Latin America's economy contracts in 2015, weakness persists at the beginning of 2016
March 16, 2016
Latin America’s economy experienced a notable deterioration toward the end of 2015. An aggregate regional GDP estimate showed that activity in the region began to decrease in Q3 2015, when GDP contracted 0.5% year-on-year, and that it deteriorated further in the final quarter of 2015. The economy is expected to have contracted 1.2% in Q4 over the same quarter of the previous year, which brings the overall economic contraction to 0.1% in 2015. The last time Latin America experienced a recession was in 2009 at the height of the global financial crisis. The region’s growth was mainly dragged down by Brazil, which is by far the region’s largest economy, and which recorded its worst economic performance in decades. But growth was also weak across the board, including in the region’s recent star performers, Colombia and Peru, as worsening terms of trade, slowing Chinese demand for commodities and increasing risk aversion toward emerging economies prompted a deterioration in investor confidence, and hence higher capital outflows and a downturn in the business and credit cycles. Currencies, therefore, remained under intense pressure at the end of 2015.
At the start of 2016, Latin America witnessed another period of strong volatility in financial markets, particularly in foreign exchange markets. The weakness in economic activity observed at the end of last year persisted at the beginning of 2016 and, of top of that, a new slide in global oil prices—and in other commodities—in mid-January had a major impact on most of the currencies in the region. The impact was felt particularly in the economies in which oil production and base metals extraction account for an important share of GDP. Therefore, central banks across the region have been forced to act, hiking interest rates in response to lower exchange rates and rising inflation. The policy response, however, is actually likely to have a negative impact on already-lackluster economic growth in the region in the coming months.
More recently, the speculation that major oil producers—mainly Russia and Saudi Arabia—might reach an agreement to freeze output at January’s levels was the silver lining on the clouds that continue to cast a shadow on the outlook for oil prices. Following February’s news of a potential production freeze, a rally in global oil prices and other major commodities materialized, maintaining the upward trend in prices at the beginning of March. The rebound in oil prices has boosted many of the currencies in the region. If major oil producers manage to hammer out a deal in the coming days to freeze output, this will provide stronger support to global oil prices and ease some concerns in Latin America. Nonetheless, significant uncertainties persist regarding the agreement as it remains to be seen whether key producers, such as Iran and Iraq, will join the deal.
Latin America is on the path toward another recession in 2016
The outlook for Latin America is getting worse. Due to an environment of low commodities prices, less positive global growth prospects and volatility in financial markets, the region is likely to continue seeing a deterioration in the terms of trade, capital outflows and pressure on the exchange rates. Moreover, a strong El Niño weather phenomenon is likely to exacerbate a deterioration in the region’s economic outlook as the damage to some countries’ harvests was worse than expected.
Following last year’s recession, Latin America is expected to contract again this year. Despite expectations that commodities prices will recover toward the end of this year (for more information regarding commodities price forecasts see the most recent FocusEconomics Consensus Forecast Commodities report), governments across the region have already taken action in response to lower commodities revenues and will cut expenditure in order to prevent a deterioration in their fiscal accounts. That, as consequence, will dampen growth in the region even more. Therefore, analysts surveyed for this month’s LatinFocus Consensus Forecast cut the region’s GDP projections by 0.2 percentage points over the previous month and now expect the region to contract 0.1% again this year. This marks the 15th consecutive downward revision to the outlook and contrasts previous projections that had seen the region growing.
Looking at the region’s individual economies, analysts cut the projections for 9 of the 11 economies surveyed, including regional powerhouses Brazil and Mexico. Paraguay and Peru were the only economies for which analysts left their projections unchanged. Next year, the region’s economy is expected to perform better and grow 2.1%.
BRAZIL | Protests put Dilma Rousseff’s future in doubt
Brazil’s economy tallied another profound contraction in the fourth quarter. The country remains plagued by high inflation, depressed confidence levels and low prices for export goods. Available data for the start of 2016 is also bleak: business confidence fell in February and the manufacturing PMI lost ground. The abysmal state of the economy combined with a large corruption scandal has rocked the government. On 13 March, citizens gathered in one of the largest protests in Brazil’s history to demand the resignation of President Dilma Rousseff. In Congress, the largest political party, the Brazilian Democratic Movement Party (PMDB), has stated it will take 30 days to determine whether it will abandon the government’s coalition—a move that could potentially be fatal to Rousseff’s administration. Meanwhile, on 16 March, the Supreme Court is expected to rule on whether impeachment proceedings against the president can continue.
Brazil’s outlook is bleak. Political developments are drawing the government’s attention away from much-needed reforms and the economy is unlikely to live up to its potential if poor fundamentals are not corrected. FocusEconomics panelists see the economy contracting 3.4% in 2016, which is down 0.5 percentage points from last month’s forecast. For 2017, the panel sees the economy rebounding and growing 0.7%.
MEXICO | Policymakers’ coordinated actions provide some respite to the peso
Mexico’s economy increased 2.5% in 2015. Although the reading marked a slight acceleration over 2014, when the economy grew 2.3%, growth in Latin America’s second-largest economy was disappointing. Subdued economic activity carried over into the first months of 2016. According to the IMEF indicator, the manufacturing sector continued to expand in February, although the pace of growth was softer. Meanwhile, the most recent consumer confidence survey reported a noticeable drop in sentiment among Mexican households in February. On 17 February, Mexico’s policymakers announced a coordinated response to the economic situation, which aims to contain the falling peso, improve the public finances and increase confidence among businesses and consumers. The Central Bank hiked interest rates and announced discretionary intervention in the foreign exchange market and the Ministry of Finance cut public expenditures massively.
The economy will continue to face significant headwinds this year from the continued low-oil price environment, a recent slowdown in the U.S. industrial sector—to which Mexico’s manufacturing sector is closely tied—and renewed cuts in government spending. Analysts expect GDP to increase 2.5% in 2016, which is down 0.2 percentage points from last month’s forecast. For 2017, the economy is expected to accelerate and expand 2.9%.
ARGENTINA | Government reaches agreement with creditors, now the ball is in Congress’ court
President Mauricio Macri has delivered on most of his key campaign promises less than three months after taking office, thus fueling hopes that the country is on the brink of a significant change. The new government struck a historic agreement on 29 February with a group of the country’s holdout creditors, which returns 75 cents on the dollar. The agreement is now pending a final green light from Congress. Even though Macri’s party lacks a majority in Congress, there is hope that he will secure a consensus in his favor. While the landmark deal marks a substantial step for Argentina as it clears the way for the country to return to borrowing on international markets, there are uncertainties going forward. Macri’s commitment to quick change might prove politically costly as high inflation, job cuts in the public sector and the ending of populist reforms have the potential to trigger public unrest.
GDP growth is likely to decelerate in the short term as the economy slowly adjusts to the new government’s policies. 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 0.3% in 2016, which is down 0.3 percentage points from last month’s Consensus. For 2017, analysts project the economy to accelerate and increase 3.0%.
VENEZUELA | Government announces a battery of measures to combat crisis
President Nicolás Maduro announced a wide set of measures to combat Venezuela’s devastating economic crisis and to stave off defaulting on its international debt. The measures include a reshuffling of his economic cabinet and cutting gasoline subsidies. Maduro also announced the devaluation of the currency and the creation of a new two-tier foreign exchange system to improve liquidity. One of the tiers of the new system allows the currency to float freely to reduce the inconsistencies created by the previous system.
The recent spike in oil prices provides some respite for the battered Venezuelan economy. However, the country’s growth prospects remain grim as runaway inflation and a dysfunctional retail sector are likely to keep the economy in a deep recession this year. FocusEconomics panelists see the economy dropping 7.2% this year, which is down 1.4 percentage points from last month's projection. Next year, the panel sees GDP dropping 0.9%.
INFLATION | New weakness in currencies fuels inflation at the beginning of the year
In the first two months of 2016, currencies remained under pressure against a backdrop of a new fall in commodities prices, continued deterioration in terms of trade within the region and depressed capital inflows. Consequently, the renewed weakness observed in most of the currencies in Latin America fueled inflation further. An estimate showed that inflation rose from 18.9% in January to 19.5% in February, marking another multi-year high. As currency weakness is sparking concerns that inflation will likely continue to rise, central banks across the region took action and proceeded with pro-cyclical monetary tightening policies as a means to support their currencies and stem inflationary pressures.
Despite recent signs of an incipient increase in commodities prices and expectations that most prices for raw materials will start to recover gradually toward the end of this year, forecasters still expect that inflation in the region will rise in 2016. Following the 17.5% inflation recorded in 2015, analysts expect inflation to close this year at 21.4%. This month’s projection was revised up 1.4 percentage points over last month’s projection. Economists expect Latin America’s inflation to fall to 15.8% 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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