Latin America in a Global Context - Economic Briefing January 2005

Global Economy to Remain Strong in 2006

In 2005, global output expanded at a slower rhythm than last year. Nevertheless, the global economy held up well, given the adverse impact of the significantly higher oil price. The United States continued to grow at a robust pace in spite of the hurricanes in August and September, which sent gasoline prices to historic highs, which, in turn, prompted consumer confidence to plummet. In Japan, the outlook improved continuously throughout the year, as the export-led recovery revived domestic consumption and investment. Latin America also put in a year of robust growth, as strong commodity prices supported a continued export expansion. Only the Euro Area continued to ail along, as governments have not found the recipes to tackle structural imbalances impeding a recovery. The pattern observed this year is likely to repeat itself virtually unchanged in 2006, with the exception of the Euro Area, where growth should pick up notably.

2005 brings long awaited rebound

With 2005 just ended, the initial indicators for economic performance are trickling in.  Even though most indicators have yet to be released, big surprises in overall economic Latin American developments should mark the exception.  Therefore, now is an opportune moment for review, taking a closer comparative look at the surveyed countries before focus turns to 2006. 

On average, the region’s economy expanded by 4.1% in 2005 - the third-fastest growth pace in the past decade.  While well short of the 5.9% expansion registered in 2004, the previous year had marked an exception, with growth reaching a ten year high.  Last year, growth was broad-based, as not a single country experienced a recession.  According to the latest Consensus Forecast estimates, economic growth exceeded the 2% threshold in all countries. 

Given the high comparison base from the previous year, a continuation of strong growth in 2005 was anything but certain.  In fact, at the beginning of the year, Consensus Forecast panellists had expected a more subdued 3.7% pace this year, which was revised upwards to the current 4.1% estimate.  However, not everything went as well as expected.  The upward revision to regional output growth is surprising when considering that Brazil and Mexico, Latin America’s two most important economies, which account for almost 70% of total regional output, developed far worse than expected at the outset of last year.   Three major trends determined economic developments in the region and accounted for the upward revision to the regional growth forecast.

1.       Global economy.  Last year, the global economy developed surprisingly well.  Even though global economic output slowed a full percentage point compared to 2004, the estimated 3.0% growth (based on market exchange rate weights) is remarkable given the higher than anticipated surge in oil prices.   In 2005, the price for the benchmark oil basket of West Texas Intermediate was 35.4% above the same period last year.  The spike in oil prices threatened to derail private consumption, particularly in the United States, where gasoline prices spiked sharply in the aftermath of the hurricanes in August and September.  However, the feared consumption slowdown did not materialise and hence, demand for products from Asian manufacturing hubs remained strong.  While Asian export growth slowed from the buoyant 23.7% registered in 2004, exports continue to expand at a healthy 14.5% pace, which is 3.4 percentage points faster than expected at the beginning of the year. 

2.       Commodity prices.  While some countries suffered from the high oil prices in terms of higher import bills as well as mounting inflationary pressures and tighter monetary policy settings, virtually all economies benefited from higher commodity prices.  Higher commodity prices had been behind the record growth registered in 2004.  While some observers had anticipated prices to fall back again, most commodities continued the price bonanza, in particular in the mining sector, which constitutes a key commodity group for most Latin American economies.  According to the World Bank’s commodity price indices, metals and mineral prices increased 25.4% (Jan-Nov 2005 compared to Jan-Dec 2004).  

3.       Export boom.  Contrary to initial expectations, the healthy global economy and high commodity prices once more prompted strong growth of Latin American exports.  In 2004, exports had expanded 24.2% and thus constituted the most important factor behind record economic growth that year.  In spite of the much higher comparison base, export growth almost kept up the stellar pace last year.  According to the current estimates, exports expanded 18.5% in 2005.  Venezuela experienced the fastest export growth, as oil prices pushed up exports an estimated 43.5% virtually maintaining the 44.3% growth pace registered in 2004.  Of the major economies, Mexico carried the red lantern in spite of strong growth in oil exports, which account for 15% of total exports.  However, in the United States, by far Mexico’s most important export destination, Mexican manufacturers faced increasing competition from Asian manufacturing hubs, which have eroded Mexico’s market share.

Latin American economies continue to profit from strong demand for commodities

This year, the Latin American economies are likely to develop broadly along the lines seen last year.  According to the current estimates, the region’s economies will expand 3.9% in 2006, just a notch short of the 4.1% expansion estimated for 2005.  Against the background of a moderate pick-up in global economic growth from 3.0% expected for this year to 3.2% in 2006, Latin American economies are likely to benefit from continued strong demand for commodities.  However, given the high comparison base set by two years of double-digit export growth, the pace of export expansion will slow to only 3.4% this year. 

Argentina and Venezuela to remain fastest growing economies in 2006

Last year’s highfliers, Argentina and Venezuela, will experience the most pronounced slowdowns but remain the strongest growing economies this year.  In Venezuela, which expanded 9.4% in 2005, growth will plummet by 3.8 percentage points.  However, with a 5.8% expansion anticipated for this year, Venezuela will remain the fastest growing economy in the region.  The country will benefit from a continued high price environment for oil, which accounts for 15.9% of GDP, 11.5% of government revenue and 86.9% of exports.  Similarly, growth will slow from 8.4% to 5.5% in Argentina, which is just sufficient to keep the country in the position of the second-fastest growing economy in Latin America.  Argentina continues the cyclical rebound from the devastating four-year recession that lasted from 1999 through 2002.  Over the past three years, the Southern Cone economy has recovered considerable ground, with the economy expanding persistently above 8%.  Thus 2006 will mark an important step from cyclical rebound to a more sustainable growth pattern.  While the Argentine outlook for this year is positive, the growth potential could be limited by strong inflationary pressures and concerns about economic policy.  Last year, inflation pierced the 10% threshold for the first time in more than a decade and in spite of government efforts to rein in pressure on consumer prices, inflation is likely to remain in the double-digit range this year.

Pace will pick up in Brazil and Mexico but growth potential remains limited by domestic factors

Mirroring the developments in Argentina and Venezuela, growth prospects for Brazil and Mexico will improve this year but both will remain the slowest growing economies in 2006.  Last year, developments in Brazil deteriorated sharply, as the Central Bank’s attempts to rein inflation with one of the highest real interest rates in the world, prompted a sharp decline in domestic demand.  While the Central Bank has meanwhile loosened monetary policy, interest rates remain high, limiting the growth potential for Latin America’s largest economy.  October elections are also likely to cast a shadow over economic prospects this year.  In Mexico, growth potential remains limited, as the outgoing administration of President Vicente Fox remains unable to adopt the necessary economic reforms to provide the country with an impetus for higher growth.  Simultaneously, the country continues to loose market share in the United States to Asian competitors, limiting the potential for an export-led recovery.  Elections in July may also prompt some jitters over economic prospects in the second half of this year.