Latin America Outlook – Waiting for better times

by: Marijke Zewuster

Latin America is going through difficult times and the risks of further setbacks remain all too real. Accordingly, our forecasts of -0.5% growth in 2016 come with the warning that the risks of lower-than-expected growth remain considerable. After two consecutive years of contraction, we see regional growth moving back into positive territory in 2017 on the back of a reviving export sector, but even then an exuberant recovery still seems unlikely. Apart from external factors such as weak global growth, persistently low commodity prices and heightened risk aversion, internal factors are playing an increasingly important role. The scope for fiscal and monetary stimulus has vanished, which also means there is much less room for the much-needed investments in infrastructure. This casts a cloud over the longer-term outlook as well.

160215-Latin-America-Outlook.pdf (290 KB)
Download
  • Regional contraction for second year in a row
  • Consumer and producer confidence remain at low levels
  • No room for fiscal and monetary stimulus
  • Export sector will ultimately pull the economy out of the through

Renewed contraction in 2016

Late last year we assumed that the worst was over for the region and that reviving exports would kick-start a cautious economic revival in the course of 2016. Based on this outlook, we expected the contraction in 2015 to make way for regional growth accelerating to 0.8% in 2016. Meanwhile, even this modest recovery now seems to be too optimistic and we have reduced our growth estimate for most countries, leading to a lower regional growth estimate of -0.5%. In Brazil we now foresee contraction of at least 3% for this year, while Argentina will not get beyond 0.5% growth. Growth in the Pacific Alliance countries – Chile, Colombia, Mexico and Peru – is also disappointing. Of these countries, only Peru is now likely to expand by more than 3% (albeit only just), while the others must make do with growth rates between 2% and 2.5%. Only a handful of small countries are still doing reasonably well. Panama remains the frontrunner in 2016 with expected growth of just over 5%, followed by Bolivia and Paraguay with growth rates of about 4%. The strongly oil-dependent economy of Ecuador, by contrast, is likely to shrink by at least 1%.

Table ENG LA

Consumer and producer confidence at a low ebb in virtually the entire region

In virtually all countries. except Mexico. confidence in the economy fell sharply last year. Brazil is being battered by a combination of economic and political factors. The sharp slowdown and rising interest rates have sent the public deficit soaring to record heights, putting the country’s creditworthiness under further pressure. Added to this, the unfolding impeachment proceedings against president Rousseff and the corruption scandal around the state oil company Petrobras will remain in the headlines in the coming months. These issues will continue to erode consumer and producer confidence. In Chile, the country with the highest credit rating based on the low public debt (20% of GDP), producer confidence has languished below 50 – the level that separates optimism and pessimism – since the inauguration of socialist president Michelle Bachelet. The low copper price is obviously one factor. But the distrust regarding the centre-left government’s economic reforms is adding to the gloom, as are some corruption scandals surrounding the president’s family. This subdued producer sentiment is clearly impacting on investments. After falling more than 6% in 2014, these grew by at most half a percentage point in 2015. Consumer confidence has also taken a knock. This led to a deceleration in consumer spending from 6% in 2013 to 2% on average over the past two years. An upturn in the country’s fortunes is unlikely before the presidential elections in November 2017.

Graph1

Disappointing US growth and low oil prices is hitting Colombia and Mexico

China is an increasingly important trading partner for Latin America and its diminishing demand for commodities partly explains the malaise. However, the lower-than-expected growth in the US is another factor of no minor significance. The US is Mexico’s strongest trading partner, accounting for no less than 80% of the country’s exports, and also has a hefty share in Colombia’s exports of almost 30%. In addition to the more subdued growth in the US, the slump in oil prices is also affecting these two oil-rich countries. Investments in the oil sector have dwindled and the low oil prices are also putting a damper on the public revenues. This greatly constrains the scope for budgetary stimulus which, in turn, is hitting investments in infrastructure. Mexico still saw investments grow by about 5% yoy for full-year 2015, but a sharp downturn occurred in the last quarter. In November (the most recent figure) investments contracted by 0.4% yoy. With oil prices set to stay low, this trend is likely to continue with investments probably turning out lower on balance in 2016 than in 2015. This, combined with the unforeseen sluggishness in the US, suggests that growth will not get much beyond 2% this year.

In Colombia low commodity prices are also causing a sharp deterioration of the current account. Half of the export revenues consist of oil and commodities in general make up some 70% of exports. Mexico is less commodity-dependent. Only 10% or so of its exports consist of oil, while the manufacturing industry accounts for over 80% of the country’s exports. Colombia ran a current account deficit of more than 6% of GDP in 2015, while Mexico managed to curtail its deficit to 2.5% of GDP. This was one reason why the Colombian peso, along with the Brazilian real, belonged to the currencies that suffered the sharpest declines versus the USD in 2015.

Inflation rising again, but with enormous national differences

All countries in the region saw their currencies weaken to a greater or lesser extent, which created inflationary pressure despite the generally slow pace of growth. Some countries. notably Colombia and Peru, were also confronted with the adverse effects of the El Niño weather phenomenon on food prices. The differences in inflation are enormous, however. Mexico is at one end of the spectrum. Apart from having the lowest inflation, it is also the only country where price levels actually fell last year, namely from 4.1% yoy at year-end 2014 to 2.1% yoy at year-end 2015. In January, however, inflation crept back up to 2.6% due to the weakening currency and rising food prices. Argentina and Venezuela continued to labour under the highest inflation. In 2015 prices shot up by an estimated 30% in Argentina and more than 100% in Venezuela. Inflation in Brazil has been above 10% since November 2015, while Colombia saw inflation jump from 3.7% yoy at year-end 2014 to 7.5% in January 2016. In Chile and Peru inflation advanced to, respectively, 4.8% and 4.6% in January, well above the central bank targets.

Graph2 Graph3

Further interest rate steps likely

Advancing inflation prompted most countries to raise their policy rates in the course of 2015. In addition, Latin America is even more sensitive than other emerging markets to US monetary policy. Despite the favourable inflation development, the central bank of Mexico therefore felt compelled to follow in the Fed’s footsteps and up its policy rate by 25 basis points in December. As the Fed now looks unlikely to raise interest rates any further this year, we also expect rates to stay put in Mexico. This does not apply to countries with high and rising inflation, such as Brazil, Chile, Colombia and Peru. After a long period of stable or falling interest rates, Chile and Peru have – since the second half of 2015 until now – hiked interest rates by 50 basis points, and Colombia by 150 basis points. Colombia’s last interest step was in January. We expect all three countries to raise interest rates further in the coming months, before keeping rates on hold in the second half of the year if US interest rates are also unchanged. Most currencies now appear to be stabilising after the recent sharp declines and are even expected to appreciate somewhat in the course of the year. This, together with disappointing growth during the year, will dampen the inflationary pressure. The last interest step in Brazil was in July 2015, when the rate was raised to 14.25%. Inflation there now appears to have peaked, making the central bank less likely to implement further interest rate increases.

Exports still a bright spot

Despite disappointing world trade growth, the weaker currencies already seem to have given exports a strong impulse in the past year. Looking at the region as a whole, the latest data of the Netherlands Bureau for Economic Policy Analysis (CPB) indicate that the export volume grew by 9.5% yoy in November, with growth for full-year 2015 probably working out at more than 10%. In the same month imports slackened by 1.1%. Latin America thus saw exports grow significantly faster than most other emerging regions. On average, emerging market exports as a whole grew by an estimated 4% yoy in 2015 while world trade expanded by around 2.7% yoy. This, as yet, is insufficient to compensate for lacklustre domestic demand, but we remain confident that the export sector will ultimately pull the Latin American economy out of the trough.

Graph7 Graph8

Argentina offers biggest chance of positive surprises

Hopes of an improving economic tide have risen after the centre-right opposition candidate Macri won the presidential elections last December. However, some caution is in order. Argentina, like all other countries in the region, is contending with the less than favourable global economic conditions and is more sensitive to the economic recession in Brazil than most other countries in the region. In addition, the Peronist of the former president Christina Fernandez still have a majority in parliament. Even more important, however, is that if Macri succeeds in pushing through his much-needed economic reforms to get the economy back on track, this will initially depress growth. Nevertheless, far-reaching austerity measures are crucial to restore the public finances.

Graph6

In addition, inflation will be fanned further by the sharp depreciation of the currency and the abolition of subsidies. More interest rate increases will be necessary to rein in inflation. The public debt swelled to 5.2% of GDP in 2015, bringing the public debt to 45% of GDP, while inflation is estimated at around 30%. The new government has tackled the challenges with great vigour so far: the currency has been devalued by 30% and the capital controls have been abolished. Duties on a broad range of export products have been scrapped, as have most subsidies on energy consumption. The price controls imposed by the previous government on a large number of products have been maintained, however, in order to prevent excessive price rises due to the currency devaluation.

In addition, the government will shortly make a proposal for a settlement with the ‘hold-outs’, the lenders who never agreed to the debt reduction agreements that Argentina reached in the years 2005 and 2010 with the majority of its creditors. Reaching this new settlement will no doubt be a rough ride, but it is a crucial step towards mending relations with the country’s international lenders. All in all, 2016 promises to be a challenging year for Argentina. If the government manages to restore confidence, limited growth this year may be followed by a strong economic revival in 2017. This also increases the chances of the government parties winning a majority in the mid-term parliamentary elections in October 2017.

To conclude

Latin America is going through difficult times and the risks of further setbacks remain all too real. Accordingly, our forecasts for 2016 and 2017 come with the warning that the risks of lower-than-expected growth remain considerable. After two consecutive years of contraction, we see regional growth moving back into positive territory in 2017 on the back of a reviving export sector, but even then an exuberant recovery still seems unlikely. Apart from external factors such as weak global growth, persistently low commodity prices and heightened risk aversion, internal factors are playing an increasingly important role. The scope for fiscal and monetary stimulus has vanished, which also means there is much less room for the much-needed investments in infrastructure. This casts a cloud over the longer-term outlook as well.