Regional Economy Outlook

Region: Growth forecasts reined in

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April could be called ‘forecast month’, with a range of multilateral institutions reviewing their forecasts for Latin American economies. On the whole, it is looking like another slow year.

One of the first off the mark in April was the UN’s Economic Commission for Latin America and the Caribbean (ECLAC), which slashed its real annual GDP growth forecast for the region to 1.0%, down from 2.2% previously. Much of the change was due to the region’s largest economy, Brazil, where ECLAC now expects GDP to contract by 0.9% (vs. 1.3% growth projected in its previous forecast). ECLAC said that part of the overall deterioration in the regional outlook should be attributed to the global economy, which is looking less dynamic than had been hoped at the end of 2014. “With the exception of the United States, growth forecasts have been reduced in the industrialized countries, while emerging economies are also slowing down” it said. The net result is that for the region as a whole this year, the picture is going to look very much like it did last year (when regional GDP growth was 1.1%).

ECLAC notes that this year will again see rather diverse economic performances throughout the region. Among the larger economies, Mexico will grow at a comparably fast rate (3.0%), because of its good linkages with the US economy. Argentina will flat line (with 0% growth). Economies specialised in the production of primary goods, particularly oil and minerals, will suffer, meaning means most of South America and Trinidad & Tobago. Those set to perform best have strong links to the US and/or are set to benefit from low oil prices. Peru is predicted to post real GDP growth of 4.2%, followed by Colombia with 3.6% and Chile with 3.0%. The fastest growing economies will be Panama (+6.0%), Antigua and Barbuda (5.4%), along with Bolivia, Nicaragua, and the Dominican Republic (all expected to post real annual growth of 5.0%). Prospects for Venezuela have darkened again, with ECLAC now expecting a contraction of 3.5%, deeper than the 1.0% fall predicted previously.

A week after ECLAC published its latest forecasts; the International Monetary Fund (IMF) issued its April World Economic Outlook (WEO). This was a little more pessimistic. It sees negative growth in Brazil, Argentina and Venezuela dragging South America into recession this year. Citing low consumer confidence, the prospect of water and electricity shortages, and negative investor reactions to the Petrobras scandal, the IMF now expects a 1.0% contraction in Brazilian GDP (down from the October 2014 WEO, which had Brazil growing by 1.4%). In Argentina, because declining investment and exports will be only partly offset by strong public spending and private consumption this election year, GDP will fall by 0.3%. And in Venezuela, the collapse in oil prices, policy distortions and government controls are resulting in intensifying shortages of basic goods, pushing inflation above 60% and leading to an overall GDP contraction of 7%.

Where the IMF coincides with ECLAC is in seeing a relatively strong performance by the Andean countries, with Bolivia growing 4.3%, followed by Peru (3.8%), Colombia (3.4%) and Chile (2.7%). The Fund’s take is that "The downturn in global commodity markets remains the main drag on activity in South America, even though lower oil prices and a solid US recovery provide a boost to other parts of the region". While the South American economy will contract, Latin America and the Caribbean, lifted by Mexican growth of 3.0% and Central American growth of 4.2%, will achieve an overall expansion of 0.9%, the IMF believes. This reflects a situation where there is “no apparent impulse for a near-term pickup in activity and the prospect of persistently lower commodity prices and reduced policy space in many economies.” While that sounds downbeat, the IMF also notes that output remains close to potential in many economies, meaning that unemployment levels remain low.

It is possible to divide the region up into various different types of geographic or trade sub-groups. It is interesting to note that according to both the ECLAC and IMF predictions the Pacific Alliance group of countries (Chile, Peru, Colombia and Mexico, which follow largely free-trade economic policies) are set to perform significantly better than the Mercosur group (which, led by Argentina and Brazil, with other members including Paraguay, Uruguay, and Venezuela, tends to be more protectionist).

The World Bank also produced a set of forecasts for the region, broadly similar (it sees Latin American and the Caribbean growing by 0.8%, with the South American economies broadly speaking being the more sluggish). Interestingly however, Augusto de la Torre, the Bank’s chief economist for Latin America, was much more explicit about saying that the end of the commodities super-cycle, marked by lower Chinese growth, is now the “new normal”. As he put it, “the evidence suggests that external shocks, slower Chinese growth, and changes in the terms of trade are permanent.” Absent structural economic reforms, this meant that the slowdown in Latin American economic growth would also be permanent. Raw material exporters with limited exchange rate flexibility would face a complicated situation, marked by fiscal austerity and requiring action to boost domestic savings rates to eventually rebuild the basis for economic stability and growth. “None of that will be easy, and it will take time”, De la Torre warned.

Brazil: Looking for the silver lining

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Recent economic data from Brazil has been dismal. Growth in consumption over the coming years will likely be in low single digits. Nevertheless, there are early signs that official policies could be moving Brazil back towards a virtuous circle of lower capital costs, lower perceptions of risk and higher investment.

The flow of news about Brazil’s economy since late March has been grim. At the end of March, the Banco Central do Brasil (BCB) lifted its inflation forecast for this year to 7.9%, up from 6.1% previously. However, the BCB noted that the impacts of past depreciation in the currency and the increase in regulated prices would be temporary. At the beginning of April, HSBC noted that its composite purchasing manager’s index (PMI), which reflects activity in both the manufacturing and the services sector, had slipped from 52.3 in February to a 70 month low of 47.9 in March. A reading below 50 indicates a deterioration in conditions and a contraction in overall activity.

In early April, official data indicated that month-on-month inflation had accelerated to 1.32% in March, thanks mainly to an increase in electricity tariffs. Shortly afterwards, the ratings agency Fitch cut its outlook for the country from stable to negative – suggesting that a downgrade to the government’s sovereign rating is a real possibility over the next year or so. Fitch maintained Brazil’s rating at BBB, or two notches above a High Yield rating. For its part, Standard & Poor’s (S&P) has assigned the government a rating of BBB-, the lowest investment grade.

All of this is in the context of a weakening currency and rising interest rates. Since mid-2014, the Real has fallen from a rate of US$1:BRL2.2 or so to around US$1:BRL3. Determined to contain inflation, the BCB has been tightening monetary policy, with the result that the benchmark Selic rate stands at 12.75% (following a 50 basis point rise in early March).

There has also been a sharp reduction in Brazil’s terms of trade. The implication is that the previous cycle of lower interest rates, currency stability and reduced risk perceptions, combined with strong growth in domestic consumption (thanks in part to official anti-poverty and welfare schemes), has ended. In the meantime, the political environment has been complicated by the massive corruption scandal at the state-owned energy company Petrobras.

Nevertheless, the behaviour of financial markets since the end of March tells a different story. At 25 April levels of BRL2.95/US$, the currency has fallen by around 10% since the beginning of the year. It is, however, around 10% higher than it was in the middle of March. In US dollar terms, MSCI’s Brazil index has risen by 18% since the beginning of April, meaning that it has performed significantly better than other emerging markets over that period. In US dollar terms, the MSCI Brazil index has regained all the ground that it had lost in early 2015, and is essentially at the level at which it began the year. Nevertheless, the index is still about 22% lower than it was in late April 2014.

At a press conference on 14 April to launch its latest World Economic Forecast the International Monetary Fund (IMF)’s Chief Economist, Olivier Blanchard, highlighted a ‘silver lining’ to an otherwise dark and cloudy outlook for Brazil’s economy in the coming years. As the chart shows, the IMF is looking for overall GDP to contract in 2015, having stagnated in 2014. The main problem is the ongoing fall in consumption, which is expected to continue to 2016. He noted that “the problem of the past few years [has been the lack of] business confidence, primarily leading to low investment. It is still there, but the government clearly is taking measures to re-establish full credibility of fiscal policy. But we are in a situation in which confidence has not come back, yet while at the same time there is a fairly strong fiscal consolidation. So the two effects are working in the same direction for the moment of making things worse, but if confidence comes back because of the measures which have been taken, things will turn around”.

Four days previously, the IMF had released a press release in relation to the conclusion of its 2014 Article IV consultation with the Brazilian authorities. The Fund noted that a number of the factors that had boosted inflation (such as a recent drought) were temporary and that the floating exchange rate had had “an important role to play as the main shock absorber”. The IMF also pointed out that, at around US$362bn, Brazil’s gross international reserves were well above the levels required by the IMF’s normal benchmarks.

It observed that the aim of the fiscal policy is to return the non-financial public sector primary surplus to 1.2% of GDP in 2015. The government thereafter hopes to increase the surplus to 2.0% of GDP in 2016, 2.2% in 2017 and 2.5% in 2018. Overall net public sector debt is expected to rise from 37.2% of GDP in 2014 to 39.3% this year, but then to stabilise. The IMF noted that reaching these budget targets “will require ambitious, front-loaded measures”. Cuts in current spending and tax exemptions are being replaced by increased investment and allocations to social programs.

The IMF’s press release pointed to other fundamental – and positive – changes. A crucial one is “the decision to end policy lending to public banks”. The implication is that the private sector will play a more central role in investment and that decisions will be less influenced by political considerations. Lower investment by the oil giant Petrobras and by other companies in the energy and minerals sectors is expected to contributed to a further fall in overall investment (by 0.6%) in 2015. However, the IMF is looking for investment to grow by 5.6% next year and by around 4% in each of the following years. Inwards Foreign Direct Investment (FDI) is expected to be just under US$54bn this year, or a lot less than the US$68bn registered in 2013 and the US$66bn estimated for 2014. Nevertheless, FDI is expected to stabilise over the coming years.

Brazil's economy - as the IMF sees it

	2013	2014	2015	2016	2017	2018
Annual % change
GDP at current prices	2.5	0.0	-1.0	0.9	2.2	2.3
Consumption	2.4	1.9	-1.7	-0.2	1.4	1.5
Investment	7.8	-10.1	-0.6	5.6	4.3	3.9
Inflation (IPCA - end of period)	5.9	6.4	7.0	5.4	4.8	4.6
Exports in US$	-0.2	-7.0	-5.7	4.2	6.3	7.2
Imports in US$	7.4	-4.4	-11.6	3.7	4.5	4.5
In % of GDP
Gross domestic investment	18.1	16.4	16.5	17.2	17.5	17.8
Private sector	15.6	13.7	14.2	14.9	15.2	15.4
Public Sector	2.5	2.7	2.2	2.3	2.3	2.4
Gross national savings	14.5	12.2	12.9	13.6	14.0	14.4
Current account balance	-3.6	-4.2	-3.6	-3.6	-3.5	-3.4
Central government primary balance	1.6	-0.4	1.0	1.5	1.7	2.0
NFPS* primary balance	1.9	-0.6	1.2	2.0	2.2	2.5
NFPS overall balance	-3.3	-6.8	-5.1	-4.3	-3.8	-3.2
Net public sector debt	33.6	37.2	39.3	38.9	38.2	38.1
In US$bn
Net inwards FDI	67.5	66.0	53.9	54.0	52.6	53.8
Exports in US$	242.0	225.1	212.3	221.1	235.1	252.0
Imports in US$	239.6	229.0	202.4	210.0	219.4	229.2
Gross official reserves	358.8	363.6	358.3	358.8	359.6	360.4

*Non-Financial Public Sector

Source: IMF Press Release 15/167 of 10 April 2015, 'IMF Executive Board Concludes 2014 Article IV Consultation with Brazil'

The publication by Petrobras of its audited accounts on 21 April could well mark the first stage of a recovery: this in the wake of the company’s estimated U$17bn in losses from the corruption scandal. Any other moves by Petrobras or the government to boost transparency in the non-financial public sector should lift investment confidence. Investor sentiment would also be boosted if official measures to strengthen corporate governance were accompanied by reforms aimed at boosting labour productivity (widely accepted as a significant problem) and reducing O Custo Brasil – the complex red tape and other factors that significantly increase the costs of doing business in the country. In this scenario, sentiment on the part of corporate and portfolio investors could improve markedly.

Colombia: Steady despite challenges

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In spite of the fall in energy and mineral prices, Colombia continues to manage sustainable growth and tolerably low inflation. This augurs well for further progress in poverty reduction.

In its preliminary overview of regional economies at the end of last year, the United Nation’s Economic Commission for Latin America & the Caribbean (ECLAC) was positive about Colombia’s performance. It noted that thanks to rising investment, domestic demand had been soaring. ECLAC noted that the re-election of President Juan Manuel Santos had been good for the continuity of policy, especially with regards to investment projects. Foreign Direct Investment (FDI) inflows the first half of 2014 rose by 10% year-on-year, from an already elevated base. In late 2014, ECLAC was looking for Colombia to achieve real GDP growth of 4.8% in 2014 and 4.3% in 2015.

ECLAC also highlighted generally favourable trends in the country’s public finances - in spite of an increase in the consolidated public sector deficit from 1.1% of GDP in 2013 to an estimated 1.6% in 2014. The deterioration was mainly due to an 8.8% rise in government spending to 19.5% of GDP. However, ECLAC noted that a tax reform proposed by the Santos administration in October 2014 should eventually yield additional revenues. Proposed reforms included a wealth tax, a surcharge to boost the income tax for equality (CREE) and a possible incentive for taxpayers to comply with tax regulations by paying a fee equal to one tenth of the assets not declared on previous returns: the fee being considerably lower than the current fine.

Meanwhile, the government continues to push ahead with structural reforms, some of which are being implemented as part of Colombia’s planned accession to the Organisation for Economic Cooperation and Development (OECD), while others relate to the current peace process with the country’s main left-wing guerrilla group, Fuerzas Armadas Revolucionarias de Colombia (Farc). The potential ‘peace dividend’ is calculated to be significant, not least because social peace and the various economic, social and political reforms in support of an eventual peace agreement should support a virtuous circle of reform and growth in household incomes. A sustained reduction in poverty and income inequality is considered essential, not least because these factors contributed to the conflict in the past.

In a September 2014 overview of policy notes, the World Bank (WB) suggested that the three objectives of peace, lower poverty and a reduction in inequality were “within reach”. It added that sustainable peace was essential for human rights to flourish in Colombia.

In mid-March 2015, an International Monetary Fund (IMF) delegation visited Colombia to assess the economy as a part of a regular Article IV mission. The IMF highlighted the strong appetite in recent months for Colombian government debt, thanks in part to upgrades in the country’s sovereign credit rating and a recent lift in Colombia’s weighting in global bond indices. This improvement came in the context of an increase in foreign reserves held at the central bank, as well as the government’s access to a Flexible Credit Line from the IMF. This improved market sentiment on Colombia allowed the Bogotá government to take advantage of historically low bond yields to issue new debt and extend the average maturities of existing borrowings. In the meantime, the capital requirements of what was already a strong and well-regulated financial system have been improved further.

The IMF is now looking for slower real GDP growth in 2015, albeit it forecasts a respectable outcome by regional standards, of 3.5% year on year. Although Colombian exporters have received a boost from the depreciation of the Peso against the US$ over the course of the last year or so, the continued slump in oil prices is a major challenge for the country. Consumption is expected to decelerate. The IMF also noted that investment (particularly in the energy sector) would slow. And indeed, FDI inflows were down by 10% in Q1 2015 to US$3.3bn, driven by a large 12% fall in inflows to the key oil sector to US$2.7bn (which nevertheless accounted for 82% of the first quarter inflow). Inflows to other sectors fell by 1.9% to US$608.7m, the central bank reported. The net FDI result was US$4.48bn in the first quarter, down by 25% year-on-year, on preliminary figures. Nevertheless, the IMF expects real economic growth to accelerate back to almost 4.5% by 2019, thanks significantly to the benefits of infrastructure investment.

The IMF emphasised that further fiscal reforms could be helpful in a scenario of low oil prices, slower investment and weaker growth. Potential options include increasing the rate of VAT, replacing traditional corporate taxation with the simplified exemption structure of the CREE (income tax for equality) and further changes to the personal income tax regime. “Enormous gains in revenue could [also] be achieved through improving tax administration, including by imposing criminal penalties for tax evasion, increasing the number of officials and strengthening the information technology of the tax administration authority”, it noted.

For its part, the OECD, in a January 2015 review of the Colombian economy, also identified additional reforms that could be undertaken. The OECD suggests that the tax system could be made greener through the introduction of a carbon tax. It also argues for wholesale reform of the pensions system, in order to reduce old age poverty and inequality. Some two-thirds of older Colombians have no form of pension. The minimum old-age income support is below the national poverty line. The OECD supports an expansion of eligibility for the Beneficios Económicos Periódicos programme, alongside increased coverage and benefit levels under the minimum old-age income support and the Colombia Mayor programme. In an April 2015 report entitled, ‘Colombia’s social security system: advances and challenges’, ECLAC highlighted the need for welfare reform to address the low levels of social protection afforded to women in particular and the rural population in general.

Colombia's economy, as the IMF sees it
	2014	2015	2016
Gross domestic product, constant prices % change	4.55	3.40	3.70
Gross domestic product, current prices US$bn	384.90	332.38	360.26
Gross domestic product per capita, current prices US$	8,075.64	6,894.62	7,388.11
Total investment % GDP	24.44	22.13	21.77
Gross national savings % GDP	19.43	16.37	16.88
Inflation, average consumer prices %	2.90	3.35	3.04
Inflation, end of period consumer prices %	3.66	3.60	3.24
Volume of imports of goods and services %	10.62	-7.82	2.97
Volume of Imports of goods %	10.62	-7.82	2.97
Volume of exports of goods and services %	-0.07	5.02	6.76
Volume of exports of goods %	-0.07	5.02	6.76
Unemployment rate % of labour force	9.11	9.00	8.90
Population mn	47.66	48.21	48.76
General government revenue % GDP	28.20	26.31	26.15
General government total expenditure % GDP	29.60	29.52	28.79
General government net lending/borrowing % GDP	-1.39	-3.22	-2.64
General government primary net lending/borrowing % GDP	0.91	-0.45	-0.01
General government net debt % GDP	27.89	30.23	30.49
General government gross debt % GDP	38.02	40.60	40.10
Current account balance US$bn	-19.29	-19.13	-17.61
Current account balance % GDP	-5.01	-5.76	-4.89

Source: IMF World Economic Outlook projections, April 2015

As the IMF forecasts indicate [see chart], the general prospects for Colombia’s economy remain favourable. Overall economic growth and per capita income levels should rise again from 2016. Investment appears set to remain substantial, at around 22% of GDP, even if it is likely to grow more slowly than the economy as a whole moving forward. For now, the IMF is not expecting tax reform to result in higher government revenues as a percentage of GDP. Nevertheless, the current government appears set to maintain fiscal discipline.

Finally, a current account deficit of US$20bn or so is manageable in the context of a US$333bn economy. The deficit was the equivalent of 5.2% of GDP last year. The IMF expects this to rise to 5.8% this year, before falling back to 4.9% in 2015, as oil prices, and therefore export earnings, begin to recover.

Peru: Modest reduction in poverty in 2014

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According to Peru’s national statistics institute (Instituto Nacional de Estadística, [INE]), the proportion of the population living in poverty fell by 1.2 percentage points in 2014, to 22.7%, down from 23.9% in 2013.

The INE says that 6.99m people, of a total population of nearly 31m in 2014, were living below the poverty line. Nationally, this means that roughly one in five people are poor. The reduction in poverty achieved last year was less than in earlier years, a slowdown attributed to the ending of the commodity price boom, which in turn has caused a relative cooling of Peru’s previously very strong GDP growth rate. Real annual GDP growth was 2.4% in 2014, its lowest rate in five years. The government expects the pace of growth to pick up in 2015 to 4.2%, but a number of analysts think that optimistic. The UN’s Economic Commission for Latin America and the Caribbean (ECLAC) is also forecasting GDP growth of 4.2% this year, but the IMF projects a lower 3.8%.

Despite last year’s slower growth, the head of the INE, Alejandro Vilches, noted that “over a quarter of a million people – 298,000 – emerged from poverty last year”. According to INE’s figures, the proportion of the population living in poverty is highest in the Andean region, where it stands at 33.8%. Ironically perhaps, this region, with its rich mineral resources, has been driving the country’s export-led growth. In the coastal region, poverty is much lower – at 14.3% – while in the Amazon region it goes up again to 30.4%.

The general reduction in poverty in recent years is attributed to a combination of strong economic growth and a variety of social programmes introduced by the government of President Ollanta Humala. In a report last year, BBVA Research economist Hugo Perea argued that as a result of 5%-plus annual growth, Peru had gone through a sustained process of poverty reduction and an expansion of the middle class. While specific poverty reduction programmes had been successful, he argued, these were less important in the longer term than a high growth rate.

A slightly different point was made in a World Bank report published in March, which focused on “chronic poverty”. According to one of its authors, Renos Vakis, Latin America has pockets of “chronic poverty” where “economic growth on its own is perhaps not sufficient” to improve peoples’ income levels. In his view other factors, such as the geographic remoteness of communities from the labour market, or the absence of key skills needed for employment, need to be tackled directly.

In another recent report, the World Bank has argued that persistent poverty is not jut a function of a lack of education or health services, but may also reflect psychological factors. It notes a case in Peru where a government-funded tuberculosis prevention programme in a Lima shantytown was rather unsuccessful – until the government also introduced depression-counselling services, at which point attendance rates improved. That report noted that “poverty can have complicated mental effects, which can make it more difficult to emerge from poverty – it can be a self-perpetuating vicious circle”. It also suggested that conditional cash transfer programmes, where poor households receive cash subsidies on condition that they do certain things such as ensure school attendance by their children, may not be effective in all cases. One such programme, Brazil’s Bolsa Familia, has been widely hailed as a highly successful approach to poverty reduction. Yet the World Bank warned such programmes do not reach everyone. The issue remains significant, says the Bank, because after a decade of sustained growth (which is now slowing down) one in five Latin Americans is still living on less than US$4 a day.

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