Latin America in a Global Context - Economic Briefing November 2008

Regional Outlook Deteriorates Sharply

The global outlook is rapidly deteriorating as the financial crisis has spread like wildfire through global capital markets, eroding trillions of dollars in market capitalisation. Although governments are announcing a host of measures to restore confidence, the major advanced economies all seem headed for a recession. Despite a massive US$ 700 billion bailout, the United States is already experiencing a major slump, as downtrodden consumers and difficult financing conditions are weighing heavily on the economy. Against this backdrop, the outgoing Bush administration is considering the execution of a second US$ 150 billion fiscal stimulus plan, endorsed by the Federal Reserve. Similarly, Europe is headed for a notable downturn. While European leaders have acted decisively lowering interest rates and preparing a bank bailout that exceeds US$ 1 trillion, the measures will only serve to mitigate the slump, as the major EU economies are already in or near a recession. While Japan’s financial system initially seemed better prepared to withstand the crisis, the government had to announce measures to prop up the country's banking system. In addition, Japan is suffering from a stronger yen, which has reached a 13-year high against the dollar and will thus exacerbate the effects of waning external demand. Against this backdrop, Latin America’s growth prospects are also deteriorating and the region is set to grow at the slowest pace in six years in 2009.

Growth forecasts for 2009 deteriorate sharply

While until recently the financial sector crisis was seen as having only a limited impact on the global economy, the latest developments in global financial markets have rapidly changed this notion.  Consensus Forecast participants have adjusted their projections and are now expecting the developed world to enter into recession and grow less than 0.5% next year.  As a result, emerging economies will face substantially weaker external demand and, consequently, export growth, which has constituted one of the key drivers of the current economic cycle, will wane.  The industrialised world’s downturn has already spread to emerging market economies and will certainly take its toll on Latin America.  According to this month’s survey, Latin American output will expand 4.4% this year, which is 0.1 percentage points below last month’s Consensus and more than a full percentage point below the 5.5% expansion registered in 2007.  Next year, the region will moderate further with growth plummeting to 2.7%, which is down 0.6 percentage points from last month’s projection and, if attained, would represent the slowest pace in six years. 

Panellists slash growth forecasts for all countries

Among the seven major economies, Argentina will experience the most notable slowdown, as panellists see the economy expanding only 2.5% in 2009 (October’s LatinFocus Consensus Forecast: +3.8%), following on a 6.1% expansion this year.  Argentina may suffer more than its regional peers from the current financial crisis, as the country may find it particularly difficult to regain access to international capital markets at a moment when the country needs to raise cash as declining commodity exports curb tax revenues.  After the country halted payments on US$ 95 billion of debt in 2001 - the biggest sovereign default ever - a restructuring of US$ 20 billion of defaulted bonds is still pending and increasingly risk averse investors are likely to shun the country.  In response, the country has once more turned to unorthodox measures to secure its financing needs by nationalising the private pension system.  Next to Argentina, Peru will experience substantially slower growth.  In part, the deceleration in Peru is due to a substantial decline of key commodity prices during the past few weeks, as the market factors in lower demand in the wake of the global slowdown.  As one of the largest metal miners in the region, Peru will suffer a direct impact on export growth.  In addition, declining commodity prices may also induce investors to postpone mining investments that had been planned amid record high commodity prices.  However, more than anything, the slowdown in Peru reflects a very strong growth performance in 2008, when the country is estimated to be the fastest growing economy in the region with a projected growth rate of 8.9%.  In fact, with an anticipated GDP growth rate of 6.1% in 2009 (October’s LatinFocus Consensus Forecast: +6.5%), Peru will continue to lead the region in terms of economic growth despite the slowdown over 2008.  Venezuela will also experience a notable downward adjustment of output growth.  Consensus Forecast panellists expect the Venezuelan economy to expand 3.2% next year (October’s LatinFocus Consensus Forecast: +3.7%), well below the estimated 5.5% growth rate estimated for 2008 and in fact the slowest pace since the 2002/2003 recession.  The slowdown in Venezuela mostly reflects the drop in oil prices observed during the past months – just in October, the average price for the Venezuelan mix of crude oil plummeted 28.4%.  More than any other country in the region, Venezuela precariously depends on high oil prices to maintain the status quo.  In 2007, oil accounted for 90% of total exports, more than a quarter of GDP and more than half of total government revenues.  In addition to the oil price decline, Venezuela is suffering from the unorthodox economic polices adopted by the Chávez administration, including price controls, nationalisations and an exchange rate freeze, which provide little chance that the economy can prosper without the windfall of soaring oil prices.  On the upper end of the slowdown scale, Mexico will shed only 0.9 percentage points of output growth between 2008 and 2009.  However, the moderate adjustment is due to a low comparison base, as the Mexican economy is estimated to grow a paltry 1.9% this year.  With around 80% of its exports going to the United States, Mexico is intimately linked to the U.S. business cycle.  In addition, remittances from Mexicans working in the U.S. have become an important source of revenue for Mexico and the country thus stands little chance to prosper when a recession seizes the U.S. economy.

Inflation expectations continue to deteriorate despite pronounced slowdown

Pushed up by surging fuel and food prices, Latin American inflation is estimated to reach 8.8% this year, which would represent the highest level in six years.  Next year however, a combination of slowing demand and falling commodity prices is likely to contain price pressures.  That said, at a projected 7.8% regional average in 2009, inflation will remain high in Latin America.  Moreover, the 2009 projection is 0.4 percentage points above last month’s Consensus, indicating a simultaneous deterioration of the growth and the inflation outlook.  Currently, several countries continue to experience strong price pressures amid sharp food price increases, supply constraints and public sector wage increases.  Moreover, while the recent moderation in international commodity prices should ease some of the pressure, several Central Banks have lost credibility by letting inflation rise well beyond established target levels.  Restoring this lost credibility will prove to be a lengthy and, in some countries, costly process.  Among the seven major economies in the region, Chile will enjoy the most pronounced decline in inflation between 2008 and 2009.  Consensus Forecast panellists expect inflation to decline 4.1 percentage points from this year to the next.  However, the decline reflects an elevated inflation rate this year.  With an estimated year-end rate of 8.8% in 2008, inflation almost triples the Central Bank’s medium-term 3.0% inflation target.  Moreover, despite the moderation in price pressures predicted for next year, inflation will stay considerably above this target rate, at 4.7% by the end of 2009.  Following Chile, Peru will experience the second-strongest decline in inflation, a 2.3 percentage point drop between 2008 and 2009.  Nevertheless, at the 3.8% year-end rate projected for 2009, inflation will remain well above the Central Bank’s target.  Colombia and Mexico will experience a 1.7 percentage point decline in inflation next year, while Brazil will register a 1.2 percentage point drop in its inflation rate.  Argentina is the only country in the region that will experience accelerating inflation next year.  Consensus Forecasts panellists expect official inflation to reach 10.7% by the end of next year, which is 1.8 percentage points above the 8.9% expected for this year.  However, since the introduction of a methodological change in measuring consumer prices in 2007, the official inflation data have been received with suspicion and most analysts believe that actual inflation in Argentina is considerably higher than the officially reported rate.  Based on a separate Consensus Forecast of panellists that are tracking actual price developments, non-official inflation is estimated to reach 22.4% this year and 18.4% in 2009.