Latin America in a Global Context - Economic Briefing June 2005

Downward revision to Latin American Growth Outlook

With the first half of the year almost complete, the impact of the anticipated slowdown of the global economy from last year’s dynamism is palpable. Nevertheless, while not as buoyant as last year, the global economy is expanding at a faster than average rhythm, with virtually no signs of a cool down in non-Japan Asia. In Japan, the outlook is beginning to stabilize following on a series of downward revisions in the past months. While the economy will remain sluggish, recent data suggest that private consumption is expanding at a more robust pace than expected and could support the economy amid dwindling export growth. Meanwhile, the U. S. economy is showing incipient signs of weakness as investment failed to offset more moderate consumer spending. The outlook for Latin America was lowered for the first time, as first quarter growth for the two economic heavyweights of the region, Brazil and Mexico, came in below expectations.

First quarter growth revised upward in the United States

According to preliminary estimates released on 26 May, gross domestic product (GDP) increased at an annual rate of 3.5% in the first quarter 2005.  First quarter growth was thus bang in line with expectations prior to the release of last month’s advance estimate, which had shown slower GDP growth of 3.1%.  However, the reading was below the 3.8% growth rate observed in the prior quarter.  The deceleration in the first quarter reflected slower consumption growth, in particular of durable consumer goods, which dropped from a 3.9% expansion in the fourth quarter to 1.7% growth in the first quarter.  Hopes that investment would offset the anticipated slowdown in consumer spending were quelled.  Fixed investment growth dropped to half the 10.5% expansion in the fourth quarter, as businesses cut equipment and software spending.  Finally, even though revised substantially downward from the advance estimates, imports still expanded at a quicker pace than exports, which lowered the overall growth rate by 0.67 percentage points.  Without the negative impact of the external sector, GDP would have grown by 4.2%.

Weaker dollar insufficient to stem current account deficit

Despite a substantial depreciation in the real effective exchange rate of the US$ versus the currencies of major trading partners, the U.S. current account position is not improving.  According to this month’s Consensus Forecast, the current account deficit will increase 0.4 percentage points from last year’s 5.7% of GDP level to 6.1% of GDP this year.  Obviously, a weaker US$ alone is considered insufficient to stem the imbalance, as both the government and consumers remain on a spending spree.  In its economic outlook from 24 May, the Organisation for Economic Co-operation and Development (OECD) highlights the dangers associated with the unsustainable deficit.  The OECD states that pressures for a correction in the deficit continue to mount and is concerned that the adjustment at some point could force an abrupt weakening of the US$ with adverse consequences for the entire OECD area.  Even though the organisation sees no immediate danger of sudden exchange rate adjustments, the OECD is concerned that a declining US$ would not only curtail net exports but also domestic demand in Japan and Europe where the resilience of economic activity is uncertain and monetary and fiscal room for manoeuvre is limited.

Japanese outlook stabilises amid surprisingly strong growth in first quarter

In Japan, forecasts are petering out at a lacklustre growth level.  However, recent data have given rise to hopes that the economy has regained some momentum amid strong profit growth and a mild recovery in the job market.  In the first quarter, GDP expanded at an annual rate of 5.3%.  The reading blasted expectations, which had the economy growing by 2.4%, less than half the actual pace.  Furthermore, the first quarter reading marked a strong acceleration compared to flat growth in the fourth quarter.  Based on a quarter-on-quarter comparison the economy expanded by 1.3% in seasonally adjusted terms, which was the highest pace observed since the first quarter last year and followed on zero growth in the fourth quarter.  In part, the recovery had been expected since the domestic side of the economy was anticipated to pick up the slack from the external sector.  In particular, consumption was expected to rebound amid better income and employment conditions.  In the final quarter of last year, consumption had been overshadowed by concerns following a series of typhoons.  In fact, private consumption was the main source for the stronger-than-expected expansion in the first quarter, as growth rebounded from 1.4% annual contraction in the fourth quarter to a 4.7% expansion in the first quarter.  Gross fixed investment also rebounded strongly to a 3.1% expansion, following on a 0.5% contraction in the fourth quarter.  However, the rebound in part reflects the postponement of construction spending that was delayed towards the end of last year amid adverse weather conditions. 

Japan likely to exit deflation next year

Further gains in employment and rising wages will support private consumption further.  Simultaneously, investment should benefit from increased profits in the business sector, replacement of old equipment and the increasingly healthy banking sector.  The external sector is likely to support domestic demand, with a continued positive contribution as the current account surplus is seen rising slightly from 3.5% of GDP this year to 3.6% of GDP in 2006.  However, with prices only mildly sensitive to demand changes, the current deflation is likely to haunt the economy until next year.  According to the Consensus Forecast, consumer prices will decline 0.1% this year and will rise a moderate 0.2% next year.  Consensus Forecast panellists remain cautious about this year’s growth prospects despite promising first quarter developments and see the economy expanding 1.3%, just half the 2.7% registered last year.  For 2006, the Consensus Forecast is a notch more optimistic, expecting the economy grow by 1.8%.  However, a number of risks, both external and domestic, could derail the economy.  A delayed pick up in world trade or a significant appreciation of the yen would slow growth.  In addition, if the downward trend in wages continues, private consumption could slow and the steady increase of public debt would drive up interest rates. 

Outlook for Asia remains bright as buoyant Chinese and Indian economies compensate for sluggish Japan

Growth prospects for Asia remain bright.  The current Consensus Forecast estimate for the entire Asian region, including Japan, shows a significant slowdown compared to 2004.  Thus the Consensus Forecast expects the Asian economy to expand 3.7% this year.  In 2004, Asia’s economies profited from surging global demand, which had boosted exports a staggering 23.5%.  This year, exports will “only” expand 11.7%, as the global economy adopts a more moderate growth rhythm.  Therefore, the trade-dependent economies in Asia will experience the sharpest downturn, whereas the economies that depend to a large extent on the domestic markets will fare better.  In particular, the region’s economic giants, China and India, continue to grow at full throttle.  Consensus Forecast participants expect China to grow 8.5% this year, as the pledges of the government to cool the economy are not yet bearing fruit.  While not quite meeting the pace, the 6.9% growth outlook for the other regional heavyweight, India, underlines the resilience of non-Japan Asia, which is expected to grow 6.4% this year.

First downward revision to this year’s growth outlook

This month is seeing the first downward revision to the economic growth forecast for the Latin American region since Consensus Forecast panellists began elaborating forecasts for this year.  Consensus Forecast panellists have continuously hiked their forecasts for output growth during the past six months.  The regional forecast for this year peaked at 4.2% in April and May but dropped back to 4.1% this month.  The downward revision reflects a deterioration in sentiment about the growth outlook of the two regional behemoths, Brazil and Mexico, contrasted by increasing optimism for Argentina and Peru.  The remaining economies are seen unchanged over last month’s forecast.

Lower outlook in Brazil amid suffocating interest rates

Consensus Forecast panellists lowered the growth forecast for Brazil by 0.2 percentage points over last month to 3.5%.  In the first quarter, the Brazilian economy expanded at a slower than expected pace amid a pronounced slowdown in domestic demand.  Domestic demand is suffering from suffocating real interest rates, as the Central Bank seems set to rein in inflationary expectations even at the cost of lower economic growth. 

Prospects for Argentina and Peru improve as both economies grow faster than expected

Similarly, Consensus Forecast panellists lowered the outlook for Mexico, as first quarter growth fell short of expectations.  Moreover, consumer confidence has been shaken and given the current political scenario, any significant economic reform before next year’s presidential elections is unlikely to materialise.  On a positive note, growth prospects for both Argentina and Peru have improved.  In Argentina, the economy continues to surprise to the upside as the ongoing recovery remains on track virtually unabated despite the higher comparison base.  The Peruvian economy also surprised positively, as the anticipated slowdown of the external sector, in the wake of a less dynamic global demand, proved less pronounced than expected.