Latin America in a Global Context - Economic Briefing August 2005

Latin American Growth Outlook Overshadowed by Jitters in Brazil

With the first half of the year over, 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 improving rapidly amid signs that the strong growth at the beginning of the year is providing a solid backdrop for a more robust recovery than anticipated earlier. Meanwhile, the U.S. economy is almost maintaining the rhythm as the external sector is showing signs of a marked improvement. The outlook for Latin America continues to drop, however, as the positive developments in Argentina are outweighed by regional heavyweight Brazil, which is suffering from political jitters and suffocating real interest rates.

U.S. economy decelerates slightly in second quarter amid reduction in inventories

According to advance estimates released on 29 July, gross domestic product (GDP) increased at an annual rate of 3.4% in the second quarter 2005.  Second quarter growth thus fell a notch short of expectations, which had GDP growing at 3.5% and was below the 3.8% growth rate observed in the first quarter.  Nevertheless, the second quarter reading constituted the ninth consecutive quarter with growth in excess of 3%.  While the overall reading remained just below the first quarter, the second quarter was characterized by a considerable weakening of the domestic side of the economy, which was compensated for by an improvement in the contribution from the external side.  In the second quarter, consumption growth slowed only marginally, as strong durable consumer goods compensated for a pronounced slowdown of non-durables.  Moreover, business investment actually accelerated from a 5.7% expansion in the first quarter to 9.0% growth in the second.  However, companies drew down inventories considerably, which sliced 2.32% of the second quarter expansion.  Without the negative impact of inventories, GDP would have grown by 5.7%. The external sector, in contrast, contributed positively to economic growth for the first time since the third quarter of 2003, as exports accelerated from 7.5% in the first quarter to 12.6% in the second and imports reversed a 7.4% expansion in the first quarter to a 2.0% annual contraction in the second.

U.S. consumer confidence continues to increase in July in spite of high energy costs

While the developments in the overall economy are only moderately encouraging, consumers, the key determinants of economic growth, are increasingly upbeat.  The latest gauge suggests that confidence continues to recover from the declines observed since the beginning of the year.  The University of Michigan’s index of consumer sentiment increased from 96.0 in the June survey to 96.5 July, further recovering from the 86.9 point reading in May, which had marked a two-year low.  While the index is still well short of the confidence peaks registered last year, the additional increase following on the 9.0 percentage point surge in June supports the view that consumers remain upbeat in spite of persistently high gasoline prices during the survey period.  However, consumers expect higher oil prices to increase the cost of living, which could dent confidence levels in the coming months.  Consensus Forecast panellists expect the U.S. economy to continue to grow along the lines observed in the first half of the year, with growth slowing only moderately to 3.4% in the second half and full year growth expected to expand 3.6%.

Japan's economy to continue recovering

The outlook for the Japanese economy looks increasingly positive for this year.  With the very robust 4.9% annual GDP growth registered in the first quarter, the economy is building on a very solid backdrop for further expansion this year.  While growth is likely to taper off in the remainder of the year, Consensus Forecast participants are increasingly optimistic, as developments of the domestic and the external side of the economy alike look promising.  As anticipated, the trade surplus narrowed in June this year amid a jump in import costs in the wake of higher oil prices.  However, the decline of the trade surplus was less pronounced than expected and export growth, while lower, remained positive.  The sluggish growth of exports to China, however, raised concerns.  In June, exports to China expanded a dismal 2.3% over the same month last year after being flat in May, in spite of continued buoyancy in the Chinese economy, which expanded at a better-than-expected 9.5% in the second quarter.  The sluggish expansion of exports to China, which has become a key destination for Japanese goods, has fuelled concerns that the efforts of the Chinese government to cool the economy could take a toll on Japanese exports.  The current sluggishness indicates that inventory adjustments within China may be underway and could slow imports.  In particular, Japanese exports of construction goods to the China have been falling significantly, as the Chinese government continues to reinforce restrictions on urban land development.  Of more concern for the future is the underlying global trend to relocate production facilities to China, which Japanese corporations have also begun to follow and is likely to eventually erode part of the export base. 

Bank of Japan remains upbeat about economic prospects

In its monthly report of recent economic and financial developments from July, the Bank of Japan (BOJ) acknowledges that exports to China have been slightly below expectations in the previous outlook.  However, the BOJ simultaneously states that domestic private demand has developed above expectations.  The monetary authorities report that industrial production is on a gradual upward trend as inventory adjustments in the IT-related sectors are progressing well.  Moreover, business investment has continued to increase, amid solid corporate profits and improving business sentiment.  Finally, the improving employment situation and stabilising wages have bolstered household income and buttressed private consumption.   Therefore, the BOJ sees the economy continuing the recovery broadly in line with the assessment from April this year, when the officials predicted that the economy would expand 1.3% this fiscal year and 1.6% next.  Consensus Forecast panellists are also increasingly optimistic and raised their forecasts for economic growth this calendar year by 0.4 percentage points from 1.4% expected last month to 1.7%. 

Outlook for Asia improves notably

Growth prospects for Asia continue to improve.  Following on last month’s 0.1 percentage point upgrade to this year’s economic growth forecast for the entire Asian region including Japan, Consensus Forecast panelists beefed up their outlook 0.2 percentage points this month to 4.0%.  The regional average growth forecast for 2005 increased even though the higher oil price and the increasingly palpable global slowdown has prompted downward revisions to some economies.  However, upward revisions to the outlook of the two regional heavyweights, China and Japan, have tilted the balance notably into the positive direction.  In particular, increasing optimism about economic recovery in Japan accounted for the lion share of this month’s regional upgrade.  China experienced the third consecutive upgrade, as attempts of the Chinese government to cool the economy prove less effective than anticipated.  In fact, the Chinese economy even accelerated in the second quarter, growing a faster-than-expected 9.5% clip.  As a result, Consensus Forecast participants expect economic growth to reach 8.8% this year, which is up 0.2 percentage points from last month’s estimate.  Moreover, the GDP growth forecast for India was lifted from 6.9% expected last month to 7.0% this month, as strong growth in the manufacturing industry will remain a key driver of the economy.  On the downside, the outlook for full-year growth in Korea was lowered from 3.9% expected last month to 3.7% this month, as the economy expanded at a less vigorous than expected pace in the first half of the year.  Consensus Forecast panellists also sliced 0.2 percentage points from the Philippine forecast for this year to 4.6%, as the country is suffering from a severe political crisis.

Growth outlook for Latin America revised downward as …

While the outlook for Asia continued to improve, the outlook for Latin America deteriorated over the past months.  Since the 4.2% expansion projected as recently as May, Consensus Forecast panellists revised the growth forecast for Latin America downward by 0.2 percentage points to 4.0%.  However, while the projected output growth is well below last year’s stellar 5.9% expansion, this year’s expansion would represent the highest rate since 1994 together with the same growth rate in 2000.  This month, a deterioration in sentiment about the growth outlook for Brazil contrasts improved projections for economic growth in Argentina, Chile and Peru.  The remaining economies are seen unchanged over last month’s forecast.

… Brazil outlook suffered from suffocating interest rates and emerging political jitters

Consensus Forecast panellists again lowered the growth forecast for Brazil by 0.2 percentage points over last month to 3.1%.  The downward revision represents the fourth consecutive month of deteriorating sentiment, as the Central Bank is reining in inflationary expectations at the cost of suffocating domestic growth, as real interest rates are now among the highest in the world.  Furthermore, political scandal is undermining investor confidence and could prompt a further slowdown in the coming months.

Peru and Venezuela benefit from strong commodity prices

On a positive note, growth prospects for both Peru and Venezuela have improved.  The Peruvian economy surprised positively, as the anticipated slowdown of the external sector, in the wake of a less dynamic global demand, proved less pronounced than expected.  Meanwhile, Venezuela is profiting from increasing oil prices.  The price for West Texas Intermediate even briefly exceeded the US$ 60 threshold and most observers expect the oil price to remain high amid continued strong demand increases in Asia.  The resulting boost to government income from rising oil prices is helping government spending, the driver behind the current strength in the economy.  The government efforts also appear to be spilling over to activity in the private sector.