Latin America: Region ends 2016 worse than expected
February 15, 2017
Region ends 2016 worse than expected
A full data breakdown shows that Latin America’s downturn last year was deeper than expected. After having virtually stagnated in 2015, the region’s economy is estimated to have contracted 0.7% in 2016 due to the combined effects of lower commodity prices and capital flight as the commodity super cycle came to an end, heightened volatility in currency markets and severe recessions in Argentina, Brazil and Venezuela caused by poor economic policy in the past.
Latin America is one of the largest producers of commodities in the world. As a proportion of total global production, it produces 50% of soybeans, 11% of copper and 15% of iron ore and it is not surprising that the region’s fastest growth period was during the commodities boom between 2002 and 2008. After that period, a normalization of commodity prices in the post global financial crisis period between 2011 and 2016 translated into significantly lower growth rates.
Due to the sharp drop in commodity prices, particularly after mid-2014, many countries experienced a deterioration in their terms of trade, a substantial drop in fiscal revenues and a massive outflow of capital. As a result, exchange rates in countries with flexible exchange-rate regimes became the first line of defense against the shifting trend, with their currencies depreciating considerably against the U.S. dollar. In this environment, many countries embarked on drastic policy adjustments, with governments restricting public spending and central banks tightening monetary policy to shore up their currencies. The tightening in both fiscal and monetary policies caused the region’s economic growth to weaken further and, with it, business and consumer confidence.
In terms of individual countries, the region’s recession in 2016 was led by Argentina and Brazil, while Venezuela’s crisis continues to drag on the region’s growth. In Argentina, ongoing structural reforms are helping to alleviate the pervasive macroeconomic imbalances and microeconomic distortions that were inherited from the policy mismanagement of the previous administration. Much has been done since the new government took office in December 2015, but the transition has proved harsh for economic activity.
For Brazil’s economy, 2016 marked the longest and deepest recession in many decades and right now the government has limited maneuvering room to support growth. In addition, the country’s recession was exacerbated by a political crisis involving corruption which paralyzed policymaking and severely affected confidence. Brazil’s measures to fuel faster economic growth between 2011 and 2014 did not address many structural issues and in fact proved counterproductive, as they contributed to a severe deterioration in the fiscal account, caused high inflation and eroded the financial positions of businesses and households.
Finally, the economic contraction in Venezuela is estimated to have deepened in 2016 due to a free fall in oil production, shortages of consumer and intermediate goods, and widespread price and currency controls which have fueled inflation, causing a further deterioration in social conditions. In the rest of the region and with the exception of Ecuador, economies grew in 2016, although at a modest pace.
Will 2017 be a turning point for the region?
2017 is expected to be a better year for Latin America, but important risks to the outlook loom on the horizon. The region is expected to return to growth this year before GDP rises steadily from 2018 to 2021. Following a 0.7% contraction in 2016, Latin America’s GDP is projected to increase 1.6% this year, which matches last month’s projection. With a 2.3 percentage-point upward swing from 2016 to 2017, the forecast suggests that the region is poised to experience the largest growth turnaround this year among the emerging markets. And yet, at 1.6% the region’s economic growth is far from its potential of 2.5%, which means that the recovery this year will be underwhelming. Moreover, it could be constrained further by new risks.
As the new year began, important risks began to materialize that are casting a shadow on the region’s economic outlook. Although Brexit does not directly impact the region, difficult negotiations between the UK and the EU to reach an understanding about a trade agreement have the potential to disrupt global financial markets and impact currencies in Latin America. Another key downside risk to the region’s growth prospects is a faster monetary policy tightening in the U.S. In the United States, an expected expansionary fiscal policy from the new administration will provide an extra boost to economic growth. Consequently, the Federal Reserve could tighten monetary policy faster than previously envisaged, as the economy remains in full employment and stronger domestic demand could fuel inflation. Higher U.S. interest rates could increase capital outflows in Latin America, provoking another episode of exchange rate volatility in the region.
The impact of Trump’s actions and policies on Latin America will fall mostly on Mexico, given the deeply-integrated trade and business cycle links between the two countries. However, a serious disruption in trade seems unlikely, precisely because of their high level of economic integration. The rest of Latin America doesn’t appear to be on Trump’s radar, but there are risks that protectionist policies could damage some of the region's agricultural exports to the U.S.
Finally, this year should be another relevant political year for Latin America. Key elections are planned in Argentina in October, and presidential elections are scheduled for Ecuador in February and for Chile in November. Perhaps more importantly, this year will set the political stage for presidential elections in Colombia, Mexico, and Brazil in 2018.
ARGENTINA | Green shoots are starting to appear
Although GDP is expected to have contracted again in Q4, there are some incipient signs of economic recovery. Stronger growth in the automotive and food sectors is shoring up industrial activity, while recent consumer confidence readings suggest private consumption has likely bottomed out. Moreover, the external sector is benefiting from better growth dynamics in the region overall, though the strong rebound in exports seen in November and December partially reflected a low base of comparison from the previous year. Treasury Minister Nicolas Dujovne announced on 24 January that the country’s fiscal deficit for 2016 was 4.7% of GDP, beating the government’s 4.8% target. Although the government plans to reduce the deficit further to 4.2% of GDP in 2017, analysts are not optimistic about the prospects. The 2016 target was met mostly due to the positive effect of a tax amnesty, while elections this year could encourage government spending.
The economy will bounce back this year as lower inflation will support private consumption, while the external sector will benefit from stronger regional growth. Moreover, the economic reforms implemented by Macri’s administration will start to take off, buttressing business sentiment and propelling investment. Analysts foresee the economy expanding 3.0% this year, which is unchanged from last month’s estimate, and 3.1% in 2018.
BRAZIL | Fiscal austerity measures on the cards
Economic data have picked up from rock bottom, suggesting that the battered economy is nearing a recovery phase. Industrial production recorded the fastest growth in over two years in December, likely supporting a reduced fall in GDP in Q4. At the onset of 2017, signs of improvement continued to emerge, with business and consumer confidence rising in January. On the political front, Rodrigo Maia, an ally of President Michel Temer, was re-elected as speaker on 2 February, improving the prospects for the approval of fiscal austerity measures. Maia has pledged to fast-track the badly needed pension reform, which is key to restoring government finances. The next few months will likely be rocky on the political scene, however, as Temer tries to push through unpopular austerity measures and testimony from a massive corruption scandal is released, which is expected to implicate scores of politicians.
An environment of lower inflation, improved confidence and easier monetary policy should jumpstart growth this year. Yet, the recovery will be meagre as austerity measures hamper consumption. Analysts see GDP growth at 0.6% in 2017, which is unchanged from last month’s forecast. The recovery is seen gaining speed in 2018 and GDP should increase 2.2%.
COLOMBIA | Government begins talks with second largest rebel group
While recent monthly data suggest that the Colombia economy experienced a slight improvement in Q4, 2016 overall is likely to have been its worst year since the financial crisis, dragged down by the collapse in global oil prices. In November and December exports benefited from a recovery in oil prices and grew at double-digit rates. However, in Q3, industrial production growth remained largely stagnant and consumer confidence continued to sink further into pessimistic territory. On 7 February, the government began peace talks with Colombia’s second largest rebel group—the National Liberation Army (ELN). The negotiations come only a few months after the government secured a historic peace agreement with the FARC. If successful, the country could put an end to over five decades of armed conflict, in which thousands were killed and millions were displaced.
GDP growth is likely to accelerate this year, supported by higher global oil prices and loose monetary policy, now that inflation is under control. Analysts expect the economy to grow 2.4% in 2017, which is unchanged from last month’s forecast. For 2018, our panel projects economic growth of 3.1%.
MEXICO | Uncertainty is driving the outlook
The economy got off to a weak start to the year, following a mild improvement in the final quarter of 2016. A preliminary estimate showed that GDP increased 2.2% year-on-year in Q4 (Q3: +2.0% yoy), causing the economy to expand 2.3% in the full year 2016. The result is below the 2.6% GDP growth achieved in 2015 and while the headline figure does not appear to be particularly alarming, the underlying trend suggests that Mexico’s economic growth is not robust enough. Recent survey-based data indicate that consumer confidence plummeted to its lowest level in 15 years in January and manufacturing PMIs continue to signal weakness in the sector.
The rising uncertainty related to the unclear path that trade and immigration policies will follow during the Trump administration will continue to drive Mexico’s future economic growth. However, domestic risks and social discontent are also rising in a year that will lay the ground for presidential elections in 2018. This month, analysts cut Mexico’s 2017 growth forecast by 0.2 percentage points to 1.6%. Next year, the panel expects GDP to expand 2.1%.
INFLATION | Inflation expected to moderate in 2017
Inflation in Latin America continued to creep up in 2016, but divergent paths were observed across the region. In South America, inflation rates remain elevated, reflecting weakness in most of the relevant currencies and high food costs as a result of adverse weather conditions. Accordingly, South American central banks maintained a tight monetary policy for most of 2016. Meanwhile, in Central America inflation was more benign, as the majority of Central American and Caribbean economies are oil importers and they benefited from low oil prices. Meanwhile, in Mexico inflationary pressures remained contained in most of 2016, but a severe depreciation of the Mexican peso following Trump’s win of the presidential election pushed up inflation toward the end of 2016.
Inflation in the region as a whole ended 2016 at 28.2%, which marked the highest rate in two decades. However, if the exceptionally high inflation in Venezuela is not taken into account, Latin America’s inflation ended last year at 8.9%.
Considering that Venezuela is experiencing an episode of near hyperinflation, inflation in Latin America is projected to end this year at 29.1%. Without considering the effects of hyperinflation in Venezuela, Latin America’s inflation is expected to fall to 6.5% this year. Going forward, analysts project regional inflation (ex-Venezuela) to fall further to 5.4%, while if we keep Venezuela in the regional aggregate, inflation in the region is seen at 25.0%.
Written by: Ricardo Aceves, Senior Economist