A more positive picture for Latin America, but Trump looms large

Participants:

• Dirk Willer, Global head of emerging markets strategy, Citi
• Juan Ruiz, chief economist for South America, BBVA
• Antonio Cortina, deputy director of economic research, Banco Santander
• Mario Mesquita, chief economist, Itaú Unibanco

The Banker has polled a select group of economists about Latin America’s prospects and threats, as the global discourse over trade and international relations takes unprecedented turns and reshapes itself around new drivers. Participants discussed the improved outlook of Brazil and Argentina, Mexico’s North American Free Trade Agreement (Nafta) scare, the potential spread of the Pacific Alliance principles and rules to others in the region, beyond the trade bloc’s current members of Chile, Peru, Colombia and Mexico, infrastructure shortfalls, as well as the ever-growing influence of China on Latin American trade.

Q: Latin America’s economic growth prospects remain low but the outlook for 2017 seems brighter than that of the past few years. Which countries will show the biggest improvements and why?

Dirk Willer: Here at Citi, we took our growth forecast for the region from -0.6% in 2016 to 1.3% in 2017, and further up to 2.8% for 2018. The main driver is, of course, Brazil, which is exiting a very deep recession. While growth expectations in Brazil for this year have come down, they are still a big improvement from 2016. So overall growth for the region is driven by the old adage that the deeper the recession, the stronger the bounce back.

The only country where we see a worsening of growth in 2017 compared with 2016 is Mexico. The external shock from US trade policies is likely to undermine both foreign and domestic investment as local confidence is falling. The weakness in the peso has already generated both inflation and a hiking cycle by the central bank, which will be reflected in growth going forward.  

Juan Ruiz: We anticipate that the region will indeed see a turning point in 2017, with growth of about 1%, after four years of decelerating activity [which resulted in] negative growth in 2015 and 2016. But dynamics are very heterogeneous. For example, both South America and Mexico will grow 1% in 2017, but for South America that means putting deceleration behind it (though 1% is still low growth compared with potential, which is closer to 3%), whereas for Mexico that growth is significantly below what we saw in previous years (2% to 2.5%) as it is hit by uncertainty about future US economic policies.

Within South America, we expect Peru, Argentina and Colombia to be the countries with the strongest growth. This will be supported by the external sector (benefiting from somewhat stronger commodity prices and past depreciations) and, specific to these countries, the [input] coming from investment in infrastructure (in Peru and Colombia) and an expected surge in private investment in Argentina as the economy starts to turn around.

Antonio Cortina: Brazil and Argentina are laying foundations for sustainable growth and are leaving behind recessions, including a particularly intense and prolonged one in Brazil. Brazil will grow by 0.7% in 2017, after suffering its deepest recession in decades in 2015 and 2016 (-3.8% gross domestic product [GDP] growth and -3.5%, respectively). The government of Michel Temer has the political will and ability – with support of more than 60% both in the Congress and the Senate – to lay the groundwork for a gradual but sustainable and well-founded expansion, that will gain strength in 2018.

Monetary policy and the fiscal framework (public expenditure caps and social security reforms are in progress) have gained credibility, [meaning] the government is now able to focus more on liberalisation and trade. The government of Mauricio Macri in Argentina has tackled macroeconomic imbalances, microeconomic distortions and a weak institutional framework with determination. The peso is mostly market-determined, the settlement with creditors has allowed a return to international capital markets, utility prices are more in line with costs, and medium-term fiscal and inflation targets have been announced.

Argentina will grow 3% in 2017, after contracting by nearly 2% in 2016. However, reversing the legacy of a decade-and-a-half of isolation will take time, and might require further measures. Particularly important is taking into account how economic costs are distributed through society.

Mario Mesquita: We expect economic growth in Latin America to improve in 2017, as Brazil and Argentina come out of their recessions. In Brazil, the combination of fiscal reform, lower interest rates, private sector deleveraging, higher commodity prices and the end of an inventory-shedding cycle will likely lift the economy.

In Argentina, the fading impact of the relative price adjustments (higher utility prices and exchange-rate depreciation) will benefit consumers (through higher real wages) amid market-friendly economic policies and growing access to international capital markets. Elsewhere in South America, improved terms of trade and lower interest rates will allow for a recovery from 2016 – though more modest than in the case of Brazil and Argentina.

On the other hand, in Mexico we expect a slowdown as uncertainty over protectionism [in the US] and higher inflation drags domestic demand down. Still, a more competitive currency and higher US economic growth is a buffer for Mexico’s exports, as long as protectionism doesn’t materialise.

Q: International trade deals are under review and new trade relations might be forged as the US takes a new, seemingly protectionist stance, and China publicly – although perhaps not in practice – supports the benefits of global trade. Which Latin American economies would be mostly affected by this new world order, and how?

Mr Willer: First, we do not agree that China is truly supportive of free global trade. In our view, China has erected very significant non-tariff barriers to free trade. Having said that, at this stage the US is moving towards more protectionism, while China is standing still.

In this environment, Mexico is clearly the most exposed to rising protectionism. Mexico is sending exports worth 26% of its GDP to the US. It also gets the majority of foreign direct investment from the US. Citi has already lowered its growth forecast for Mexico for this year to 1.2%, and we see downside risks to those numbers. Conditions in Mexico could feel borderline recessionary if US president Donald Trump is able to push ahead with his favoured policies.

If oil does not get excluded from the border tax adjustment that is discussed as part of the US tax reform, Colombia would be the second most heavily impacted country in the region. The rest of Latin America is more geared towards China than the US. But if the US were to get involved in a trade war with China, even the more China-centric countries would very likely be severely negatively impacted by the fallout.  

Mr Ruiz: The economy most obviously affected would be Mexico, given [its] strong ties with the US. Countries in South America will probably not be that affected by a protectionist bout from the US aimed at revising bilateral trade agreements, as US trade balances towards those countries are relatively small and traded goods do not generally compete with industrial production in the US (the apparent focus of the US administration drive to protect domestic production).

On the contrary, South American exports of basic materials are more of a complement, than a competitor, to US industry. So it is unlikely that the US will focus on revising those free-trade agreements signed with some South American countries.

On the other hand, other initiatives under consideration – not directly protectionist, but that may affect trade, such as a border adjustment tax – would indeed affect exports to the US, even from South America. The US is still among the main three destinations from exports coming from South America.

Mr Cortina: There is clear evidence about the benefits of cross-border economic integration on productivity and income. This consensus among economists has been questioned by some political parties in various countries. The benefits of globalisation have not reached everyone, particularly in advanced economies, so we should pay attention to the distribution of benefits of globalisation. If any country takes a protectionism stance, we could enter into a retaliatory spiral with negative consequences on growth and financial stability.

Mexico is obviously – among the big countries of the region – the most sensitive to US policies, given the two countries’ close trade, investment and migration relations. It seems clear that Nafta [the trade agreement between Mexico, the US and Canada] will be renegotiated and updated but this is not necessarily bad news. We shouldn’t forget either that the competitiveness of US companies benefits from the integration of value chains with Mexico.

Mr Mesquita: Mexico is by far the economy in the region most integrated commercially with the US, so it would be directly hit by protectionism. However, if trade relations between China and the US deteriorate, the impact on commodity prices could be meaningful, with negative consequences for the commodity exporters of the region – which means most countries in South America.

Q: What about Latin America’s own trade blocs? Are we going to see faster integration within the region both in terms of trade and investment? Will this spur the development and financing of much-needed infrastructure projects in the region?

Mr Willer: As the US moves towards more protectionism under Mr Trump, we think Latin America has the opportunity to deepen its own trade blocs. While Mercosur has not been a strong trade bloc in the past – tending to be protectionist – Brazil, especially, is expected to join forces with the Pacific Alliance now that its government is more pro-trade than its successors.

The Pacific Alliance, in contrast, has been successful in rapidly integrating its participating countries and creating multiple trade agreements with other parts of the world. As Latin America’s main blocs come together, we expect the Pacific Alliance’s principles to dominate and, therefore, see faster integration both in terms of trade and investment.

This increased integration is likely to spur the development of infrastructure projects in the region in order to reduce transportation costs, but these projects are long term and are unlikely to offer a quick [improvement].

Mr Ruiz: If we see the US turning more protectionist, that indeed may spur [a search] for alternative markets for the region’s exports, including inside Latin America. However, the region’s intra-regional trade was underperforming relative to what one would expect before the change in the US administration. And that certainly is driven by a lack of proper infrastructure integrating Latin American markets among themselves.

Thus, we will probably need to see more investment in infrastructure and trade harmonisation before we can see faster trade integration within the region.

Mr Cortina: The Andean countries are more open to international trade and capital flows and have performed better than [the more closed] economies of the region. The new governments of countries such as Argentina and Brazil show more political will to deepen international integration. Given the challenges both are facing (very positively I have to say), it will not be easy to see major steps in that field immediately.

However, I would expect gradual but important movements in that direction in the short to medium term. Regional blocs are gaining importance worldwide and Latin America cannot ignore these trends. Of course, infrastructure projects are key and we have seen significant progress in some countries with a growing role of the private sector through public-private partnerships.

On the other side, low intra-regional trade has a lot to do with the relatively low weight of industrial and services tradeables in a number of countries in the area, and the large role of commodities in production.

Efforts to diversify the economies are key to increasing trade and integration in the area. The potential of trade and investment within Latin America has barely been tapped – the Inter-American Development Bank says regional integration offers a $5000bn-plus market opportunity to boost scale, productivity and competitiveness.

Mr Mesquita: The new governments of Brazil and Argentina (two of the three largest economies in the region) are more open-minded on trade than their predecessors. This, combined with a more protectionist stance in the US, has the potential to foster trade agreements within Latin America.