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14 Jan 2014

Latin America inches forward

Andre Loes

by Andre Loes

Chief Economist for Latin America, HSBC

Latin America inches forward

Colombia is one of the fastest-growing countries on the Pacific coast

Latin America is gradually recovering but the pace will likely be weak and uneven. Mexico is expected to grow 4.1 per cent in 2014 but Brazil should continue to lag, with forecast growth of just 2.2 per cent.

The region still splits between the fast-growing countries on the Pacific coast – Chile, Colombia, Mexico, Panama and Peru – and the slower-growth Atlantic countries such as Argentina, Brazil, Uruguay, and Venezuela.

The key factor holding back some nations while recovery powers ahead in others remains the trade-off between growth and inflation. An adverse trade-off limits a country’s ability to float its currency, delaying current-account adjustments and thus restraining growth. High inflation also limits the capacity of governments to support a stronger rebound through interest rates.

The trade-off has deteriorated in the low-growth countries, especially Argentina, while it has improved in the higher-growth nations, with Colombia and Peru the bright spots. This divide does not seem about to change.

The key factor holding back some nations while recovery powers ahead in others remains the trade-off between growth and inflation

Shifts in US monetary policy and domestic political issues have pushed governments of the Atlantic coast countries into proposing corrections to policies that led to higher inflation and lower growth. However, the impact may be limited, with policy changes restricted by looming elections and the short-term inflationary impact of reducing price misalignments on electricity, fuel and real exchange rates.

Venezuela has been reducing petrol prices in US dollar terms since 2000 from already very low levels. This hits its fiscal accounts because PDVSA, the state-owned oil company, is by far the largest taxpayer. The record fiscal deficit we estimate for 2013 suggests the need for a strong price adjustment but that would impact on inflation that already exceeds 50 per cent a year.

Argentina has, by far, the most significant price misalignment in electricity. Energy and transport subsidies have turned trade and budget surpluses into twin deficits. Subsidies may have reached 4 per cent of GDP in 2013 from almost zero nearly a decade earlier and the year ended with severe blackouts. Colombia also has energy subsidies and Brazil started to subsidise electricity in 2013.

Real effective exchange rates are also misaligned in some Latin American countries. Argentina, Brazil, Uruguay and Venezuela have the most appreciated currencies.

The problem with price misalignments is that fiscal deterioration or weak investment can develop if governments systematically reduce energy tariffs – either through transparent subsidies or state-owned companies’ pricing policies. Moreover, loss of competitiveness and current-account imbalances can result from keeping exchange rates above natural levels.

Over the long term this leads to balance-of-payment adjustments that can include sharp currency swings or the need for a quick catch-up in prices. That poses an inflationary risk with negative secondary effects for economic activity.

But elsewhere in Latin America, the Pacific coast countries should maintain their smooth ride in 2014. Colombia and Peru should show accelerating growth, backed by policy easing, while we expect Chile’s growth to be close to 4.5 per cent.

However, the region’s main contribution to growth in 2014 should come from Mexico, where we expect a rebound to 4.1 per cent from the lacklustre 1.3 per cent we forecast for 2013. Indications suggest the neighbouring US economy is accelerating while Mexico’s government has cut interest rates and will increase fiscal spending to accelerate a cyclical recovery.

Last but not least, it is hard to overstate the significance of the new administration’s reforms, including ending the 75-year state oil monopoly. A more productive oil sector, resulting in increased investment and lower energy prices, should lead to potential GDP growth at least 1 per cent higher than current levels.

This research was first published on 7 January 2014.
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