Latin America in a Global Context - Economic Briefing January 2007

Prospects for Latin America Improve

The global economy is headed for a moderate slowdown this year. The U.S. economy mainly hinges on the impact of the bursting housing bubble on private consumption, which has constituted one of the key pillars of global consumption during the past years. In fact, the U.S. economy is showing clear signs of a slowdown for the second consecutive quarter. However, consumer confidence remains above average, which could support consumer spending in the months ahead. In addition, the some European economies are strengthening and may compensate for the softness in U.S. demand. Meanwhile, the Japanese economy has just marked its longest expansion since the end of World War II and the economic outlook remains robust. Moreover, non-Japan Asia will continue to grow at a robust pace, driven by resilient growth in China and India. Finally, prospects for Latin America are improving, as the region enters the fifth year of solid growth propelled by the drawn out upward cycle in commodity prices.

Outlook for Latin America improves amid upward revisions to most economies

The outlook for Latin American output growth this year improved over the past month.  Since the 4.1% expansion projected in December, Consensus Forecast panellists revised the growth forecast for Latin America upward by 0.1 percentage points to the current 4.2%.  Thus, the Latin American region will experience yet another year of above average growth, following on last year’s estimated 4.7% expansion.  In fact, 2007 constitutes the fourth consecutive year with growth rates above 4% following on three years with barely positive growth between 2001 and 2003.  This month, an improved growth forecast for four of the seven major economies lifted the regional outlook.  The outlook of two countries remained unchanged and one country (Chile) was revised downwards over last month.  Peru and Venezuela experienced the strongest upward revision to this year’s growth forecast, with both GDP growth rates lifted half a percentage point over last month’s projection.  After being the fastest growing economy in 2006, the Consensus believes Venezuela will experience yet another year of resilient growth, as the government generously distributes the oil wealth among the population, fuelling private consumption growth.  Similarly, Peru is profiting from domestic factors.  Buoyed by strong commodity prices as well as robust agriculture and commerce, consumers are increasingly optimistic about the prospects for this year, which promises to buttress private consumption.  In addition, the new García administration is planning to increase public spending in infrastructure projects, which will boost investments.  As a result, Consensus Forecast panellists raised last month’s 2007 growth projection by 0.5 percentage points to 6.2% and the 2007 forecast by the same margin to 5.7%.  The Consensus is also more upbeat about prospects for Colombia.  Panellists lifted the outlook for the most important economy of the Andean Community from 4.5% to 4.9%.  The economy is being boosted by resilient domestic demand, which has begun to fuel price pressures, prompting the Central Bank to lift interest rates to the highest level in more than two years.  Next to Peru and Colombia, Consensus Forecast panellists are increasingly optimistic about the outlook for Argentina and have raised their 2007 GDP growth forecast from 6.6% expected last month to 6.9%.  Following on four years of recession, culminating in the default and abandonment of the currency peg to the US$ in 2002, the country is entering the fourth year of a strong rebound, which makes Argentina the fastest growing economy during this period.  Nevertheless, in spite of four years of strong growth, Argentina has not yet recovered the wealth it enjoyed a decade ago.  Measured in GDP per capita in US$ terms, Argentina will this year surpass the level last seen in 1991.  On the bottom end of adjustments to this year’s growth outlook is Chile.  In spite of a spectacular copper price bonanza in 2006, the world’s largest copper producer failed to benefit with a proportional development of the economy.  Owing to a strict laws enforcing fiscal discipline the government is prohibited to spend copper windfall profits.  In addition, repatriation of profits by foreign-owned mining operations reduces the beneficial impact of higher copper prices on the entire economy.

Inflation set to rise this year

With virtually all countries having reported year-end inflation rates for 2006, the regional average came in a notch below the rate expected last month.  Nevertheless, at 4.6% year-end inflation keeping inflation under control remains a challenge in Latin America.  Moreover, the region will make no progress in lowering inflation this year.  To the contrary, in 2007, the average regional inflation rate will rise to 5.0%.  Two of the seven major economies in the region, Argentina and Venezuela, will record double-digit inflation rates this year.  Next to traditional monetary policy tools, both countries adopt unorthodox policies to contain inflation.  In Argentina, the government strikes deals with major companies to hold back price increases, whereas in Venezuela the government employs exchange rate controls and intervenes less subtly into the economy by outright price fixing for certain goods and services.  Nevertheless, with 16.2% year-end inflation this year in Venezuela and 10.3% in Argentina, both countries have the highest inflation rates in the region and also fail to reduce inflation compared to 2006.  On the positive side of the inflation spectrum are Peru and Chile with rates of 2.3% and 2.9% respectively, which is below the inflation target rates set by their monetary authorities.  However, both economies are relatively small and carry little weight in the calculation of the regional average.  More important for the inflation in the region are the developments in Brazil and Mexico, which account for almost 70% of total regional output.  Both countries are moving towards a more controlled inflation environment.  While Mexico exceeds the long-term inflation target of 3.0% set by monetary authorities, inflation will remain within the 1% tolerance margin with a projected year-end headline inflation rate of 3.5%.  Brazil has made substantial progress in its fight against inflation.  Inflation dropped from 7.6% in 2004 to 3.1% by the end of 2006.  However, the tight monetary policy implemented by the Central Bank has contributed to stifle economic growth.  The Central Bank has meanwhile loosened the reins to revive the ailing economy, which will prompt inflation to rise to 3.9% by the end of this year.