Economy remains in muddy waters and Brexit exacerbates volatility
July 13, 2016
Latin America's economic downturn that began in the second half of 2015 persisted in the first half of this year. A regional GDP aggregate elaborated by FocusEconomics estimates that the economy contracted 1.2% year-on-year in Q1, while recent activity data suggest that growth continued to falter in the second quarter. This dismal performance has exposed the region's persistent structural weakness of commodity dependence and the lack of clear policies to promote further economic diversification and encourage productivity gains.
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Latin American currencies, which had experienced a period of stabilization on the heels of a sustained recovery in commodities prices since late January, saw a renewed episode of volatility toward the end of Q2. The UK's decision on 23 June to leave the EU (Brexit) has heightened global uncertainty with implications for economic growth, monetary policy and asset prices worldwide. Shortly after the official results were announced, on 24 June, the pound sterling plummeted 11% and stock prices fell across the globe, wiping out a total of USD 3 trillion. These developments were mirrored by a relative weakening in Latin American currencies. The Mexican peso—the preferred emerging-market currency for traders for its liquidity—lost 5% of its value against the greenback on 24 June, which prompted Mexico's Central Bank to take action by hiking the interest rate drastically. Nonetheless, domestic circumstances within the economies in the region vary, 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. Meanwhile, the outcome of the presidential election in Peru supported the nuevo sol.
However, as in the case of Mexico, volatility in the foreign exchange markets will put pressure on several central banks across the region in order to mitigate pass-through effects on consumer prices. This, in turn, has the potential to hurt domestic demand and ultimately damage economic growth in the region even more. The economies with large current account deficits—Colombia, Mexico and Venezuela, just to name a few—are likely to be weakest links and will feel the impact of volatility in their currencies more strongly while risking capital outflows at the same time. Should protracted and messy Brexit negotiations prolong uncertainty, a further fall in investor confidence will prevent a recovery in oil prices, which will then hit exports and fiscal revenue in oil-producing economies such as Ecuador, Colombia, Mexico and Venezuela. A silver lining for the region is that the Brexit vote and the subsequent uncertainty caused by the negotiations between the UK and the EU will likely postpone any interest rate increase by the Federal Reserve, at least until 2017. Moreover, for most of the region, the direct effects of Brexit on trade will be limited.
As the British government attempts to right itself in the aftermath of the vote, the rest of the world must now grapple with the ripple effects. Brexit is likely to take a good amount of time to sort out and, overall, the Anglo-European divorce does not radically change the picture for Latin America, where regional growth continues to disappoint and countries have bigger problems to be worried about.
Latin America is expected to have another disappointing year in 2016
Following a lackluster year in 2015—the region's worst performance since 2009—Latin America will face another disappointing year in 2016. The analysts we surveyed this month expect the region to contract 0.5% this year, before rebounding to a 2.0% expansion in 2017. Latin America's economy will continue to be held down by a protracted recession in Brazil and a deep economic crisis in Venezuela. Furthermore, Argentina is projected to contract this year as the economy undergoes a painful, yet necessary, macroeconomic adjustment. In fact, new GDP data released by the Argentine statistical office (INDEC) showed that economic growth was substantially lower for several years than had been reported. As with many series produced by INDEC under the previous government, the old GDP data were considered to be unreliable and the recent revisions in the series are a welcome step forward in the process of providing reliable statistics to enable businesses to make better informed decisions. Meanwhile, the Ecuadorean economy is expected to deteriorate further this year following feeble growth in 2015. The economy's adjustment to low oil prices and a loss of competitiveness resulting from a strong U.S. dollar will dampen export growth. In addition, the high tax burden implemented in order to contribute to the reconstruction costs of the 16 April earthquake is likely to constrain domestic demand.
Economists that participated in this month’s LatinFocus Consensus Forecast cut the regional GDP growth projection for 2016 by 0.1 percentage points over June. This downward revision reflected lower growth prospects for Colombia, Ecuador, Uruguay and Venezuela. Analysts left the forecasts unchanged for Argentina, Bolivia, Chile, Mexico, Paraguay and Peru, while Brazil was the only country for which the economic outlook improved over the previous month’s projection.
ARGENTINA | New data show economy in recession
The transition from a highly-regulated economy to a market-oriented economy is proving difficult for Argentina. Recent GDP data released by the statistical office show that the economy entered recession after recording the third consecutive quarter-on-quarter contraction in the first quarter of this year. GDP expanded a weak 0.5% on an annual basis as a deterioration in private consumption due to high inflation and the removal of utility subsidies took a toll on growth. Moreover, government spending decelerated notably and fixed investment swung to a contraction. Meanwhile, President Mauricio Macri’s push for reforms continues. In a bid to stimulate domestic demand and halt growing opposition to his austerity reforms, Macri has recently announced limits on utility price increases and an increase in pension benefits. Moreover, despite his party’s minority, last month both chambers of Parliament approved a tax amnesty that aims at repatriating capital stashed abroad in order to increase government revenues.
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 Argentina’s GDP to contract 1.0% in 2016, which is unchanged from last month’s Consensus. For 2017, analysts project the economy to rebound and expand 2.9%.
BRAZIL | Tentative green shoots are appearing
Brazil’s economy lingered in a deep recession in Q1 as high unemployment and political turmoil hit the domestic economy. However, tentative signs of improvement have begun to emerge suggesting that the economy may be returning from rock bottom. An improvement in the trade balance led the current account to record a surplus for the second consecutive month in May and both consumer and business confidence rose in June. Meanwhile, the country will be thrust further into the international spotlight just as political turmoil comes to a head. Brazil is gearing up to host the summer Olympic Games in August, yet security concerns coupled with the government’s empty coffers are casting a shadow on the event. The Senate will hold an impeachment vote in August for ousted President Dilma Rousseff. It must pass by two-thirds for Rousseff to be removed from office and a number of senators remain undecided. In addition, the Lower House of Congress must elect a new leader after suspended speaker Eduardo Cunha resigned in July on implications that he was involved in a corruption scandal.
The economy is expected to remain in a deep recession this year as political noise has delayed fiscal adjustment and stalled much-needed reforms. While interim President Michel Temer has made some steps forward with reform legislation, it remains to be seen whether he has the support needed to pass bills through Brazil’s divided Congress. FocusEconomics panelists see the economy contracting 3.3% in 2016, which is up 0.1 percentage points from last month’s forecast. For 2017, the panel sees the economy starting to recover meekly and growing 0.9%.
COLOMBIA | Government and rebels reach historic end to hostilities
Colombia’s economy slowed in the first quarter of the year. The country experienced a shock to its current account last year when oil prices collapsed, leaving the country with an unsustainable external imbalance. However, in the first quarter, exports picked up while imports dropped, which took some pressure off the current account deficit. This is partly due to increased activity in recently-refurbished refineries that are ramping up production, which is exhibited by recent improvements in industrial production and exports. Meanwhile, an historic end to the 50-year-long hostilities between the government and the FARC rebel group was reached when President Juan Manuel Santos singed a ceasefire agreement with rebel leaders on 24 June. All indications suggest the nascent peace deal will result in the full cessation of hostilities, which could open up large parts of the country to government and business investment, particular in the oil rich regions.
Although prices for hydrocarbons, which make up nearly 70% of Colombia’s exports, are expected to continue to increase steadily, the effects of last year’s drop in prices have persisted into this year. Analysts expect the economy to grow 2.3% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, the panel projects economic growth of 3.0%.
MEXICO | Lack of traction in manufacturing sends signals of slowdown
Following solid growth in Q1, Mexico’s economy is expected to have shifted to a lower gear in Q2. A lack of traction in the manufacturing sector is partly responsible for the slowdown in Q2 with no visible signs of a pick-up any time soon. Healthy consumer fundamentals—such as growing employment, rising real wages and remittances increasing at a healthy pace—continue to suggest that private consumption remained strong in Q2. However, the bad news in the manufacturing sector seems to suggest that economic growth is fragile and underlines the fact that Mexico is unable to sustain significant growth rates. Shortly after the United Kingdom announced that citizens had voted to abandon the EU, Mexico’s Ministry announced MXN 31.8 billion (USD 1.7 billion) in budget cuts in response to expected volatility resulting from Brexit. Unlike the last cut in February, this one will not affect PEMEX and will fall almost entirely on current spending, with the objective of maintaining the government’s fiscal deficit target of 3.0% of GDP this year.
The Consensus view among analysts is that economic growth will be supported by private consumption this year. However, Mexico’s difficult adjustment to low oil prices and the fact that monetary and fiscal tightening come at a time of softening economic activity are casting a shadow on the outlook. Analysts expect the economy to expand 2.4% this year, which is unchanged from last month’s forecast. Next year, the economy is projected to accelerate to a 2.7% expansion.
INFLATION | FX volatility increases pressure on central banks
In a context of hyperinflation in Venezuela and high volatility in currency markets, inflation in the region continued to spike in June. An aggregate inflation estimate elaborated in-house shows that that inflation in the region rose from 21.2% in May to 22.0% in June—the highest point since 1995.
The recent volatility caused by Brexit is increasing 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 jitters, while Colombia’s monetary authorities maintained their hawkish stance and hiked interest rates again in June in order to combat rising inflation and anchor inflation expectations. Meanwhile, in Brazil, 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 25.8%. This month’s projection was revised up from the 24.3% expected last month. Analysts see inflation in the region falling to 20.4% at the end of 2017.
Written by: Ricardo Aceves, Senior Economist
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