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Latin America: Deteriorating Outlook and Growing Downside Risks

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The outlook for Latin America has significantly deteriorated in recent months. Brazil has seen the biggest downgrades, with our current forecasts predicting a decline in GDP of 3.1% in 2015 (compared to a 1.4% decline in our August forecasts) and a further 0.8% contraction in 2016 (compared to 0.7% growth in our August forecast). But expectations have worsened significantly for other countries in the region as well, with reductions in annual growth forecasts of around 0.5-1 percentage points for 2015-2017. The region was already suffering from a slowdown in 2010-2014. The more negative outlook suggests the decline in growth is here to stay.

Real GDP Growth in % 2014-2022, Euromonitor International Baseline Forecast

Real GDP Growth 2014-2022

Source: Euromonitor International Macro Model

Notes: Forecasts start in 2015.

Latin American Real GDP Growth Rates: 2005-2014

Real GDP Growth LatAm

Source: Euromonitor International from national statistics

  • One of the main factors behind the growth slowdown is the reversal of the commodity price boom of the 2000’s. With commodities accounting for most of the region’s exports (between 60-90% of exports in key economies such as Argentina, Brazil, Chile, Peru and Colombia in 2014), this has had a large negative effect on growth prospects. However, the importance of commodity exports in the slowdown risks being overestimated, due to the relatively low trade openness of Latin American commodity exporters. For example, as of 2014 exports only accounted for 13% of GDP in Brazil and 16% of GDP in Argentina.

All Commodities Price Index: 2005-2015

Commodity price index 2005-2014

Source: Euromonitor International from the IMF

Note: The All Commodities Price Index in an aggregate price index of all commodity groups.

  • Domestic factors such as greater political uncertainty and a general decline in private sector confidence may have played an even bigger role in the slowdown, reducing domestic consumption and investment. While political uncertainty is highly country specific (for example Brazil’s corruption scandals), other factors such as lower long-term growth expectations are common to most countries in the region.

Business Confidence Indices (Standardised) in Latin America 2013-2015

Business Confidence Indices in Latin America 2013-2015

Source: Euromonitor International from national statistics

Dismal Productivity Performance Lowers Long-Term Growth Expectations and Contributes to Lower Confidence

  • Growing awareness of Latin American economies’ structural difficulties and their likely persistence in the long-term can act as a major drag on business and consumer confidence, depressing consumption and investment in the short term.
  • Low productivity growth is one of the biggest problems of Latin American economies. Annual total factor productivity growth (a measure of the economy’s efficiency in using both capital and labour) has been negative over the last 25 years.
  • Country scores on business environment indicators are below the world average. Workforce education and training levels are generally low, with many employers identifying an inadequately trained workforce as a major constraint on business. Infrastructure is poor, with logistics costs taking up 16-26% of GDP (compared to an average of 9% in advanced economies).
  • Latin America is also suffering from a demographic slowdown and the constraints it poses on employment growth. The OECD forecasts annual employment growth in key economies such as Argentina, Brazil and Chile to decline by 1.2-1.7 percentage points from 2001-2007 to 2018-2030.
  • All of these factors contribute to low long-term output growth in comparison to other economies with similar levels of economic development.

Downside Risks Have Increased

  • Like other emerging market economies, the region is vulnerable to capital outflows, with significant current account deficits in some countries. However, most of these deficits are related to less volatile FDI, and foreign debt levels are modest. Therefore, there is limited potential for big debt and currency crises such those of the 1980’s, or the 1997 East Asian crisis.

External Debt in 2014

External debt in latin american countries in 2014

Source: Euromonitor International from the IMF

  • Interest rate normalisation in US has already been factored into forecasts, with the federal funds rate expected to reach 3.25% in 2019. The most likely alternative scenario is for a slower than expected increase in US interest rates, due to greater concerns by the Federal Reserve about low inflation and higher external risks to the US economy. Faster than expected US interest rate increases would follow from better global economic conditions, which should actually benefit Latin America.
  • The region is vulnerable to the slowdown in China, in large part due to the diminishing Chinese demand for commodities. A major downturn or Chinese hard landing in 2016-2017 would reduce growth rates in the region by up to 0.8 percentage points.

Latin American Real GDP Growth Difference from Baseline Scenario: 2015-2018 in case of Chinese Hard Landing Scenario

Latin American Real GDP Growth Difference from Baseline Scenario 2015-2018 in case of Chinese Hard Landing Scenario

Source: Euromonitor International Macro Model

Notes: Chinese Hard Landing scenario assumes a credit crisis and difficulties in rebalancing reduce China’s GDP by 9% relative to the baseline forecast in 2016-2017. Scenario starts in 2016Q1.

  • The bigger risk is that the current combination of low commodity prices, lack of structural reforms and pessimism about future growth gets entrenched and leads to even lower private sector confidence and significant foreign capital outflows. In this medium-term stagnation scenario, Investment and productivity growth decline much more strongly than in the baseline forecast. Annual GDP growth in 2016-2020 declines by another 1.3 percentage points. We assign an approximately 10% probability to such a scenario occurring in 2016.

Latin American Real GDP growth in case of Latin America Stagnation Scenario: 2015-2020

Latin American Real GDP growth in case of Latin America Stagnation Scenario 2015-2020

Source: Euromonitor International Macro Model

Notes: Scenario starts in 2016Q1.

Latin America is facing a worsening outlook over the next few years due to a combination of low commodity prices, a slowdown in major trade partners such as China, greater political uncertainty and greater pessimism about the region’s long-term potential. There is also a generally greater pessimism by foreign investors about emerging markets relative to the beginning of the decade that could also depress growth in the region. While low external debt levels limit the probability of a major banking or currency crisis, downside risks to the outlook have increased.

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