Latin America's recession masks contrasting realities
June 15, 2016
Latin America remains trapped in recession. Economic weakness persisted at the beginning of the year following two consecutive periods in which the economy contracted in the third and fourth quarters of 2015—the sharpest fall in six years was registered in Q4. The region’s aggregate GDP is estimated to have decreased 1.2% year-on-year in the first quarter, which continues to suggest overall weakness in the region. However, this data mask the fact that some economies within Latin America are managing the region’s recession better than others and are growing, while others are facing a severe economic deterioration.
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The regional GDP aggregate is mainly being held down by Brazil, Ecuador and Venezuela. Brazil, the region’s largest economy, is experiencing its deepest recession since the 1930s. The Ecuadorean economy, which was hit hard by an earthquake in April, is suffering from persistent fiscal weakness in the wake of low oil prices. Venezuela, where electricity is being rationed, the work week has been shortened and the government even changed the time zone to reduce evening electricity usage, remains rooted in a profound political and economic crisis, which shows no signs of ending anytime soon. Meanwhile, in Mexico, economic activity continues to grow, although at a tepid pace. Colombia’s economy, which was once a regional star, began to show signs of cooling at the beginning of the year. In fact, Peru is the only economy where growth remains close to its potential, despite a challenging regional and global economic scenario. Peru will also retain its prudent, business-friendly economic policy framework in the next years, following the results of the presidential election in which Pedro Pablo Kuczynski won by a narrow margin.
Latin America did begin to see some signs of improvement in Q2, reflecting the current external conditions and global developments. After having experienced heightened volatility in financial markets earlier this year, the region transitioned to a smoother period in the second quarter, which prompted a stabilization in exchange rates. Moreover, a positive evolution in global commodities prices is alleviating concerns for many of the region’s commodity exporters. Heading into the second half of the year, the region’s economic activity is expected to stabilize and is seen improving gradually in the coming quarters. Nevertheless, risks to the short-term outlook persist. Despite a slow recovery in commodities prices, signs that China’s economy has stabilized, and a less risk-averse mood among global investors, fears prevail that the rally in both commodities prices and the region’s financial assets won’t be sustainable. Against this backdrop, major currencies in Latin America are likely to experience a renewed episodes of volatility as capital inflows reverse their path—due to developments with U.S. interest rates—and commodities prices lose the ground they gained in recent weeks. These factors, in turn, have the potential to fuel inflationary pressures and, in a context in which fiscal stimulus remains constrained as several governments in the region are tightening their budgets, they could prevent central banks from using monetary policy to stimulate domestic demand.
Analysts foresee another year of recession for Latin America
The region’s economy contracted 0.1% last year and the recession is expected to deepen this year. The scenario painted by most analysts in our latest Consensus Forecast for Latin America is that the region will contract 0.4% this year, which, if confirmed, will mark the first time that Latin America has registered two consecutive years of negative growth since 1982 and 1983 when it was hit hard by a severe debt crisis. For next year, analysts foresee a rebound and expect the region to expand 2.0%.
The expected contraction in Latin America’s GDP this year reflects a projected contraction in Argentina, Brazil, Ecuador and Venezuela, which together account for 50% of the region’s GDP. This month’s regional GDP growth forecast was revised up by 0.1 percentage points over the previous month’s projection and stemmed from an increase in the forecasts for Bolivia and Brazil. Meanwhile, the forecasts for Chile, Colombia, Mexico and Peru were left unchanged, while the projection for the remaining five economies surveyed was cut.
ARGENTINA | Structural adjustment is proving painful
Argentina’s economy is experiencing a period of macroeconomic adjustment as a result of the structural reforms undertaken by the administration of Mauricio Macri. According to official data released recently by the statistical office, in April, industrial production contracted a sharp 6.7% on an annual basis, thus highlighting the effect of the government’s austerity measures. Moreover, massive layoffs and record-high inflation rates are a cause of concern for Argentinians and consumer confidence hit the lowest level in nearly two years in May. On a positive note, the currency strengthened significantly against the U.S dollar at the end of last month as the annual soy harvest boosted demand for pesos. In the political arena, Marci recently presented a tax amnesty to Congress that aims at repatriating capital stashed abroad in order to increase government revenues and lure dollars into the battered economy.
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 the renewed access to international capital markets, the economy is expected to largely benefit from fresh capital inflows. Analysts project Argentina’s GDP to contract 1.0% in 2016, which is down 0.2 percentage points from last month’s Consensus. For 2017, analysts project the economy to rebound and expand 2.9%.
BRAZIL | All eyes are on Temer as recession worsens
Brazil’s economy remained mired in the deepest recession in recent history in the first quarter of the year, although the pace of contraction did improve slightly. Exports, which have been a bright spot in recent data, hit an over-four-year high in Q1 thanks to a weaker real, while data from the domestic economy remained abysmal. In the political arena, all eyes are on new interim President Michel Temer to see if he can right the sinking economy and avoid the setbacks the Rousseff administration had faced. While early signs suggested that Temer’s government had started on the right foot—Congress approved his target of a budget deficit in May—recent developments are less encouraging. Two government ministers have resigned, and in June, the prosecutor general requested that four prominent members of Temer’s party be arrested in connection with the Petrobras scandal.
The slight improvement in GDP data for Q1 is supporting an upward revision to the forecast. However, despite the change in leadership, Brazil’s economy is expected to remain in a profound recession this year. FocusEconomics panelists see the economy contracting 3.4% in 2016, which is up 0.3 percentage points from last month’s forecast. For 2017, the panel sees the economy recovering slightly and growing 0.8%.
MEXICO | Economy remains solid, although ruling PRI party is not
Revised data provided more solid evidence that Mexico’s economy was resilient to external headwinds at the outset of the year. GDP increased 2.6% annually in Q1, which marked an acceleration over the 2.4% expansion tallied in Q4. The improvement stemmed from healthy growth in the three main sectors of the economy. This development is consistent with recent trends indicating that economic activity is being fueled by strong household consumption. In fact, a strong performance in consumer spending likely persisted in Q2 as suggested by an increase in consumer confidence in May. Moreover, manufacturing gauges in May suggest that success in the sector continued. On the political front, the opposition National Action Party (PAN) was the clear winner in 7 of the 12 states that held elections on 5 June. The result is a stunning blow to the ruling Institutional Revolutionary Party (PRI) whose leader, Manlio Fabio Beltrones, had vowed to win at least nine states.
The economic forecasts for Mexico suggest that the economy will maintain the pace of growth seen last year in 2016. The Consensus view among analysts is that growth will be supported by private consumption, while the economy’s difficult adjustment to low oil prices casts a shadow on the outlook. Mexico’s GDP is projected to grow 2.4%, which is unchanged from last month’s forecast. For 2017, growth is seen picking up to 2.8%.
PERU | Kuczynski to maintain market-friendly economic policy
Peru’s economy continued to expand at a solid pace in Q1 following Q4’s strong growth. On the political front, Pedro Pablo Kuczynski won the 5 June run-off presidential election against Keiko Fujimori by a razor thin margin. The candidates had been in a close race since the first round in April as both pro- and anti-Fujimori sentiment was strong. In fact, Kuczynski’s final boost in support can be accredited to an endorsement by ex-candidate Verónika Mendoza, who emphasized her aversion to Fujimori. Mendoza’s backing of Kuczynski’s business-friendly economic policy was unexpected as she is a leftist politician. Kuczynski has pledged to sustain Peru’s current economic momentum by increasing public investment, especially in infrastructure projects. He is likely to face opposition in Congress, however, as Fujimori’s Popular Force party has an absolute majority. The new president will have to seek political alliances in order to move his plans forward.
While markets welcomed the outcome of the presidential election, Kuczynski’s economic policy agenda is likely to face challenges in the legislature, causing some uncertainty, at least in the short term. FocusEconomics panelists see the economy rising 3.6% this year, which is unchanged from last month's projection. Next year, the panel expects GDP growth to accelerate to 4.0%.
INFLATION | Upward trend remains despite FX stabilization
The upward trend in inflation seen in the region since March 2015 continued into May of this year. Inflation remained high in Latin America in the second quarter, despite a recent stabilization in the region’s major currencies and a decline in exchange rate pass-through. An aggregate inflation estimate elaborated in-house, showed that that inflation in the region rose from 20.2% in April to 21.3% in May—the highest point since 1995.
Central banks across the region have refrained from raising monetary policy rates. The exception is Colombia’s Central Bank, which continued to tighten the reins. The Bank has hiked the monetary policy rate nine consecutive times, most recently on 27 May, with a 25-basis-point increase. Meanwhile, in Brazil, rate cuts are the most likely scenario this year, although the Central Bank is attempting to lower expectations of such cuts in the short term.
High inflation is seen persisting this year as economists project that inflation in the region will end 2016 at 24.3%. This month’s projection was revised down from the 24.5% expected in last month’s Consensus. Analysts see inflation in the region falling to 18.5% at the end of 2017.
Written by: Ricardo Aceves, Senior Economist
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