Latin America – long live the US

by: Marijke Zewuster

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Growth in Latin America has dropped to the lowest level since 2009. Estimated at barely 1%, the region’s growth rate is the lowest within the emerging market universe in 2014. Nor does the expected recovery in the second half of the year look particularly robust. A substantial recovery is likely in 2015/16 but, as in past years, Latin America will still continue to lag behind the global economy. The revival in the industrial countries – particularly the strong upsurge in the US – is the key driver of the recovery. By contrast, internal developments are increasingly playing a negative role. Due to the deterioration in fundamentals, most countries have no scope for fiscal measures while only a few have room for monetary stimulus.

2014: Worst in class

A year ago we forecast that growth would accelerate from 2.4% in 2013 to 3.5% in 2014. As things stand, however, we would be happy to settle for 1%. The risk scenario we sketched at that time, which assumed disappointing growth in the developed countries and China plus the impact of political uncertainties and a growing risk aversion, appears to have become the base scenario. Increased internal imbalances are exacerbating the impact of a less vigorous global recovery. The result is growth deceleration instead of the expected recovery.

 

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With the exception of Colombia, the seven largest economies are performing poorly. A year ago, we predicted marginal positive growth for both Argentina and Venezuela. But while the data are not extremely reliable, there now seems no doubt that these countries are in recession. Adding to their woes is a strong deterioration of their external financial position and mounting problems in meeting their foreign debt commitments. In terms of political direction and macro-economic policy, both countries occupy an exceptional position in the region. Still, with general elections on the agenda in no less than seven countries, uncertainty over the future political and economic course was also a major unsettling factor elsewhere on the continent. Against this backdrop, not only investors but also consumers, who have long been the main engine of growth, are holding back in a growing number of countries. The growth contribution from private consumption is estimated to have fallen from just over 4 percentage points in 2010 to less than 1.5 pp in 2014. During the same period, the contribution from investments has dropped from 3.4 pp to fractionally negative. In Brazil, investment decisions were postponed ahead of the elections and the cautious recovery of investments in 2013 turned to a substantial contraction early in 2014. In Chile, too, uncertainty over the policy of the new Socialist government headed by President Bachelet was partly to blame for the sharp growth deceleration in the second quarter. However, the chief culprit here would appear to be flagging copper exports.

In Peru, where uncertainty over the economic course is much less in evidence, growth declined nearly as sharply in the same period. Colombia is the main exception. The elections in the spring did not undermine confidence, and both investments and consumption gathered further momentum. Growth in Mexico was disappointing in the first half, but this is almost the only country that appears to have genuinely enjoyed a vigorous upturn in the second half, driven by the recovery in the US and major reforms in the energy sector. Strikingly, smaller economies like Bolivia, Ecuador and Paraguay are doing very well, with expected growth of more than 4%.

 

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Little scope for monetary stimulus

Due to structural shortcomings, many countries – despite their lower growth – are still contending with problems on the supply side, which is causing rising or persistently high inflation. The upshot is that in countries where growth decelerated, inflation either remained high (Brazil) or rose sharply (Chile). During the prosperous years, major steps were taken in large parts of the region, and particularly in Brazil, to reduce poverty and, to some extent, income inequality. However, insufficient investments were made to improve the poor infrastructure and education. As a result, due to a lack of qualified staff and low labour productivity, unemployment levels remain low and wage rises considerable, even in countries where growth is faltering.

Another detrimental factor is protectionism. This can be seen in its most extreme form in Argentina and Venezuela, where government policy not only leads to a misallocation of resources but to actual scarcity and the rationing of goods and services, giving rise to a thriving black market. Moreover, increased risk aversion has caused a significant weakening of many countries’ currencies, which is also having an inflationary effect. However, the lower oil price will help to dampen inflation in the coming period. Interest rates in Chile and Peru may therefore be cut slightly further. In Brazil, by contrast, the end of monetary tightening is not yet in sight. It should also be noted that, with the exception of Argentina and Venezuela, inflation in all countries is below 10% and nowhere near the hyperinflation that held sway in the 1980s and early 1990s.

 

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Falling savings is also inhibiting growth

Throughout the region, little was done during the ‘fat’ years between 2003 and 2011 (with a small dip in 2009) to boost the savings ratio and reduce dependency on foreign capital. The high commodity revenues were mainly channelled to increased consumption and lending. After the financial crisis in 2009, savings in many countries actually shrank at a rapid rate. The savings ratio decreased in virtually all major countries, most notably in Brazil where the already low savings ratio dwindled from 19% of GDP in 2008 to a current historical low of only 13% of GDP. The average savings ratio in the region is 17%, which is below both the non-OECD (34%) and OECD (20%).

The fall in savings is also attributable to a deterioration of public finances. This makes it difficult for most countries to adopt expansionary fiscal policies in order to tackle structural shortcomings in education and infrastructure and give the economy an impulse – not just for the short term but for a more sustained period. Investments also slackened during this period, albeit to a less dramatic extent. Expressed as a percentage of GDP, the regional average retreated from a peak of 21% in 2008 to 19% in 2014. Here too, the region’s countries score poorly compared to other emerging nations, with an investment ratio ranging from 17% in Brazil to 26% in Peru and Colombia. The decline in savings is also reflected in the growing current account deficit. Moreover, the part of the deficit that is covered by foreign direct investments is shrinking and foreign debt is growing. The structure of foreign debt is healthy in most countries, so debt servicing commitments are affordable. In addition, the levels of international reserves also remain high. Nevertheless, the current situation makes countries vulnerable to negative developments. For example, an unexpected spike in interest rates in the international capital market could trigger a rapid further deterioration of these ratios.

Outlook for 2015/2016: long live the US

The major positive for the 2015/2016 growth outlook in Latin America is the worldwide recovery, particularly the strong rate of growth in the US. Another plus is that political uncertainty will be a less prominent factor in most countries in the coming two years. The biggest exception is Argentina, where no improvement is anticipated until the elections in late 2015. Yet another plus, notably for Chile and Peru, is the lower oil price. This factor is less beneficial for Argentina, Brazil, Colombia and Mexico. A lower oil price will temper inflation in these countries, but this positive effect is offset by the fact that their more positive future is based partly on the further development of the oil sector. Investments in this sector may be lower if oil prices remain depressed. On these grounds, we expect regional growth to pick up to 2.5% in 2015 and 2.9% in 2016. This is higher than the growth forecast for emerging Europe, which entails that Latin America is no longer worst in class. Nevertheless, it will once again lag behind global growth.

The deterioration in economic fundamentals is the main reason the growth forecasts for the coming period remain relatively sombre and the risks high compared with the growth rate in the US and the world at large. At country level, Colombia and Mexico stand to benefit the most from the strong growth in the US, so we expect these countries to achieve growth of around 4% in 2015/2016. Meanwhile, the recovery in Chile and Peru will be tempered by the more moderate growth in China. On the upside, however, both these countries still have reasonable scope for economic stimulus measures. Growth is expected to work out at around 4.0-4.5% in 2016. Brazil remains the biggest question mark. We currently foresee that structural imbalances will continue to play a major role in the coming years, and therefore do not expect growth to exceed 2%. In view of the increased imbalances on the balance of payments, the biggest risks are sharper interest rate increases in the international capital markets and a stronger decline in commodity exports. A final concern, now that things are not going so well, is that social unrest may rear its head. The recent protests in Mexico are a case in point.