The impact of the Brexit vote on global markets and the world’s economy has prompted analysts and market participants to assess both the nature of the shock and the cyclical context in which it occurred. The result: the Brexit vote was an idiosyncratic UK shock that came at a juncture in which the global economy has failed to deliver strength. The knock-on effects to economic growth in the UK began immediately after the vote, at the outset of the second half of the year. While the overall drag from this shock on the global economy is expected to be moderate, this depends on a number of factors that are still evolving.
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Heightened volatility in the global financial markets and commodities prices caused enormous financial and economic stress in Latin America last year and at the beginning of this year. Latin American currencies, which had experienced a short period of stabilization on the heels of the recovery in commodities prices starting in late January, saw a renewed episode of volatility toward the end of Q2. The Brexit vote has increased global uncertainty with implications for economic growth, monetary policy and asset prices worldwide. In the aftermath of the vote, the pound sterling plummeted, global stock markets fell and the recovery in commodities prices halted abruptly. These developments were felt in Latin America and, as a result, currencies tumbled. The Mexican peso, which is a preferred emerging-market currency for its liquidity, has become the world’s second-worst performer, just after the British pound.
However, the volatility in the region was short lived as major central banks around the world have responded with the continuation of loose monetary policies that aim to limit any financial contagion from Brexit. The European Central Bank and the Bank of Japan have recently reaffirmed their ultra-loose monetary policies, yet they have signaled that there is still room for easing should uncertainties regarding Brexit and the global economy increase. The Bank of England cut rates for the first time since 2009 in August and signaled that it may provide further stimulus should Brexit headwinds worsen going forward. In the U.S., although recent data supports the view of an interest rate increase this year, uncertainty related to Brexit, and also to the November presidential election, remains high regarding whether the Federal Reserve will postpone the rate hike until next year. Various domestic situations within the individual Latin American economies played a role in diminishing the noise in the foreign exchange markets, and some currencies—such as the Brazilian real—experienced only mild volatility. The Brazilian currency’s relative resilience to the headwinds provoked by Brexit reflected expectations of an extended tight monetary policy as well as greater optimism for fiscal reform prospects. Peru’s nuevo sol was propped up by the outcome of the presidential election and Colombian authorities’ aggressive monetary response supported the peso.
Brexit jitters and their effect on financial and commodities markets are far from abating. For Latin America, the main channel through which Brexit can cause relative damage is in financial markets. This means that, against a backdrop of intensifying Brexit concerns, growing uncertainty could prompt global investors to look for safe haven assets. Consequently, risky asset classes, such as commodities, are likely to fall again just as investors are deciding to withdraw capital from Latin America and other emerging markets. This, in turn, could lead to a renewed weakening of regional currencies and put pressure on several central banks across the region to mitigate volatility and the pass-through effects on consumer prices. Monetary tightening has the potential to hurt domestic demand and ultimately further damage already-anemic economic growth in the region.
The economies with large current account deficits—Colombia, Mexico and Venezuela, just to name a few—are likely to be the weakest links and will feel the impact of volatility in their currencies more strongly while concurrently risking capital outflows. Should protracted and messy Brexit negotiations prolong uncertainty, a further fall in investor confidence will prevent oil prices from recovering, and this will hit exports and fiscal revenue in oil-producing economies such as Ecuador, Colombia, Mexico and Venezuela. The silver lining of this conundrum is that the direct effects of Brexit on trade will be limited for most of the region.
Weakness persists in Q2, twin deficits remain high in most of the region
Latin America’s economy continued to struggle in the first half of 2016 against a backdrop of heightened volatility in financial markets, which was exacerbated by the Brexit vote toward the end of H1. A regional GDP aggregate elaborated by FocusEconomics showed that the economy contracted 1.1% year-on-year in Q1 and a preliminary estimate suggests that growth continued to falter in Q2. GDP is estimated to have decreased 1.0% in the second quarter, which, if confirmed, would represent the fourth consecutive quarter of economic contraction. That would also corroborate analysts’ view that a sudden recovery in the region is not in the cards for the near future.
This trend is mostly driven by a protracted recession in Brazil and a deteriorating economic situation in Argentina, Ecuador and Venezuela. In addition, most economies in the region have been adjusting to the significant negative external shock that accompanied the end of the commodities super-cycle last year. Due to a deterioration in the terms of trade and heightened volatility in global financial markets, most major currencies in Latin America have weakened. Most economies also had to painfully adjust growing fiscal and current account deficits in the first half of 2016, and much of this ongoing process is being done by reducing government spending drastically and through a substantial contraction in imports. Nonetheless, current account deficits are still very high in countries such as Colombia, Mexico and Peru, which makes them vulnerable to external shocks. In addition, fiscal shortfalls will have to be adjusted further, should the recovery in commodities prices stall this year.
2016 will mark another disappointing year
Latin America’s economy is expected to deteriorate this year and is seen recovering in 2017, according to a group of economists surveyed by FocusEconomics this month. Following stagnated growth in 2015, analysts project the region’s GDP to contract 0.5% in 2016 before rebounding to a 1.9% expansion in 2017. The expected contraction this year reflects that analysts foresee economic contractions in Argentina, Brazil, Ecuador and Venezuela, which together represent over 50% of the region’s GDP.
In this month's LatinFocus report, analysts left the 2016 GDP growth forecast unchanged, although significant vulnerabilities continue to cast a dark shadow on the economy. Latin America’s economy remains particularly vulnerable to a deterioration in the global economic outlook, a subdued recovery in commodities prices and the negative spillover effects from Brazil’s worst recession in decades.
ARGENTINA | Economy is enduring a painful transition
Argentina’s growth remains at a standstill as the transition into a market-oriented economic model is proving difficult. The economy fell into recession in Q1 and most likely had another disappointing performance in Q2. Exports contracted at a double-digit rate in June mainly due to the deep recession in Brazil—Argentina’s main trading partner. Moreover, industrial production contracted for the fifth consecutive month and consumer confidence remained in contractionary territory in July. That said, in the same month, the Central Bank’s reserves hit a 10-month high after the sale of nearly USD 3.0 billion in bonds with maturities of 12 and 20 years. Economic sentiment has been negatively affected by high inflation and by the removal of utility subsidies. The massive layoffs that President Mauricio Macri’s government has been undertaking since he took power in December 2015 and the increase in tariffs have provoked protests and strikes across the country. Growing public discontent has caused Macri’s approval rating to drop considerably in recent months.
Low commodity prices, the prolonged recession in Brazil and a slow adjustment to the new government’s policies are factors clouding this year’s growth outlook. However, following renewed access to international capital markets, the economy is expected to largely benefit from fresh capital inflows. Analysts project that Argentina’s GDP will contract 1.2% in 2016, which is down 0.2 percentage points from last month’s Consensus. For 2017, analysts expect the economy to rebound and expand 3.0%.
BRAZIL | Temer’s temporary administration shores up confidence
Although economic activity remains feeble, tentative signs of improvement are emerging from Brazil’s battered economy. Industrial production accelerated in June and consumer and business confidence continued to improve in July. In addition, despite growing concerns over global growth, the real has remained resilient and rose to a one-year high on 4 August. Michel Temer’s temporary takeover as president has helped shore up confidence in Latin America’s largest economy, however, not enough has been done to halt the government’s sinking finances. A constitutional amendment to cap public spending is not expected to be passed until next year, while a proposal for a desperately-needed overhaul of the country’s bureaucratic labor laws likely will not be ready until the end of this year. Meanwhile, a final verdict in ousted President Dilma Rousseff’s impeachment case is expected in the coming weeks.
Political uncertainty continues to tilt risks to Brazil’s forecast to the downside. A swift implementation of economic reforms and a fiscal adjustment are key to correcting the country’s macroeconomic imbalances, yet this hinges on a stable political situation. FocusEconomics panelists see the economy contracting 3.3% in 2016, which is unchanged from last month’s forecast. For 2017, the panel sees the economy starting to recover meekly and growing 0.9%.
COLOMBIA | Economy slows and government implements austerity
Colombia’s economy started off the year on a soft footing, growing at the slowest pace in almost seven years in Q1. The low-commodity-price environment has damaged the country’s important mining and energy sector and led consumer confidence to fall to historic lows. More recent data for Q2 suggest that economic activity is still struggling: industrial production decelerated in May and the unemployment rate ticked up in June. Moreover, low oil prices have put pressure on government finances and widened the current account deficit, leading Fitch Ratings to revise Colombia’s outlook from stable to negative in July. Against this backdrop the government unveiled the budget for 2017, which slashes social spending by 10%. Despite the cuts, a rise in debt servicing expenses due to the depreciated value of the peso caused the budget to come in at USD 7.6 billion, nearly 7% larger than the previous year’s.
The FocusEconomics panel sees GDP growth slowing to an over-decade low this year due to external headwinds. However, recent strides toward securing a peace agreement with the FARC are positive for the country’s outlook. Analysts expect the economy to grow 2.3% in 2016, which is unchanged from last month’s forecast. For 2017, the panel projects economic growth of 2.9%.
MEXICO | Economy slows in Q2; weakness likely persists in Q3
The economy lost traction in Q2, as expected. An advance estimate showed that GDP increased 2.4% year-on-year in Q2 (Q1: +2.6% yoy) and on a quarterly basis it contracted a seasonally-adjusted 0.3%, which suggests a sharper economic deterioration. Meanwhile, the latest round of PMIs showed that weakness persisted in the manufacturing sector at the outset of Q3 as the IMEF manufacturing indicator and the manufacturing PMI dropped further in July. The National Statistics Institute (INEGI) released a Socio-economic Survey with a new controversial methodology that showed household income improving over the past year, particularly for the poor. Concerns about political influence over INEGI have been growing since the president handpicked the institute’s head. In fact, the July consumer sentiment survey showed that households remain overly pessimistic, since they continue to see the country’s economic situation getting worse, and thus their own economic prospects.
The economic forecasts for Mexico suggest that policy tightening—both fiscal and monetary—along with downward-spiraling oil production will weigh on growth this year. Moreover, volatility in the exchange rate is expected to continue on the back of Brexit jitters. Analysts expect the economy to expand 2.3% this year, which is down 0.1 percentage points from last month’s forecast. Next year, the economy is projected to accelerate to a 2.6% expansion.
INFLATION | Rising inflation adds pressure on central banks
In a context of hyperinflation in Venezuela and high volatility in currency markets, inflation in the region continued to rise in June. An inflation estimate for the region calculated by FocusEconomics showed that it rose from 21.3% in May to 22.8% in June—the highest point since 1995.
Rising inflation and volatility in foreign exchange markets caused by Brexit put pressure on central banks across the region to tighten monetary policy. Mexico’s Central Bank increased its monetary policy rate in June in response to Brexit concerns, while Colombia’s BanRep hiked interest rates again in July. Meanwhile, in Brazil, monetary authorities, under the new leadership of Ilan Goldfajn, left the SELIC interest rate unchanged in July, and expectations of a rate cut are gradually fading as analysts now expect that Brazilian monetary authorities will prolong a tight policy.
High inflation is seen persisting this year and analysts project that inflation in the region will end 2016 at 27.5%. This month’s forecast was revised up from the 25.8% expected last month. Analysts see inflation in the region moderating to 26.9% at the end of 2017.
Written by: Ricardo Aceves, Senior Economist