- Regional growth to accelerate from 0.8% in 2018 to 1.7% in 2019
- This is below the long term regional trend and less than global growth
- Chile, Colombia and Peru remain the strongest growers
- Only moderate growth in Brazil and Mexico, Argentina to remain in recession
- Significant downward risks for all countries
2018 was a turbulent year
The economic recovery faltered in 2018. At the start of last year, we still expected growth to accelerate from 1% in 2017 to 2% in 2018. Now, a number even lower than the 1% of 2017 looks likely. One key reason for the disappointing growth was the upsurge in risk aversion towards emerging markets amidst mounting global uncertainties. This prompted sharp currency depreciations as well as monetary tightening. Another factor was the political uncertainty in the run-up to the elections in Brazil, Colombia and Mexico. Furthermore, the figures are being distorted by the spiralling crisis in Venezuela. The fifth-largest country in the region saw its economy contract for the fifth year in a row. No exact data are available, but estimates suggest that the economy has more than halved since 2014. Omitting Venezuela, regional growth in 2018 is somewhat higher than 0.8%, but still only a meagre 1.5%.
Argentina hit heaviest by increased risk aversion
Except for Venezuela, Argentina had the toughest ride last year. A toxic combination of a large current account deficit, a substantial foreign debt, weak public finances and towering inflation made the country extremely vulnerable to the increased risk aversion. The resulting strong capital outflow triggered a full-blown currency crisis in April 2018. To stem the currency’s decline, the central bank had no option but to jack up interest rates. When the Turkish lira came under strong pressure in the summer of 2018, the Argentine peso plummeted again, bringing the country to the brink of a liquidity crisis. Argentina was compelled to knock on the IMF’s door for a huge bailout package in a bid to avert new debt payment problems. A three-year stand-by loan of no less than USD 57bn was agreed with the IMF. This restored calm to the currency and capital markets. In return, however, president Macri was forced to abandon his ultra-cautious reform policy in favour of more draconian austerity measures. Combined with sharp interest rate increases, this pushed the economy into a renewed recession. To make matters worse, agricultural production was afflicted by severe drought.
Political uncertainty impeded growth in Mexico and Brazil
The elections kept Brazil and Mexico on a knife edge almost throughout 2018. As the elections drew nearer, confidence ebbed away and investment decisions were put on hold. In Mexico, confidence was further undermined by the negotiations about the renewal of the free trade agreement with the US and Canada. The convincing victory of the left-wing Lopez Obrador (AMLO) and his Morena party in mid-2018 did not help matters either. As a result, Mexico failed to benefit from the vigorous economic performance in the US, with growth in 2018 remaining stuck at an estimated 2%, the same level as in 2017. In Brazil, by contrast, confidence revived after the ultra-conservative Bolsonaro won the elections in late October. This, however, was too late to have a positive effect on growth in 2018. All in all, growth in 2018 will probably work out at 1.5% – lower than the 2.5% we foresaw in early 2018 but still above the 1% realised in 2017.
Subdued outlook for 2019/20
The outlook for 2019/20 is mixed. Looking at the global dynamics, these are moderately positive for economic growth in the region. Whilst some global weakening is likely, we do not expect a recession in any of the major countries or trade blocs. We are also moderately positive about the outlook for commodity prices and do not foresee further monetary tightening in the US. In addition, our baseline scenario assumes that the trade war between China and the US will not escalate.
Homing in on the region itself, the sharp depreciation of most currencies has been good for competitiveness. Consequently, the current account deficit has decreased further in most countries, making them better able to withstand external shocks than in the past year. Despite the currency depreciation, inflation in most countries is under control, so there is less reason for monetary tightening. Particularly if, as we assume, the Fed will not raise rates further in the US. Political uncertainty will also play a less prominent role in the coming period. Most countries are not due to hold major elections in 2019 and 2020. One important exception is Argentina, where presidential elections are scheduled in October.
Unfortunately, alongside these reasonably positive factors, many uncertainties and structural flaws continue to bedevil the region, so that we only expect moderate growth in the coming years. The main external uncertainties stem from the US-China trade conflict, while the most important internal uncertainties relate to political and public finance issues. Though few elections are on the calendar, social unrest is never far away, particularly in those countries where weak public finances necessitate further austerity. Given the increased political polarisation, the governments in Brazil, Colombia and Mexico will also face stiff opposition in their efforts to keep their election promises. The deepening crisis in Venezuela and the flow of refugees out of the country constitute yet another source of concern. All in all, we expect regional growth to rise slightly from 0.8% in 2018 to 1.7 % in 2019. Latin America will thus lag behind other emerging regions and also remain below its already rather tepid long-term average of 2.3%.
Chile, Colombia and Peru remain the strongest growers
Prolonged periods of exuberant expansion are the exception rather than the rule in Latin America and alternate with periods of debilitating decline. Chile, Colombia and Peru boast the highest average growth over the past twenty years. These are also the countries that have implemented the most structural economic improvements since the mid-1990s. Compared with the likes of Argentina and Brazil, they have experienced fewer and less severe recessions since the 1990s. Chile, Colombia and Peru also have the best prospects now. In Chile and Peru, the expected revival of the copper price adds lustre to the growth outlook. And in Peru, heavy investments in mining can further stoke the economic engine. Moreover, both countries enjoy a relatively low public debt, moderate inflation and a limited current account deficit. In Colombia, investments in infrastructure and relatively good oil prices can prove to be vital propellants of growth in the coming period.
Whereas the election of left-wing president Andres Manuel Lopez Obrador in Mexico led to concerns in the financial markets, the victory of ultra-conservative Jair Bolsonaro in Brazil was greeted with more optimism. Nevertheless, our growth expectations for both countries are largely similar. One reason is that growth is driven less by internal politics than by the global growth picture and the structural shortcomings in the countries themselves (which will obviously not improve overnight). We expect the pace of economic reform and change to be modest in both countries. Now that the elections have brought clarity about the new government, investments will recover in both countries.
Alongside the more settled political landscape, another factor stimulating investments in Brazil is the low inflation outlook and, therefore, continuing low domestic interest rates. On balance, we foresee growth of 2.5% per year in 2019/20. The biggest uncertainty is whether the right-wing conservative government, which took office on 1 January 2019, will manage to steer the promised economic reforms through Congress. The chance of failure is very real given the deep divisions in this legislative body. The fragile state of the public finances remains the main inhibitor, therefore.
For Mexico, we see growth stabilising at 2% in the coming years. Due to the growth slowdown in the US, exports will expand at a more moderate pace. This, however, will be compensated by domestic spending. Despite doubts about the political course, the new trade agreement with the US and Canada will encourage companies to invest more. Inevitably, however, unrest will flare up from time to time. A recent example of this occurred even before the new president was installed on 1 December when the announcement of the discontinuation of the construction of a new airport caused a sharp fall of the peso and an increase in the CDS premiums. The scrapping of the airport plan also led rating agency Fitch to change the outlook for its A+ credit rating to negative. Investors can, however, derive some comfort from the government’s professed commitment to budget discipline. It’s worth noting, incidentally, that Mexico is still far more creditworthy than Brazil.
Argentina remains the most vulnerable country
Venezuela aside, Argentina is the biggest economic question mark. Though the sharp currency depreciation last year and the ensuing recession has led to a strong reduction in the current account deficit, the foreign debt is still so large that the country remains vulnerable. The IMF bailout package provides an extensive safety net, but has provoked sharp protests and the re-election of president Macri in October 2019 is very much in doubt. All in all, we assume that the economy will clamber out of the trough in the course of the year on the back of accelerating exports and an improving agricultural outlook. However, the recovery will be insufficient to prevent contraction for the year as a whole. Moreover, the downward risks remain even more substantial than for the other countries in the region.