Latin America Outlook – Agonisingly slow recovery

by: Marijke Zewuster

  • First quarter disappointing, mixed outlook for second quarter
  • Growth estimates again revised down
  • Falling inflation trend offers scope for interest rate cuts
  • Packed election calendar creates uncertainty
  • No adverse Trump fall-out for Mexico as yet
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Latin America lagging behind other emerging regions

The growth gap within Latin America is narrowing. The economies of Pacific Alliance countries (Chile, Colombia, Mexico and Peru) are slowing, while Argentina and Brazil are gradually climbing out of the trough. The first quarter produced a downright poor performance for Chile, Colombia and Peru. Hence the downward revision of our 2017 growth forecasts for these countries. Likewise, we have cut our growth forecast for Brazil (from 1% to 0.5%), partly because of the protracted political scandals (see Brazil Watch: Recovery killed before being born). One exception is Mexico. Nothing so far suggests that the country is suffering from the new wind blowing from Washington. Accordingly, we have reversed our earlier forecast downgrade in March to 1.5%. We now put growth for 2017 and 2018 at 2%. On balance, average growth in the region will slow from 1.3% to 1%. Latin America thus continues to lag behind emerging Europe. Moreover, the growth differential with emerging Asia is widening. Back in 2010, Latin America joined emerging Europe in a powerful recovery from the global financial storm in 2009, but the region now appears unable to latch onto the global growth revival.

  

First quarter disappointing…

Virtually all countries displayed disappointing growth in the first quarter of this year. Argentina just managed to climb out of the red, but Brazil is still undergoing slight contraction. Mexico is the positive exception, being the only country that managed to post unreservedly robust growth (2.9% y-o-y) in the first quarter. The export sector is growing fast and the flow of remittances from Mexican migrants in the US continues unabated. In Colombia, growth picked up for the third consecutive quarter, but remained weak at 1.9% y-o-y. Growth in Peru halved from 4.5% in the third quarter to 2.1%. The worst performer was Chile. After limping along at a lacklustre 0.5% in the fourth quarter of 2016, growth in the first quarter almost ground to a halt, not least due to strike action at the important Escondida copper mine.

… mixed picture for second quarter

The second-quarter data show a mixed picture for most countries. The monthly GDP figure for April declined in Brazil and Mexico after rising in March. Chile, Colombia and Peru saw growth slow in April, although economic activity perked up in May. Both consumer and producer confidence remains subdued in most countries, but the manufacturing purchasing managers index (PMI) in both Brazil and Mexico presents a positive picture. The reading for Brazil dipped slightly in June, but has been above 50, the threshold between growth and contraction, since April. In June, the same index rose to 52.3 in Mexico.

Caught between low commodity prices and politics

The decline in Latin America has persisted for a while now. Since the end of the prolonged commodity price boom in 2014, strong growth has eluded most Latin American countries. The combination of lower commodity prices, turbulent political conditions and the associated weak economic policies plunged Argentina, Brazil and Venezuela into a deep recession. The Pacific Alliance countries were also unable to escape a growth deceleration. Here too, political developments are part of the story. However, in contrast with the three earlier-mentioned countries, these economies remained structurally sound, and thus avoided recession. The sharpest growth deceleration occurred in Chile, Colombia and Peru. In Mexico, which is much less dependent on commodity exports, growth has traditionally been a lot lower, and 2014 was not a turning point. Looking at the smaller countries in Latin America, we also see substantial growth deceleration in Ecuador and Uruguay. Notable exceptions are Bolivia and Paraguay, where average growth continued to power ahead at about 5% per year in both periods.

Scope for monetary relaxation has increased

One positive factor is that inflation truly past its peak in most countries. This opens up scope for lowering the policy rates, notably in Brazil and Colombia. In both countries, inflation showed a spectacular fall to levels close to – and in Brazil’s case even below – the inflation target. Further interest rate cuts therefore remain on the cards in both countries. Chile and Peru have also cut interest rates, but their monetary policy was already fairly expansive, leaving little room for further relaxation. Once again, Mexico is the exception. The combination of prolonged currency weakness and rising food and utility prices pushed inflation sharply higher, and the answer was an aggressive interest rate hike. In addition, Mexico is more sensitive to the Fed’s interest rate policy than other countries. Interest rate cuts are therefore unlikely for the time being. After a strong first quarter, we consequently expect growth to slacken slightly there in the next few months.

  

Elections casting shadow ahead

Latin America has a packed election calender for the coming period. Argentina is set to kick things off in November 2017 with elections for part of the parliament, followed by general elections in Chile in the same month. Colombia will hold parliamentary elections in March 2018 and presidential elections in May. Next, Mexico will choose a new president and senate in June 2018, while Brazil will close the year with elections in October 2018. In most countries, the extra uncertainty surrounding the elections will cause a further postponement of investment decisions, thus posing an extra obstacle for recovery. On the upside, a favourable result for investors could give the economy a substantial impulse. Chile is a good example of a country where political events exacerbated the adverse impact of the lower copper price. After the election of socialist president Michelle Bachelets, business confidence dipped below the 50 mark – separating growth from contraction – and has not recovered since. In particular, a tax reform created a lot of bad blood among businesses and led to a sharp fall in investments. The market is now counting on an election victory for centre-right candidate Piñera. If this happens, and copper prices stage a moderate recovery as predicted, the economy could well bounce back.

Agonisingly slow recovery

The growth deceleration appears to be coming to an end, but the regional growth rate of 1% that we project for this year remains insufficient to compensate for the contraction of 1.3% in 2016. This stands in stark contrast with the strong revival in 2010. At that time, virtually all countries in the region achieved sufficiently strong growth to more than make up for the contraction of 2009. The big difference between then and now is the lack of scope for expansive monetary policies in the last few years. Weaker currencies fanned inflation and actually forced many central banks to raise interest rates. Most governments have also exhausted their fiscal options in the past years. Moreover, the combination of local and global political developments – such as fears of US protectionism – is keeping consumer and producer confidence subdued. Add to this the expected gradual upward interest rate trend in the international capital markets plus the very moderate commodity price recovery, and the scene is set for a limited recovery at best. Just for good measure, most countries are also still contending with major structural imbalances, such as a low savings rate, flawed infrastructure, poor education, and severe income inequality. The conclusion is that, even in the longer term, most countries can only look forward to a moderate growth path.