Latin America: Latin America - Economic Outlook October
October 7, 2018
Argentina dents regional recovery in Q2
A more complete picture of the region revealed that Latin America’s recovery lost steam in the second quarter of the year and performed more poorly than expected. Regional GDP growth (excluding Venezuela) waned from 2.0% year-on-year in Q1 to 1.7% in Q2, the worst result in one year. While firmer commodity prices, improving household spending and recovering sentiment supported growth in several economies, shocks in major-players Argentina and Brazil held back regional activity.
The downgraded Q2 GDP result was due to a worse-than-expected result in Argentina, which saw the economy contract at the sharpest pace since Q3 2014. A severe drought caused agricultural output to plunge in the quarter, while household spending was muted in the face of high inflation and investment slowed. Meanwhile, activity in Brazil also decelerated as a nationwide truckers’ strike disrupted the economy. Elsewhere in the region, the economic backdrop was more upbeat, particularly in Chile and Peru where growth hit multi-year highs.
Venezuela—which is not included in the regional aggregate—is expected to have remained by far the worst performing economy as shrinking oil output, exchange rate misalignments and basic goods shortages fuel an economic and humanitarian crisis.
On the political front, risks to the region’s outlook have ebbed somewhat in recent weeks thanks to developments regarding Argentina and Mexico. Canada, Mexico and the United States agreed to a revamped NAFTA on 30 September, reducing risks that North America’s tariff-free trade regime could come to a halt. The new deal, dubbed the United States-Mexico-Canada agreement, safeguards Mexico’s preferential access to the United States’ markets, although contains some notable tweaks to NAFTA regulations. Reduced uncertainty should pave the way for revived business confidence and investment in Mexico going forward, while the implications of the tweaks to the agreement, most notably regarding the automobile sector, are difficult to determine. Although the deal still needs to be approved by all three governments, it is expected to pass.
After weeks of capital flight and a sinking peso, on 26 September the IMF announced it was upgrading its financial assistance to Argentina, a move which has helped restore some confidence in the crisis-stricken economy. The agreement, which accompanied a radical change in monetary policy and stricter fiscal goals, has helped stabilize the peso and provides the government with funding to cover this year’s and next year’s debt repayments. While the road ahead will be tough, and risks threaten Argentina’s outlook, short-term risks have subsided somewhat since the announcement. The country is now adequately financed for the coming quarters and IMF-support should help boost economic sentiment, although fiscal tightening will continue to dent growth.
Meanwhile, the region’s largest economy remains consumed by its election cycle and will head to a presidential run-off vote between two opposing ends of the political spectrum on 28 October. Right-wing Jair Bolsonaro dominated the first-round presidential vote on 7 October, winning by a larger than expected margin, followed by Workers’ Party candidate Fernando Haddad. Bolsonaro is seen as the more market-friendly candidate between the two and his victory buoyed Brazilian markets and the real, although policy uncertainty still lingers. While the momentum heading into the second-round is clearly in Bolsonaro’s favor, how the votes from other candidates will shift is unclear, while there are doubts over whether polarizing Bolsonaro could successfully navigate a divided Congress that comprises nearly 30 parties.
2019 Regional prospects cut due to recession in Argentina
Latin America’s (excluding Venezuela) growth outlook for both 2018 and 2019 was downgraded this month, chiefly due to a worsening trajectory for Argentina’s economy. High inflation, fiscal austerity and worse than expected impact from the drought is projected to have pushed the economy into a recession in 2018 and is seen languishing in recession next year as well. Outside of Argentina, regional growth is expected to hold up relatively well next year. A solid U.S. economy should support activity in Mexico, with firm commodity prices propelling many others countries. Brazil’s recovery is also expected to gain steam as politicians turn their attention to the economy and the effects of the truckers’ strike fade.
Regional GDP (excluding Venezuela) is seen growing 1.7% this year, down 0.2 percentage points from last month’s forecast. Next year, regional growth is seen picking up pace and coming in at 2.4%, which is also down 0.2 percentage points from the previous month’s forecast. The downward revision in the 2019 forecast was due to lower growth forecasts for Argentina, Brazil and Uruguay. Argentina’s economy is seen contracting next year and a less favorable global environment will weigh on Brazil’s recovery. In contrast, Colombia and Paraguay had their projections raised, while the rest of the region’s economies saw no changes to their forecasts.
Given the current economic conditions in Venezuela and the limited availability of official data, it has become extremely difficult to forecast the country’s economy. We have therefore removed Venezuela from the regional aggregates and discontinued its long-term forecasts. Rampant inflation, dwindling oil production and a dysfunctional exchange rate system are expected to keep Venezuela trapped in a dire economic crisis, and the economy is seen contracting 13.1% this year and 6.7% next year, down 2.5 percentage points from last month’s forecast.
BRAZIL | Bolsonaro wins decisively in first-round presidential vote against fragile economic backdrop
Weak economic data is rolling in for the Brazilian economy as the country’s crucial election season is in full swing. Business and consumer confidence dropped in September in the run-up to the turbulent vote, while industrial production plunged in August. Moreover, economic stress in key trading partner, Argentina, is hampering export growth, while political uncertainty has sparked volatility in the country’s financial markets. The soft third quarter data comes after an already weak Q2 GDP print due to economic disruptions from a nationwide truckers’ strike. Against a sour economic backdrop, voters went to the polls on 7 October in presidential and legislative elections. Far-right and outsider candidate Jair Bolsonaro came out resoundingly on a top with a better than expected 46% of the vote. Nevertheless, Bolsonaro will face second place Workers’ Party candidate Fernando Haddad in a run-off election on 28 October as he failed to secure over half of the vote in the first round.
FocusEconomics panelists downgraded Brazil’s 2018 and 2019 prospects this month. Rising inflation partly stemming from a weak real is expected to take a bite out of households’ purchasing power and impel the Central Bank to tighten rates, removing support for the economy. Although the continuation of tough economic reforms remains critical for the country’s outlook, there remains a degree of uncertainty over whether the incoming president will have the ability and willpower to do so. The economy is seen growing 1.5% in 2018 and 2.3% in 2019, down 0.1 percentage points from last month’s projection.
MEXICO | USMCA shores up economic outlook
Incoming data suggests that the second quarter’s improved momentum largely held up in the third quarter as the Mexican economy continues to benefit from buoyant growth in the United States. Economic activity surged in July and exports grew at a double-digit pace in both July and August. Meanwhile, recently-released GDP by expenditure data for Q2 revealed an all-round strengthening of the economy, with private consumption, fixed investment and exports all picking up pace in the quarter, which were also boosted by positive calendar effects. On the political front, Canada, Mexico and the United States struck a deal to update NAFTA on 30 September. The new deal, named the United States-Mexico-Canada agreement (USMCA), safeguards tariff-free regional trade and should improve business confidence in Mexico as the country maintains premium access to export to the U.S. However, some notable changes were made to NAFTA, including upping the regional content of automobiles and demanding that a portion of car production must be done by workers being paid over USD 16 dollars per hour.
GDP is expected to grow a healthy 2.2% this year, in large part thanks to a booming U.S. economy. Next year, a tight labor market and solid remittances inflows should maintain solid growth and the economy is seen expanding 2.2% again, unchanged from last month’s forecast. Risks to the forecasts have diminished with the USMCA struck, although there remains some uncertainty surrounding new President AMLO’s future policy.
ARGENTINA | IMF increases government lifeline, boosting confidence
President Mauricio Macri’s government and the IMF reached a new agreement on 26 September which provides further financial support and will most likely shield the country from any credit distress this year and next. The revised standby agreement (SBA), however, comes with conditions, most importantly including: a primary budgetary balance by 2019—one year earlier than stipulated in June’s SBA—and a strict monetary base rule to curb inflation. The latest fiscal data shows that, although the primary deficit narrowed by almost a third in January–August, interest payments surged. The SBA came after national accounts data showed that GDP shrunk dramatically in Q2, reflecting contractions in both domestic and external demand, compounded by the effects of a severe drought. That said, data on economic activity in July, without changing the broad picture, suggests some improvement, given that the pace of year-on-year contraction softened considerably in the month. However, other indicators point to prolonged economic weakness as demonstrated by consumer confidence, which continued to plunge in September, and the trade deficit, which widened further in August.
There is a great deal of uncertainty surrounding the performance of the Argentine economy in 2019. Not only will it depend on the success of the fiscal deficit and inflation reduction program agreed with the IMF; its fate also rests on the subsequent restoration of investor confidence and on achieving more solid macro fundamentals. That said, the contraction of the economy should ease significantly, thanks to growing agricultural output and increasing external demand, while domestic demand should remain weak due to high interest rates. LatinFocus Consensus Forecast analysts see the economy contracting 2.0% this year and a much softer 0.1% in 2019, down 0.8 percentage points from last month’s estimate.
COLOMBIA | Government plans tax reform
Available data for the third quarter suggests that the economy kept pace from the previous quarter. The industrial sector accelerated in July and while moderating from the previous month, export growth remained robust in August. On the downside, retail sales growth tumbled to a seven-month low in July as the unemployment rate climbed and inflationary pressures remained largely stable. In addition, the manufacturing PMI fell for the second consecutive month in September, indicating downbeat prospects for the industrial sector. Moreover, consumers were less upbeat about both their personal financial situation and general economic conditions. On the fiscal front, Finance Minister Alberto Carrasquilla stated that a draft of the government’s tax reform would likely be tabled for review by Congress in October. One of the key proposals of the reform include tax cuts for corporations. While the Ministry of Finance has announced a cutback in overall government spending to plug a funding shortfall in next year’s budget, plans to slash corporate tax rates puts Colombia’s fiscal position at risk.
Increased investment in the extractive sector and higher oil prices should support a faster pace of expansion next year. Growth should also be buoyed by stronger consumer spending against the backdrop of stable inflationary pressures. While government spending is expected to weaken on planned fiscal tightening, the tax reform’s proposal to slash corporate taxes will likely pose challenges in meeting the fiscal target unless they are offset with new sources of revenue. FocusEconomics panelists expect GDP to grow 2.7% in 2018 and 3.2% in 2019, which is up 0.1 percentage points from last month’s forecast.
MONETARY SECTOR | Price pressures build in September
A preliminary estimate, without considering the current period of hyperinflation in Venezuela, revealed that inflation continued to rise in September. FocusEconomics estimates that inflation in Latin America (excluding Venezuela) came in at 6.6%, above August’s 6.4% and the highest reading seen so far this year. Higher energy prices and pass-through effects from weaker currencies caused price pressures to build at the end of Q3.
Despite rising inflation, central banks across the region largely held interest rates unchanged in recent weeks. Policymakers in Brazil, Colombia, Mexico and Peru all left interest rates unchanged. Meanwhile, Argentina’s Central Bank announced a major policy overhaul in efforts to try and rein in inflation and the peso’s plunge. The Bank abandoned its inflation targeting regime to adopt a rigid monetary rule which will keep the monetary base unchanged until June 2019. As a result, interest rates will fluctuate going forward instead of being set by the Bank.
Pass-through effects from weaker exchange rates and soaring prices in Argentina are seen causing regional inflation (excluding Venezuela) to rise by the end of the year. Inflation is forecast to end 2018 at 7.6%. Next year, price pressures should calm somewhat as tight monetary policy reins in Argentina’s inflation. In 2019, inflation is seen ending the year at 5.6%, which is up 0.3 percentage points from last month’s forecast. Venezuela is experiencing an episode of hyperinflation and is thus not included in the aggregate