Nieto, one of his major achievements, have also garnered lacklustre results. In July, the first round of auctions for exploration rights saw only two of 15 available blocks receive successful bids. At the end of that month, state oil company Pemex posted its 11th straight quarterly loss.

The Peña Nieto administration has since worked hard to make the offerings more appealing. In early August, the government sought to add flexibility to the bidding process to attract major oil companies.

“It can be expected that the government will adjust whatever is necessary in the tender terms to avoid another failed bid round,” Petersen told Business Insider in an email.

“The success of the energy reform is key for the administration and they will act in correspondence.”

Amid these broader economic doldrums, Mexican workers have experienced growing poverty and a striking wealth gap.

At the end of 2012, more than half of all Mexicans were living in poverty; 2 million more joined them by 2014. More than half the country reportedly fell short of the monthly minimum income level that is set by the government.

Mexicans also saw their purchasing power decline, and, between 1994 and 2012, wages grew just 2.3% when adjusted for inflation. In terms of real GDP growth, Mexico is 18th of 20 countries in the region.

Meanwhile, 2,540 Mexicans — about two-thousandths of a per cent of the population — hold 43% of the country’s total individual wealth.

Many Mexicans have also had to endure widespread violence in addition to economic hardship. In the last year, scores have been killed in suspected attacks by police, hundreds of migrants have been kidnapped or killed, journalists have been slain, and politicians have been assassinated with impunity.

Moreover, the world’s most powerful drug lord, Joaquin “El Chapo” Guzmán, brazenly escaped a high-security prison in central Mexico in July; an escape Peña Nieto said “would be unpardonable” in early 2014, when the kingpin was apprehended.

Stratfor drug cartels mapCourtesy of Stratfor

El Chapo’s escape notwithstanding, Mexico’s crime problem has taken on a local dimension, with the fragmentation of cartels leading to a proliferation of local criminal groups. To confront them requires, in part, more hearty state and local institutions.

“Some cities and states have shown successful efforts on this regard,” Petersen told Business Insider, “but places like Guerrero, Michoacan, or Tamaulipas face more challenges given the weakness of their local institutions.

Mexico also faces a mixed economic outlook. Both O’Neil and Petersen noted that the weakening currency had not yet led to inflation or higher prices, but neither has it caused a major boost to exports.

Moreover, growth remains a concern, as the government has few “tools to meaningfully boost growth,” the Eurasia Group said in a note on August 31.

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