Tuesday, April 14, 2009

Economic Outlook for Latin America - Part 1

Given that in the next week or so the IMF will release its World Economic Outlook, we decided to present to our readers our view on the prospects for Latin countries in 2009. In turn, we present today a broad overview of the current growth conditions in Latin America. Tomorrow we present a more detailed analysis on the impacts of the crisis on the main Latin countries. Then on Thursday we plan to write about trade, external sector. Friday we conclude with our outlook for FX.

Economic Outlook for Latin America in 2009

In 2009, Latin American countries will face a significant slowdown in economic growth. Economic activity in the major industrialized economies will likely shrink in 2009. A combination of negative external shocks will slow down regional GDP growth to -1.3% in 2009, compared to average growth rates of 5.0% between 2003 and 2008. Under our scenario, all countries in the region will experience significant either a significant deceleration of economic activity in 2009 or a recession. Argentina, Brazil, Chile and Mexico are going to experience a recession in 2009. For the region as a whole, recovery will likely begin between the second and third quarters of 2010, although countries appear to be moving toward weaker growth at varying speeds: Argentina, Colombia, Mexico, and Venezuela slowed down relatively sooner; Brazil and Peru are already showing signs of cooling off. This suggests that the regional slowdown will happen gradually while the recovery will probably be slow too, especially considering that Brazil (and Argentina) continue to drag regional growth.

In 2009, Latin American countries will face a significant slowdown in economic growth. Economic activity in the major industrialized economies will shrink in 2009. Indeed, the weaker global outlook will affect Latin economies through the following channels: 1) trade market; 2) labor market and remittances; 3) capital inflows. Weaker domestic demand in the industrialized countries will likely depress import demand. Lower import demand will be translated to a decrease in Latin America’s exports.

The first channel - trade - suggest that the looming recession in developed economies and the significant slowdown in the emerging ones will reduce demand for exports from Latin America. The trend in the region’s exports to the United States and China illustrates how the international financial crisis has been affecting the region’s economies through trade. As explained by the latest Eclad report, the decrease in merchandise exports can be expected to have a greater impact on growth in the more open economies, in those that trade more with developed countries and, in particular, in those that sell a larger proportion of manufactured goods to developed markets, as it will be more difficult to find alternative markets for such goods quickly. Indeed, Mexico, Ecuador, Chile, Costa Rica, Venezuela and Honduras, trade with developed countries accounts for over 10% of GDP. An examination of manufacturing exports alone, however, reveals that such exports account for over 10% of GDP only in Mexico and Costa Rica, and close to 5% in Honduras.

The second channel of transmission is the labor market and the total amount of remittances flowing into the region. According to the World Bank, remittances from workers abroad into Latin America have become an important source of foreign earnings, totaling an estimated US$61 billion in 2007. These inflows are already falling especially considering the more difficult labor market conditions in industrialized countries which tends to amplify the magnitude of the real shock.

The third important channel of transmission of world shocks into the region is a very likely and sharp reduction in capital flows. A dramatic swing in risk appetite will likely reduce the amount of debt and portfolio flows quite significantly, especially in a context of declining interest rates. A weaker growth outlook, combined with much tighter financing conditions for real investors will also likely significantly lower FDI inflows, which expanded 55% between 2006 and 2008. According to our estimates FDI inflows will decline 45% in 2009. In this respect all the Latin American countries will be negatively affected. While Argentina and Ecuador might lose more FDI than Brazil and Chile it means that besides the negative external environment the former two countries do not have stable and credible democracies.

Such a combination of external shocks will slow down regional GDP growth to -1.3% in 2009, compared to average growth rates of 5.0% between 2003 and 2008. Under our scenario, all countries in the region will experience significant deceleration of economic activity in 2009. We expect the following countries to present negative growth rates (on a year over year basis): Brazil, Argentina, Chile and Mexico.

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