Most Latin American countries should show significant recovery this year for the first time since 2014. We expect the region to grow by 1.1 per cent in 2017 with growth returning to 3.2 per cent next year.
This brighter outlook comes after two years of difficulties. LatAm’s slowdown resulted from both external and internal factors – worsening terms of trade plus higher interest rates to fight rising inflation caused by weaker currencies and fiscal expansion. This is all set to turn around in 2017. The forecast 1.1 per cent growth represents a 2.8 percentage point turnaround.
Most LatAm countries are working to improve their fiscal accounts to allow lower real interest rates and a return to growth. And unlike G7 countries, additional fiscal austerity should not threaten the region’s recovery.
Fiscal adjustment is essential for growth and countries that have started putting their accounts in order, such as Chile and Peru, are faring better and have less work to do. Argentina and Brazil, which went in the wrong direction, are having a harder time, but even they are pursuing reforms, despite political storm clouds.
However, there are signs of escalating trade protectionism in the United States and Europe. Of all the economic risks over the last decade, we think this is by far the most ominous. Mexico is the most vulnerable Latin American country, because of the new US administration’s threatened renegotiation of Nafta, the North American Free Trade Agreement.
Brazil is the least exposed of the larger countries, because its share of trade with the United States has shrunk over the last decade. However, previous protectionism had increased the cost of investing in Brazil and excluded it from past trade agreements, hitting efficiency and growth.
Chile and Colombia have trade agreements with the US, so are directly less vulnerable, but, along with Peru, the US withdrawal from the Trans Pacific Partnership will indirectly affect future trade growth.
The receding risk of China slowing has bolstered a slow recovery in commodities that should improve Latin America’s terms of trade. And the risk of higher US interest rates seems to have receded too, but the LatAm countries’ own tightening and reduction of dollar-denominated debt has reduced vulnerabilities across the region except, possibly, Mexico.
Almost all Latin American countries have embarked on fiscal adjustment programs in the past two years to adjust to the decline in their terms of trade. But the region is avoiding a repeat of the ‘1980s lost decade’ when it wasted the windfall of the prior commodities boom. Prudent fiscal policies and opening their economies have improved economic performance in Chile, Colombia, Peru, and Mexico. Argentina’s and Brazil’s return to poor policies mean they now need substantial reform.
Latin America nevertheless has more adjustment ahead. The region as a whole is still running primary deficits, meaning governments are not even contributing to pay for their interest bill. Only Colombia and Mexico are poised to reach primary surpluses over the next two years and they are two countries hit hardest by the fall in revenues from recent low oil prices.
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