Latin America Economic Outlook Jan 2017

Latin Americans became poorer in 2016, triggering political shift

Latin America: Latin Americans became poorer in 2016, triggering political shift

January 18, 2017

In most of Latin America, persistently weak economic conditions have triggered a political shift from the left to the right of the political spectrum. Voters moved away from populism as a perceived solution to economic and social issues as progress on poverty reduction had stalled and income inequality remained higher than in any other region in the world. According to estimates produced by FocusEconomics, which are based on our panelists’ forecasts, Latin Americans became poorer in 2016. Considering a population growth rate of 1.1% in the region last year, estimates show that GDP per capita fell for a second consecutive year in 2016 and decreased to levels seen in 2009. The drop reflected the protracted recession in the region and, to some extent, the slump in global commodity prices that substantially hurt exporting countries of raw materials—such as ArgentinaBrazilColombiaMexico and Venezuela—while benefitting net commodity importers, particularly importers of hydrocarbons.

A key source of frustration and unrest in the region in 2016, and likely in this year too, was the failure of governments to bolster the institutional framework and combat corruption. Institutions remain weak in many countries, leading to institutional governmental deficiencies as well as lax public governance. Engagement in politics and in political organizations is also low due to weak confidence in the government and the perception that public institutions are corrupt and puzzling. Against this backdrop, protests to denounce corruption have erupted in many countries, including BrazilChileMexico and Venezuela. Even in countries where the risk of unrest is not that significant, political effectiveness remains weak, given the presence of minority governments and unstable political alliances.

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Center-right governments in the continent are moving forward with policy reforms, which are focused on macroeconomic adjustment and improvements to the business environment, which should produce stronger economic growth and propel private consumption.

2017 should be a better year 

2016 was an unpredictable year. Few people predicted that Trump would win the U.S. elections nor that the UK would vote for Brexit. Even that the Chicago Cubs would win the World Series or that the Leicester City would take the Premier League title seemed farfetched. But our panel of economic experts did predict last year’s economic recession in Latin America, forecasting it since at least early 2016. After having stagnated in 2015, the region’s economy began to feel the recession in Q1 2016 and it worsened as the year progressed. An aggregate estimate with preliminary data shows that Latin America’s GDP decreased 0.5% year-on-year in Q4, which was less severe than the 0.9% contraction in Q3. Although the result signals that the battered economy is gradually stabilizing, 2016 will be remembered as the year of the worst economic performance since the global financial crisis hit in 2009. Analysts’ estimates suggest that Latam’s economy contracted 0.7% in 2016, reflecting Argentina’s painful economic adjustment, Brazil’s deepest recession in decades, Ecuador’s plunge in economic activity and the most severe economic depression in Venezuela’s history.

2017 looks like a better year for Latam as the economy is expected to record a modest recovery, which, nonetheless, is plagued with risks that are causing a downward bias in analysts’ growth forecasts. Economists forecast Latin America’s GDP to increase 1.6%, which has been revised from the 1.8% projected last month. Economic data was stubbornly weak across the region in 2016 and growing uncertainty surrounding the global outlook in the aftermath of Donald Trump’s victory is weighing on sentiment, adding to concerns over the trajectory of the recovery in 2018. The prospect that a Trump presidency might be both protectionist and in favor of a substantial fiscal expansion have altered expectations for U.S. monetary policy. Therefore, weakness is looming on the horizon for several currencies in the region, raising risks of a further tightening of monetary policy across the board. 

Looking at the countries in the region, economists made sizeable cuts to the 2017 GDP growth forecasts for BrazilEcuadorMexico and Venezuela, which together represent big portion of the region’s economy. Meanwhile, analysts kept the outlook unchanged for 5 economies, including ArgentinaChile and Peru, while Paraguay was the only economy for which economists raised their forecasts. 

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ARGENTINA | Tight economic policy continues amid emergence of green shoots

The economy continues to feel the impact of tighter economic policies aimed at reducing macroeconomic imbalances. In Q3, GDP contracted at the sharpest pace in two years as household spending remained constrained by high unemployment and declining real wages. The dire economic situation is affecting business sentiment, which, in turn, is causing private investment to drop. Some green shoots, however, are starting to emerge: on a sequential basis, the fall in economic activity softened in Q3, and consumer confidence and industrial production improved in December and November respectively. Finance Minister Alfonso Prat-Gay resigned on 26 December due to growing disappointment over the pace of the economic recovery and disagreements over economic policy with other cabinet members. The ministry of finance will now be split into two ministries: finance and treasury. Despite Prat-Gay’s resignation, officials stated that the new ministers will broadly follow the same direction of economic policy.

Although Argentina will return to growth this year thanks to a combination of higher real wages, improved business sentiment and stronger regional growth, spillovers from the government’s tough economic reforms are casting doubts about how strong the economic recovery will be. Analysts foresee the economy expanding 3.0% this year, which is unchanged from last month’s estimate. Next year, the panel sees GDP growth at 3.1%. 

BRAZIL | Will the economy finally recover this year? 

High unemployment, tight credit conditions, political turmoil and weak external demand kept Brazil’s economy in the worst recession in modern history last year. While signs of stabilization have emerged, activity is meagre and gains are uneven. Consumer and business confidence both fell to six-month lows in December along with the manufacturing PMI. However, retail sales surged to the best result in over three years in November and the current account deficit came in at a multi-year low. In the political arena, the government continues to progress with reforms. A constitutional amendment to limit social spending was approved in December and a recovery agreement was reached with indebted state Rio de Janeiro.  

After an expected 3.4% contraction in GDP last year, the economy should return to growth in 2017 but activity will be meagre. Analysts see GDP growth at 0.6% in 2017, which is down 0.2 percentage points from last month’s forecast. The recovery is seen gaining speed in 2018 and GDP should increase 2.2%. 

COLOMBIA | Congress approves fiscal reform

In Q3, the Colombian economy recorded its worst performance since the height of the global financial crisis in 2009. The latest monthly data sent mixed signals of the economy in Q4, which suggests that Colombia was still in bad shape at the close of 2016. In October, industrial production decelerated sharply, while retail sales grew again after two months of decline. Meanwhile, in November, exports grew at a double-digit rate but consumer confidence fell for a second consecutive month. On 23 December, Congress approved the long-awaited tax reform that aims to bolster tax revenues and allow the country to retain its credit rating amid a slump in oil earnings. The reform includes a new tax on dividends, an increase in the Value-added Tax and a gradual decrease in income tax for businesses, among other measures.

Higher oil prices following the OPEC output freeze coupled with increased infrastructure spending should provide a boost to Colombia’s economy this year. Analysts expect the economy to grow 2.4% in 2017, which is down 0.1 percentage points from last month’s forecast. For 2018, our panel projects economic growth of 3.1%. 

MEXICO | Trump’s policies weigh on the outlook

Mexico is by far the most exposed economy in Latin America to risks from the U.S., given the strongly integrated trade and manufacturing cycle links to its northern neighbor. At the same time, December’s fall in the manufacturing PMIs give little hope of stronger GDP growth in Q4, following a slowdown in Q3. Adding to the bad news for the manufacturing sector, carmakers are feeling the pressure coming from Trump’s threats to impose tariffs on vehicles assembled in Mexico and exported to the U.S. On 3 January, Ford Motor Company bowed to the pressure and announced that it had cancelled plans for a new plant in the country. It remains to be seen if future U.S. investment into Mexico’s industrial sector, particularly in the car industry, will be under threat of cancellation or reduction this year.

With fears that Trump’s protectionist agenda will wreak havoc on Mexico’s economy, the outlook is becoming gloomier. Analysts expect the economy to decelerate to 1.8% growth in 2017, which is down 0.2 percentage points from last month’s projection, after an estimated 2.1% growth in 2016. For 2018, GDP is forecast to increase 2.3%.

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INFLATION | Inflation in the region (excluding Venezuela) to fall

Trump’s victory has put pressure on most Latin American currencies. A large fiscal expansion—as advocated by Trump during his campaign—in an economy close to full employment has prompted an increase in U.S. Treasury yields, which in turn, strengthened the U.S. dollar against most emerging-market currencies. All currencies were affected by the “Trump shock”, especially the Mexican peso, which has strong trade links with the U.S. Nonetheless, even with the recent weakening, the performance of most Latam currencies—with the exception of the Mexican peso—were stronger in 2016 than the previous two years. At the same time, growth remains weak across the region and these conditions are still supporting disinflation in Latin America.

Inflation in the region as a whole ended 2016 at 26.1%, which marked the highest rate in two decades. However, if the exceptionally high inflation in Venezuela is not taken into account, Latin America’s inflation ended last year at 8.9%.

Considering that Venezuela is experiencing an episode of near hyperinflation, inflation in Latin America is projected to continue rising this year to 30.0%. Stripping the effects of hyperinflation in Venezuela, Latin America’s inflation is expected to fall to 6.5% this year. Going forward, analysts project Latam’s inflation (ex-Venezuela) to fall further to 5.4%, while if we keep Venezuela in the regional aggregate, inflation in the region is seen increasing to 24.1%.

Written by: Ricardo Aceves, Senior Economist

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