This week we are offering another preview of our global economic outlook for Q4, which will be released to RGE’s clients later this month. The following is a sample of our analysis on Latin America. The full version of the outlook goes into greater detail and includes RGE’s country-by-country projections for economic growth and several major indicators.
RGE maintains the position we took in our July outlook: Latin America will recover in 2010, but its expansion will likely be below potential. Given aggressive foreign and domestic policy responses in Latin American countries, the region is stabilizing in H2 2009 after having contracted severely in H1 2009. Although global and regional economic and financial conditions will likely improve in 2010, RGE expects the pace of external and local demand revival to be measured. Commodity prices will stay on hold in the middle ground between record highs and recent lows, mainly because of below-potential recovery in the U.S. and advanced economies, as well as in China. Though global liquidity will remain elevated in the upcoming quarters, favoring LatAm asset classes, market anxiety about the timing of exit strategies around the world represents a significant risk. Miscalculations in exit strategies and disappointing economic results pose the main risks to LatAm market dynamics in 2010.
Regional Growth Outlook
Latin America is stabilizing in H2 2009, benefiting from massive global fiscal and monetary policy stimulus programs, while domestic countercyclical efforts soothed local confidence and eased downside pressures on labor markets. Furthermore, strong fundamentals contained the free-fall in internal demand, while global inventory restocking, which had tapered off, picked up again in Q3 2009. However, recovery of external and domestic demand will likely be limited, keeping LatAm’s recovery below potential in 2010. Against this backdrop, RGE has revised up its regional GDP forecast to a contraction of 2.6% y/y from 3% y/y in 2009, and we now project growth of 3.3% y/y in 2010, up from our prior projection of 3.0%. The main driver of our shifting forecast is an improved economic outlook in Brazil. But it should also be noted that LatAm’s regional growth outlook in 2010 remains well below the 2003-2008 trend of around 4.5% y/y on average.
Inflationary pressures will likely be contained in 2010, and the disinflationary trend should continue through the rest of 2009 due to slow closing of the output gap, stable if not strong currencies, temperate commodity prices and measured domestic demand. Central banks will most likely achieve their inflation targets but will likely start moving away from an accommodating monetary stance toward a neutral one in 2010 in order to temper medium-term inflation expectations once the recovery has gained momentum. The central banks that acted first and most aggressively in the cycle of monetary accommodation will lead the way (such as Chile), while the ones who lagged in responding will have to wait longer for a more sustained recovery (such as Mexico).
External Accounts and Budgets
The current account deficits of Latin American countries will likely widen in 2010 after having shrunk in 2009, but strong capital flows should cover the gap. While imports have fallen at a faster pace than exports so far this year, RGE anticipates a reverse of these dynamics in 2010, mainly because we expect domestic demand to rebound at a stronger rate than external demand, putting widening pressures on current accounts. Meanwhile, significantly improved global financial conditions and risk appetite, elevated global liquidity, and LatAm’s relatively palatable rebound will mean that capital flows to the region will likely improve, thus keeping balance-of-payments risks contained. Risks associated with worse-than-anticipated global and regional growth, higher global benchmark yields and a failure to implement reforms could potentially cap capital inflows.
Balancing fiscal accounts will likely remain a major challenge for Latin American countries in 2010, much as it was in 2009. Since RGE anticipates a gradual global and regional upturn, fiscal revenues will recover slowly, but the political cycle, rising social pressures and structural fiscal rigidities will place constraints on the opportunity to enact meaningful spending cuts.
RGE maintains the view that LatAm currencies will be supported by a weak U.S. dollar and solid commodity prices, as well as higher potential growth and wider interest rate differentials. However, verbal interventions or administrative measures by the central banks to contain financial flows, together with risks associated with disappointing economic numbers (globally and locally), and policy actions to restore the stock of international reserves, could emerge as a counterbalance. Moreover, as advance economies approach their exit strategies, upward pressures on LatAm currencies should subside.
The political cycle in several LatAm countries starts at the end of 2009. In Chile, most polls suggest that the right-wing opposition candidate, Sebastian Pinera, leads the race in the country’s December 2009 presidential election. Pinera is followed by the candidate for the ruling Concertacion party, former president Eduardo Frei, and independent candidate Marco Enriquez Ominami is not far behind. Regardless who wins, market-friendly policies and sound macroeconomic management will likely continue, and the institutional framework will be reinforced.
In Colombia, presidential elections will be held in May 2010. Although it is not clear yet whether the current president, Alvaro Uribe, will run for a third term, the country’s next president will likely maintain Colombia’s current domestic-security policy and market-oriented policies. In Brazil, although presidential elections are still a year away, polls indicate interesting dynamics: the latest Datafohla poll from September 2009 shows that Sao Paulo State Governor Jose Serra, from the Social Democratic Party (PSDB), leads the race with 37% support, followed by President Lula’s chief of staff Dilma Rousseff, from the Workers Party (PT), with 16%. Overall, RGE maintains that regardless of who takes power, Brazil’s current achievements in economic policy are most likely to be maintained. Market watchers should keep a close eye on fiscal dynamics and the likelihood of the incoming government taking action to consolidate the fiscal accounts.