Latin America in a Global Context - Economic Briefing December 2008

Regional Outlook Worsens Sharply

The global outlook continues to deteriorate as the world’s economies are headed for a synchronised downturn. Although governments have announced a host of measures to support their economies, most advanced economies are already in a recession. According to the National Bureau of Economic Research (NBER), the United States has been in a recession since December 2007. Moreover, the United States is headed for a severe contraction in the final quarter of the year, as private consumption is suffering from surging unemployment while investment is slowing in the wake of the severe credit crunch. Simultaneously, the Euro area is sliding deeper into recession. The European Central Bank, long reluctant to ease monetary policy, has shifted gears and applied the biggest rate cut in its history. However, governments are slow to come forward with fiscal stimulus packages and the current outlook suggests that virtually all Euro member states will contract in 2009. Japan is doing no better. The country is experiencing its first recession since 2001, as business confidence tumbles. Against this backdrop, Latin America’s growth prospects continue to deteriorate and in 2009 the region is set to grow at the slowest pace in six years.

Growth forecasts for 2009 plummet

As the global economic crisis unfolds, Consensus Forecast participants continue to adjust their projections for Latin America downwards.  According to this month’s survey, Latin American output will expand 4.4% this year, which is unchanged from last month’s Consensus but more than a full percentage point below the 5.5% expansion registered in 2007.  Next year, the region will decelerate more markedly, with growth plummeting to 2.2%, which is down 0.5 percentage points from last month’s projection and, if attained, would represent the slowest pace in six years.  Among the seven major economies, Argentina will experience the most notable slowdown, as panellists see the economy expanding a paltry 2.0% in 2009 (November’s LatinFocus Consensus Forecast: +2.5%), following on a 6.2% 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.  In response, the country has once again 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 declining commodity prices during the past few months, as the market factors in lower demand in the wake of the global slowdown.  As one of the largest metal producers in the region, Peru will suffer a direct impact to export growth.  However, more than anything else, the slowdown in Peru reflects a very strong growth performance in 2008, when the country is estimated to be the second-fastest growing economy in the region with a projected growth rate of 9.0%, just behind Uruguay’s estimated 10.0% expansion.  In fact, with an anticipated GDP growth rate of 5.5% in 2009 (November’s LatinFocus Consensus Forecast: +6.1%), Peru will 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 2.3% next year (November’s LatinFocus Consensus Forecast: +3.7%), well below the estimated 5.4% growth rate 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 November, the average price for the Venezuelan mix of crude oil plummeted 37.1%.  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.  On the positive end of the slowdown scale, Colombia will shed only 0.8 percentage points of output growth between 2008 and 2009.  However, the moderate adjustment is due to a low comparison base, as the Colombian economy is estimated to grow a modest 3.7% this year.  Moreover, exports are likely to contract next year, as the external sector is already suffering from falling commodity prices and slowing external demand, especially in the United States and Venezuela, Colombia’s most important trading partners.

Inflation expectations deteriorate further despite pronounced slowdown

Surging fuel and food prices in the first half of 2008 have pushed up Latin American inflation to an estimated 8.9% 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 7.9% 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.  The recent moderation in international commodity prices should ease some of the pressure.  However, several Central Banks have lost credibility by letting inflation rise well beyond established target levels.  Restoring 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 partially reflects an elevated inflation rate this year.  With an estimated year-end rate of 8.6% 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 4.5% at the end of 2009.  Following Chile, Peru will experience the second-strongest decline in inflation, a 2.4 percentage point drop between 2008 and 2009.  Nevertheless, at the 3.9% year-end rate projected for 2009, inflation will remain well above the Central Bank’s target.  Mexico will experience a 1.8 percentage point decline in inflation next year to 4.1%, while Brazil will register a 1.1 percentage point drop in its inflation rate (2009 year-end inflation: 5.2%).  On the other hand, Argentina and Venezuela will experience accelerating inflation next year.  For Venezuela, Consensus Forecasts panellists expect inflation to reach 32.5% by the end of next year, which is 1.2 percentage points above the 31.3% expected for this year.  The country is suffering from the effects of short-term oriented economic policy, which sought to contain price pressures by price controls.  As a result, Venezuela is now facing supply constrains in several important sectors.  Combined with an artificially strong exchange rate and abundant public sector spending, monetary authorities stand little chance of reining in inflationary expectations, and inflation will again reach the highest level in the region next year.  In the case of Argentina, Consensus Forecasts panellists expect official inflation to reach 9.5% by the end of next year, which is 0.9 percentage points above the 8.6% 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.