Lower growth in Latin America and a lack of reforms in areas such as education, infrastructure and taxation are not inviting propositions, but the region still shows some areas of great promise in 2014.

Participants

  • Guillermo Mondino, head of emerging markets economics and strategy, Citi
  • Andre Loes, chief economist for Latin America, HSBC
  • Juan Ruiz, chief economist for South America, BBVA
  • Antonio Cortina, deputy director economic research, Banco Santander
  • Rodrigo Valdés, chief economist for the Andean region, BTG Pactual

Q: After a disappointing 2013 for most Latin American economies, what will drive growth this year? Which countries will do better, and why?

Guillermo Mondino: We expect growth in 2014 to exhibit some modest return to the mean in many countries after a disappointing 2013. Global conditions, particularly led by stronger US growth and, hopefully, some positive activity in Europe, should be important contributors.

However, while improving in some quarters, growth will still be disappointing. The drivers of years past are waning: ultra-low long-term real interest rates, high commodity prices and the dividend of past reforms is dissipating.

Mexico stands as an outperformer, followed by Colombia and the Dominican Republic. Note, however, that we are not saying these countries will grow faster, but rather that they will recover more noticeably. Venezuela and Argentina [which have very different dynamics from the other Latin American economies], on the other hand, are expected to show the poorest growth performance relative to trend.

Andre Loes: Activity in Latin America is recovering, but the pace of recovery in the region will likely be weak and far from even. The countries on the Pacific coast hold an advantage over the countries on the Atlantic coast. On this brighter part of the region, Mexico is expected to register strong recovery – 4.1% growth – on the back of policy easing and US recovery. The important reforms approved last year may help push up potential growth in gross domestic product [GDP], but there is a time lag for this to materialise.

Colombia and Peru are expected to grow by 4.7% and 5.6%, respectively, in 2014, backed by policy easing. Chile may stabilise growth at a level similar to last year’s. Here, a weakening of the competitiveness of mining, owing to higher costs related to mature geology and more expensive energy, may prevent a rebound in 2014.

Juan Ruiz: Indeed, the region slowed down in 2013 to an estimated 2.2% growth, from about 4% two years earlier. The region’s average growth was dragged down in particular by Mexico’s soft patch in the first and second quarters. This year we expect regional growth to rise to 2.7%. In addition, foreign demand will gradually recover in line with higher global growth.

The three biggest Andean countries will continue to be fastest growing in the region. We expect Chile to grow at about 4% this year, Colombia close to 5% and Peru above 5.5%. Next is Mexico, which we expect to grow close to 3.5% in 2014 [with an upward bias depending on the implementation of recent reforms]. These four countries, which constitute the Pacific Alliance, are reaping the benefits of prudent macroeconomic policies and a clear commitment to increasing integration into the global economy.

Antonio Cortina: Growth in Latin America in 2014 will be about 2.7% according to our forecasts – very similar to that of 2013. Tailwinds that were so supportive between 2002 and 2011 [such as Chinese investment, commodity prices and global liquidity] are fading. Now domestic fundamentals are making the difference.

Growth expectations for the region in 2014 hide significant disparities. Among the big countries, Colombia is doing very well and prospects are positive in the medium term, thanks to the effects of the peace process and a long-term agenda running in the right direction. Mexico is improving and expectations have improved dramatically due to the comprehensive structural reforms (particularly in the energy sector) that were recently approved and that will trigger faster growth in the medium term. Chile will also do well, although we will have to wait and see how the reforms of the new government are carried out.

Rodrigo Valdés: Most countries [in Latin America] will need to transition towards more balanced growth in which domestic demand expands more in tandem with output and tradable goods activities become more relevant again. This path will involve weaker currencies and, temporarily, slower growth.

That said, some countries will grow faster in 2014. Colombia is working its way out of the deceleration in late 2012/early 2013 and is continuing to benefit from relatively high oil prices. Ongoing [expansionary] macroeconomic policies are helping the economy to pick up steam in line with potential output growth of about 4.5%.
Peru, in turn, should grow above 5%. This is not as fast as in previous years, but is still a respectable pace. The mining investment boom should yield important output gains and support external accounts.

Our macro team forecasts a sharp acceleration in economic activity [for Mexico] from 1.1% last year to 3.5% in 2014. Besides the ongoing reforms, Mexico will benefit from the US expansion. An expansionary fiscal policy and the [expansionary] monetary policy stance will also play a role.

Q: To different degrees, most Latin American countries are in dire need of structural reforms, ranging from education to infrastructure to taxation. Yet, aside from the most notable example of Mexico, no government has been able to tackle these pressing issues. Will things change in the short term?

GM: Many other countries are not making huge leaps [in the same way as Mexico has], but this is because they had been making more consistent progress in the past decade. Furthermore, each country has a different set of needs to generate greater potential growth.

Take, for instance, Colombia. An eventual peace agreement with the Revolutionary Armed Forces of Colombia would massively improve the country’s business potential, opening the agricultural frontier and facilitating the demilitarisation of the country. Or take Chile, where the economy is more competitive and the reform margin is more limited.

Having said that, it is still true that the region seems more focused on other aspects than on improving efficiency or in adopting a business model for the post-commodity super-cycle… or increasing the savings rate and pace of capital investment [mostly in infrastructure].

AL: The reduction of global liquidity is a powerful stimulus for the emerging economies to engage in reforms. In an environment where external financing becomes way less abundant, countries will be more severely differentiated by their growth and competitiveness. It becomes a matter of sink or swim.

JR: Mexico is setting a very good example for the region, with ambitious, wide-ranging and much-needed reform. Other countries in Latin America surely need to push structural reforms to increase productivity and ensure sustainable long-term growth.

Although less dramatic than in the case of Mexico, there have also been some advances in Andean countries, with a push for tax reform in Colombia to help reduce informality [in the labour market] and a drive to fund much-needed investment in infrastructure. Peru has also been actively reforming its civil service and expanding its capital market.

Chile has announced significant changes in its tax and education system, with the potential to increase long-term growth. Much more is needed, but these are steps in the right direction and more decisive ones than in other countries in the region.

AC: Most countries tend to promote structural reforms in times of crisis rather than during booms. Nevertheless, according to the Organisation for Economic Co-operation and Development, Chile has made great progress in easing product market regulation and increasing female labour force participation. The new government has announced its will to improve the quality and access to education through deep reforms.

In Brazil, access to education has improved dramatically in the past few years, informality in the labour market has been reduced and now there are important programmes to improve infrastructure. Much more needs to be done and it seems that the more challenging the situation the [region] is facing, the more it will push [forward the reform process].

RV: We see no reason to be so pessimistic about the reform agendas in South America. True, the reforms in Mexico are impressive and some countries have thin agendas when it comes to tackling the need to lift potential output growth. But several important ongoing initiatives look set to brighten the prospects for growth.

The elected government in Chile, for example, is embarking on ambitious educational reform. Human capital is the scarcest resource in the region, so returns on investment are likely to be significant. [Some] countries are also taking decisive steps [to improve] infrastructure. Colombia is in the midst of an aggressive concessions programme to build and upgrade roads, and construction should begin in 2015. Peru and Brazil are also making important strides. In Brazil, the government has launched a very ambitious concessions programme, involving roads, railroads, ports and airports, and important steps in its implementation have been seen late last year.

There are other examples. Colombia’s recent tax reform is helping formalisation and lowering unemployment, and the country has implemented important free-trade agreements. Peru has made progress in the financial sector and is carrying out important reforms in the civil service.

Q: Monetary policies in the developed world, particularly in the US, have strongly affected emerging markets in recent years. What external shocks are likely to hit Latin America in 2014?

GM: Monetary policy in the advanced world remains a concern. While tapering [of quantitative easing by the US Federal Reserve] is by now largely discounted and understood, as US interest rates [may be about to] increase, funding conditions will become a new threat to capital flows and exchange rate stability [in Latin America].

Another risk to the region is the potential hard landing of the Chinese economy where a complicated mix of imbalances has been accumulating over the past few years. A meltdown in commodity prices could also affect Latin America. The last two factors appear to be unlikely, although a declining trend in oil prices could be a real threat to Venezuela.

Within the region, a crisis in Venezuela or Argentina is unlikely to have significant ripple effects. Furthermore, it could help focus market attention on sustainability problems [much as Argentina’s crisis in 2001 did]. In our view, 2014 looks reasonably benevolent from an external perspective.

AL: Possible external shocks include an acceleration of the pace of quantitative easing tapering by the US Fed, as well as disappointing growth in China. Lower US dollar liquidity would obviously reduce capital inflows to the region at a time when many countries have a current account deficit north of 3% of GDP – such as Brazil, Chile, Colombia and Peru – or a potential for a hike in their deficit, should foreign exchange controls ease, such as in Argentina.

Slow growth in China would negatively affect commodity prices, leading to further deterioration of the current accounts of the South American commodity-exporting countries. Argentina and Venezuela are the two countries in the region that seem more vulnerable to these external threats, and our forecasts for 2014 growth indicate this.

JR: The more pressing issue for the region in 2014 will be managing the withdrawal of the monetary stimulus in the US. We have seen significant turbulence since May last year, but a good signal is that the actual start of the Fed’s tapering of bond purchases in December has not had a material effect on asset prices. Most of the effects of the tapering seemed to have been priced in already.

As long as the Fed continues to err on the side of caution, the tapering of the monetary stimulus should be readily absorbed by most countries in Latin America, especially those with flexible exchange rates, low debt levels, high international reserves and some space for countercyclical policies. Here, again, Pacific Alliance countries seem to be the least vulnerable.

In addition, a shock to growth in China would also have a significant negative impact on the region. However, the odds of that are small.

AC: So far, the Fed has been able to manage tapering without major effects on financial markets, but in the short term it is probably the main risk faced by emerging markets, particularly those with higher external financing needs. The Fed will keep trying to delink tapering from interest rate moves, but episodes of volatility will be unavoidable. If tapering is based on the good reasons [such as higher growth] and does not include big surprises, the effects on Latin America should be manageable.

The slowdown in China so far is in line with expectations and [public] authorities have room to stabilise growth. However, if such measures were needed, they might water down or delay reforms and policies targeted to correct domestic imbalances, including shadow banking.

RV: Latin America will likely continue facing the two threats it encountered in 2013. First, commodity prices could soften if growth in China disappoints. The risks there are not minor and are well known. China faces the massive challenge of shifting its growth pattern towards more domestic consumption.

Second, there is the possibility that markets will reassess the Fed exit and push US dollar interest rates up faster. This is a distinct possibility for short- and medium-term interest rates if the very gradual normalisation expected from the Fed becomes more similar to previous exit episodes.

The good news, however, is that countries are generally more prepared than in the past to confront these difficult threats. International reserves are plentiful in several countries. Flexible exchange rate regimes, along with solid inflation anchoring, are critical tools, particularly in the Andean region. Some countries also have ample sovereign wealth funds and assets invested abroad.

Q: The region’s giant, Brazil, is still highly dependent on commodities exports and domestic consumption to sustain its economy. Will the country be able to shift to an investment-based growth model in the medium term? What are its growth prospects in general this year?

GM: Extraordinarily low investment rates, private and public, keep [Brazil] from growing. But it is difficult to have a faster investment rate if savings are even lower. Thus, to sustainably improve Brazil’s growth, the key is to increase its savings rate. Paradoxically, ex-president Luiz Inácio Lula da Silva’s greatest economic achievement [was to boost] the consumption potential of previously excluded segments of the population. Such remarkable gains, however, came at the price of low savings rates, which were not compensated by public savings. Tax, social security, financial inclusion reforms and a deep expenditure re-budgeting are critically needed.

Once Brazil manages to save more, proper incentives to develop infrastructure and private investment are desperately needed. Unfortunately, going into 2014, an electoral year marked by FIFA’s World Cup [hosted by Brazil], this is unlikely to be a year where any of that happens. We therefore forecast a slowdown in growth to a disappointing 1.8%. 

AL: The Brazilian economy is expected to grow by 2.2% in 2014. The trade-off between inflation and growth in Brazil has deteriorated over recent years because of the emergence of supply-side bottlenecks. Inflation has emerged as a factor limiting growth, as the central bank has been forced to deliver a significant monetary tightening since the second quarter of 2013. High current account deficit is an additional constraint and commodity price dynamics are hardly expected to be on the positive side in the foreseeable future.

While factors that have supported consumption in the recent past – growing indebtedness of households and a strong rise of real wages – faded lately, weak business confidence is preventing any solid rebound of fixed-asset investment. This should not change ahead of the general elections in October.

JR: The Brazilian government’s macroeconomic set-up has failed to restore competitiveness: lowering interest rates and paving the way for a weaker currency have not been sufficient to offset the country’s structural problems (low investment, high tax burden and poor infrastructure, among others). The Brazilian growth model of the past few years, excessively based on private consumption and the expansion of credit, is running into its natural limits. Economic policies have generated more concerns about excessive interventionism by the government in the economy.

Brazil needs to implement supply-side reforms and reduce interventionism so that private investment increases to levels closer to the average of other emerging countries. Unfortunately, there have been only timid steps in this direction and it seems unlikely that there will be a significant push for reforms in an electoral year. Overall, we expect growth of about 2.5% this year, but a significant slowdown to 1.9% in 2015 after the pre-electoral stimulus is over.

AC: Brazil is going through a phase of moderate growth in order to adjust inflation and external competitiveness. GDP will grow this year close to 2%. Brazil is carrying out this adjustment in an orderly manner and has a much greater capacity to adjust than 10 years ago, thanks to the credibility of the central bank, a floating currency, good public debt management, institutional stability, a particularly sound financial system and a relatively strong external position.

The basis of an investment-led recovery is improving gradually. We expect [to see better fiscal prospects thanks to] the ‘contingenciamento’ [budget provision] this February, on top of the government’s announcement to decelerate public bank lending. The government is also taking important steps in its key infrastructure concessions. More needs to be done to improve business confidence and the adjustment is only in its first stages, but the country is moving in the right direction.

RV: Our macro team in Brazil forecasts growth this year at 2%, with risks skewed to the downside. With a historically tight labour market after the significant decline in unemployment over the past several years, faster growth will require higher investment and greater productivity gains. 

As for the sources of growth, one needs to recognise the difficulties in the past few years of diversifying away from commodities and consumption. As with other countries in the region, Brazil will progressively adjust to the new environment of softer commodity prices and less liquidity.

Yet our team expects the adjustment to be gradual, with consumption demand cushioned by the strength of the labour market and moderate further expansion in credit to households, and investment demand also showing some delay in the uptake in an environment of marked uncertainty.

Of course, Brazil faces other challenges beyond rebalancing domestic activity; rationalising and simplifying the tax structure and upgrading infrastructure would both be instrumental to increasing potential output growth, and neither is easy. Moreover, greater domestic savings will also be required to keep the current account deficit in manageable shape if the country succeeds in raising its investment rate.

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