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Liquidations by investors in Latin America spark fears of contagion

An old fear haunts emerging markets again: contagion. Unlike the Russian and Asian crises that hit emerging markets in the 1990s, contagion this time is not primarily a financial market phenomenon. Instead, it has spread through street protests in Latin America that have spooked investors.

The trouble began in Brazil on November 6, when a long-awaited auction of oil deposits ended in embarrassing failure. This gave some investors the excuse they wanted to sell the Brazilian real, given growing risk aversion triggered by weakness in emerging markets. The real lost 2.2% of its dollar value that day, its biggest daily drop in a few months.

In the background, however, a larger crisis was brewing. Street protests had been increasing in Chile since the end of October. A popular uprising in Bolivia was growing. Social and political unrest had erupted elsewhere, in Ecuador, Peru, Brazil and Central America, not to mention Venezuela, hit hard by the crisis.

Things came to a head in the second week of November, when the protests in Chile turned increasingly violent.

On November 11, Evo Morales, Bolivia’s leftist president for almost 14 years, resigned.

The sell-off in regional currencies that followed was broad and deep. The Chilean, Colombian and Mexican pesos fell sharply, while the Brazilian real accelerated its decline.

Social unrest across the region had been brewing for years. But its eruption surprised politicians and investors. Just days before riots engulfed Santiago and Chile ‘s conservative president Sebastián Piñera declared a state of emergency, the billionaire leader gave an interview to the Financial Times in which he described Chile as “an oasis” of democracy, stability and growth in a continent plagued by recessions and political crises.

The unrest in Chile spread to Colombia, where up to half a million people took to the streets in a wave of apparently scattered protests over various grievances. The Chilean and Colombian pesos, and the Brazilian real, rank as the worst performing emerging market currencies in the last month.

Siobhan Morden of Amherst Pierpont Securities , who has long followed Latin American markets, said each country had its own problems. However, she added, the protests were “putting a lot of pressure on politicians to focus on public awareness of the results of austerity and the need for social justice.”

He warned that many countries had little or no fiscal space to pursue countercyclical stimulus policies.

Alberto Ramos of Goldman Sachs believes the protests have implications for markets across the region and beyond. “Contagion increases risk premiums, which creates headwinds as the cost of capital rises and people make more cautious decisions,” he said.

“The populations are much more aware than before,” added Mr. Ramos . “Global tolerance for income inequality and billionaires is falling sharply everywhere.”

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