Explosive mix of recession and political developments hits the region
April 20, 2016
Concerns are mounting regarding the health of Latin America’s economy. The region fell deep into recession toward the end of last year and there is no sign that relief is coming any time soon. Moreover, politics in Brazil, Peru, Venezuela and, to some extent, Colombia, took center stage at the outset of the second quarter this year.
In 2015, the region’s overall economic activity contracted 0.1%, which followed a five-year period in which the economy grew, on average, 3.6%. The last time Latin America experienced an economic downturn was in 2009 when the global financial crisis hit the economy. Brazil and Venezuela account for the lion’s share of the recession within the continent, while overall economic weakness was observed in the rest of the region. Argentina, Chile, Mexico and Peru were resilient to the downturn in 2015 and actually grew faster than in 2014.
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Economic weakness persisted at the start of 2016 and the region continued to face strong headwinds in the form of lower commodities prices, a deterioration in investor confidence, heightened financial volatility—particularly in foreign exchange markets—and a more challenging global economic backdrop. Consequently, Latam’s already severe economic contraction observed at the end 2015 deepened further in the first quarter of this year. According to an aggregate GDP estimate, the economy is expected to have contracted 1.4% year-on-year in Q1, which was down slightly from the 1.3% decrease observed in Q4. Heading into Q2, weak economic growth will be the norm in a region that, nonetheless, is beginning to feel some relief from abroad. The external environment has recently shown signs of improving and commodities prices, in particular prices for oil, are sending signals of a gradual, albeit subdued, recovery. These factors, along with recent weakness in the U.S. dollar—on the back of the Fed’s more dovish monetary stance—are providing currencies in the region with a more supportive environment. It remains to be seen, however, whether financial stability will persist in Q2.
The combination of fragile economic growth and ongoing political developments in some countries in the region could disrupt the current stable environment. Moreover, a recent leak of documents, dubbed the “Panama Papers”, with sensitive information regarding offshore tax heaves, the creation of shell companies and potential illicit activities is starting to reverberate across the region. In Brazil, political turmoil continued and, on 17 April, the country’s Chamber of Deputies voted to continue with impeachment proceedings against President Dilma Rousseff. The result was in line with expectations and the case will now be passed on to the Senate, where a simple majority will be required to make Rousseff step down temporarily. In Peru, the result of the 10 April presidential elections showed that populist right-wing Keiko Fujimori and center-right Pedro Pablo Kuczynski will face one another at a runoff election on 5 June. Despite the runoff, the two right-wing candidates are expected to guarantee Peru’s market-friendly economic model. In crisis-stricken Venezuela, a malfunctioning economic system and the tense political situation are worsening the tug of war between the opposition-dominated National Assembly and the executive power dominated by Nicolás Maduro. In Colombia, a final agreement for the peace process between the government and leftist guerilla groups is not likely to materialize any time soon. The longer the negotiations take, the more concerns could grow, thus affecting President Juan Manuel Santos’ already-low approval ratings and his ability to mobilize political capital.
Meanwhile, the finances of leaders and businesspeople across Latin America have been left exposed as confidential documents obtained from a Panamanian law firm were made public on 3 April by a German newspaper and the International Consortium of Investigative Journalists. The exposé of the available documents has shed light on the financial affairs of some of the world’s richest and most powerful individuals, including a number of leaders in Latin America, and has sparked immediate global response, with some governments around the globe launching investigations into potential illicit activities and wrongdoing. Some repercussions have already been seen around the world—Iceland’s prime minister and Spain’s industry minister are the latest casualties. Nevertheless, it will take some time before the full implications of the leak fully emerge.
Latin America descending the stairway to recession for the second consecutive year
The economic outlook for Latin America remains bleak. While a slow pick up in commodities prices this year could provide some relief, a protracted recession in Brazil—the region’s largest economy—and Venezuela, as well as tight fiscal and monetary policies across the region, will continue to weigh heavily on Latam’s economy. Overall economic growth in the region is expected to be negative for a second consecutive year. Analysts polled this month by FocusEconomics project Latin America’s GDP to decline 0.3% in 2016. This month’s forecast was cut by 0.2 percentage points from last month’s projection and reflects analysts’ downward revisions for almost all the economies surveyed. Rising concerns regarding the health of Latin America’s economy has prompted analysts to reduce the region’s GDP forecast for 2016 for 16 consecutive months.
Looking at some of the region’s economies individually, analysts made substantial cuts to the projections for Argentina (-0.4 percentage points), Ecuador (-0.4 percentage points), Paraguay (-0.4 percentage points) and Uruguay (-0.3 percentage points). Meanwhile, the region’s largest economies, Brazil and Mexico, experienced only mild reductions to their forecasts in this month’s survey. Next year, the region’s economy is expected to perform better and grow 2.1%.
BRAZIL | Rousseff’s impeachment nightmare continues
Brazil entered the deepest recession in over two decades last year as high inflation, abysmal confidence levels and low prices for exports rocked the economy. At the outset of 2016, the recession shows no sign of abating. Industrial production tallied the largest drop since December 2013 in February and consumer confidence fell in March. Moreover, political noise is drawing the government’s focus away from much-needed fiscal adjustments and economic reforms—interfering with a potential recovery. After days of intense debate, the lower house of Congress voted to move forward with impeachment proceedings against President Dilma Rousseff on 17 April. The impeachment hearing will now move to the Senate and if a majority of senators vote to continue with the proceedings, Rousseff will have to step down for a maximum of 180 days while the trial continues.
The recession is expected to continue throughout this year as political uncertainty impedes an improvement in confidence levels and reform implementation. FocusEconomics panelists see the economy contracting 3.5% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, the panel sees the economy recovering slightly and growing 0.7%.
MEXICO | Credit rating outlook lowered on prospects of worse public finances
Economic growth is holding up well at the beginning of the year. A modest expansion in economic activity in January eased concerns raised by the latest Q4 GDP data that the economy may be decelerating more rapidly than expected. Meanwhile, the manufacturing sector continued to be robust in Q1 and received an extra boost from its U.S. counterpart in March. Moreover, consumer confidence improved timidly in March, although it remains weak despite low inflation, growth in employment and a strong influx of remittances. On a negative note, Moody’s downgraded Mexico’s A3 credit rating from stable to negative on 31 March, citing the potential impact of external headwinds on the government’s fiscal consolidation measures. The government recently released a preliminary draft of its Macroeconomic Framework for 2016 in which it outlines the design for next year’s budget and continues to highlight the importance of fiscal consolidation.
Strong consumer fundamentals—growing employment, rising real wages, and increasing remittances and credit—will continue to support private consumption and, in turn, overall economic growth this year. However, persistently low oil prices, public expenditure cuts and sluggish growth in the U.S. manufacturing sector will limit more meaningful growth. Analysts expect GDP to increase 2.4% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, the economy is seen accelerating to a 2.8% expansion.
ARGENTINA | Economy expands remarkably in 2015 supported by strong agricultural production
Argentina’s national statistical office recently began publishing first official data again, following a months-long data dearth that resulted from the statistical overhaul the new government had pledged to undertake. According to a preliminary estimate, the economy expanded a remarkable 2.1% in 2015, thus accelerating over 2014’s increase. Last year’s expansion was led by a record soy harvest, which boosted production in the agricultural sector. Encouraging developments were also recorded in the construction and services sectors. Meanwhile, Argentina is now one step closer of settling the decade-long dispute with the country’s creditors. In late-March, Congress approved the deal with the holdouts and, earlier this month, the United States Court of Appeals upheld a ruling to lift the injunction that had banned the country from paying its creditors. The government has likely settled the sale of USD 15 billion in bonds on 18 April, the proceeds of which will be used to pay holdouts.
A slow adjustment to the new government’s policies, low commodity prices and the prolonged recession in Brazil are factors clouding the growth outlook for this year. However, the economy will likely speed up in the medium-term amid an improvement in the external sector and the country’s return to international credit markets. Analysts project Argentina’s GDP to contract 0.7% in 2016, which is down 0.4 percentage points from last month’s Consensus. For 2017, analysts project the economy to accelerate and increase 2.9%.
VENEZUELA | Authorities announce questionable measures to curb energy consumption
President Nicolás Maduro shortened the working week for public employees to four days in an effort to limit energy consumption amid widespread energy blackouts. The opposition argues that the measure, which will last until May, will exacerbate shortages of consumer goods and constrain economic activity further, as Venezuela slides ever deeper into the worst economic crisis in its history. In March, car sales tallied their largest contraction on record and the bolivar traded at a new record low in the parallel market. Even though oil prices recovered in March, oil-producing states failed to reach an agreement on 17 April to freeze output. The lack of consensus among oil-producing states will keep prices subdued and put additional pressure on Venezuela’s public finances ahead of international debt payments due this year.
The country’s growth prospects remain bleak as runaway inflation and a dysfunctional retail sector are likely to keep the economy mired in a deep recession this year. FocusEconomics panelists see the economy contracting 7.2% this year, which is unchanged from last month’s projection. Next year, the panel sees GDP dropping 1.1%.
INFLATION | High inflation persists in Q1 and central banks stay put for now
Inflation continued to accelerate in the first quarter of the year as most of the region’s currencies remained under pressure from low commodities prices. Terms of traded deteriorated in the majority of countries in the region and therefore weakness in exchange rates continued to fuel inflation via higher prices for imported goods. An estimate elaborated by FocusEconomics showed that inflation in the region rose from 19.8% in February to 20.9% in March, which came in also above Q4’s 17.0%. Despite higher inflation, interest rate increases are becoming rare. The central banks of Chile, Peru and Mexico have left interest rates unchanged recently. Conversely, Colombia’s Central Bank hiked interest rates and has not indicated that the tightening cycle is close to ending. Meanwhile, in Brazil, rate cuts are the most likely scenario this year, but the Central Bank is lowering expectations of rate cuts in the short term.
Inflation is expected to remain relatively stable in the coming months. Economic experts expect inflation in the region to end 2016 at 21.9%. This month’s projection was revised up 0.5 percentage points over last month’s projection. Analysts expect Latin America’s inflation to fall to 17.2% at the end of 2017 due to a recovery in commodities prices and a stabilization in the foreign exchange markets.
Written by: Ricardo Aceves, Senior Economist
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