Thursday, 06 Jun 2013
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South America: Economy: Less Of A Tail Wind
British Embassy Buenos Aires
South America is going to do better this year than last year with an expected growth of around 3.5% against 2.6% in 2012. The main explanation for this is Brazil, which represents almost half of the region and will grow three times as much as in 2012. For the rest, performances are in general quite good with Venezuela and Argentina being the underperformers but well above the freezing line. Inflation is low in the 4 Pacific countries and the two landlocked (Paraguay and Bolivia) but gathered speed in Venezuela. Debt ratios are mostly low.
There are a couple of challenges moving forward. Some commodities (metals in particular) seem to have lost steam creating a bit of uncertainty in a few countries. Overvalued currencies are damaging manufactured exports (but favouring imports from the UK) and productivity growth rates well below Asia are another factor that endangers the sustainability of this growth cycle. Although there is no systemic difficulty for the region in sight, it is true that there is less policy space than before and reforms are not so easy to produce. That said, the main risk for South America would be the unwinding of ultra easy monetary policy in the North or some sort of unexpected shock in commodity prices.
Colombia is launching its package to boost growth, Peru is fighting appreciation, Ecuador is mulling a debt issue 10 years on and Venezuela is slowing down as inflation and scarcities go up
The South American economy continues to do reasonably well. The weighted average growth rate for this year is expected around 3.5% compared to 2.6% last year. For 2014 the latest forecasts speak about 3.8% but it is too early to analyse this. The only two localised risks are in Argentina and Venezuela but neither of these are immediate, as both will continue growing in 2013.
Is South America really doing much better than last year? The short answer is no. Brazil explains all the uplift in growth projections. When a country that is 47% of the region trebles its growth rate, numbers change immediately. For most of the rest (point more, point less) everything will remain the same. Venezuela is expected to reduce growth as the election stimulus wanes and a rampant inflation hurts pockets. On the opposite side, Paraguay coming out of a drought in 2012 is expected to grow by 11%, according to the IMF and by even more according to local authorities.
In broad terms, countries should not increase growth at a time where tail winds are not as strong as they used to be. While commodity prices are still quite high in historical terms, some (especially metals) have come down a long way of late. Also while numbers in the US have been reasonably encouraging (not in Europe), exports have stagnated. According to ECLAC, exports from Spanish-speaking South America rose by a paltry 1% in 2012 compared to 28% in 2011, a clear sign of diminishing help from the world. Domestic demand came to the rescue in most of the countries. Investment is moving up, thus making the whole growth cycle increasingly sustainable while the swollen middle classes contribute to consumption much more than in the past.
Another good factor for this growth cycle is that inflation is under control in most of the countries (there are only 2 sinners plus Uruguay which is not in an ideal situation with 8% inflation (see chart on last page with all the data). This good inflation data has enabled, for instance, the Central Bank of Colombia to lower its rate two full percentage points to 3.25%, a policy more geared to contain currency strengthening than stimulating the economy. Countries with superb growth such as Chile and Peru did not bother to raise interest rates on account of a relaxed inflation situation.
Fiscal accounts remain in order in spite of a marginal worsening of deficits but with debt ratios well at bay. The combined South American deficit was 2% of GDP. Some countries, such as Colombia, managed to reduce their deficits while those in Venezuela, Argentina and Uruguay increased. There have been some tax changes, which should increase revenues in Chile, Ecuador, Peru and to a lesser extent Argentina. Only two countries would be (just) outside the Maastricht criteria for debt in the region: Brazil and Venezuela. Taking a simple average of debt ratios, the region only owes 35% of its income or 50% weighting the average by economic size and this is gross debt.
Short term policy challenges
In the short term, the 3 challenges that South America faces are: appreciation of currencies; less ample policy space than before; and how to deal with more uncertain world scenarios whereby commodity prices are no longer keys to open all doors.
The currency appreciation is a pressing factor in Colombia, Uruguay, Argentina, Brazil, Peru, Venezuela and Chile. There are different sources for this appreciation. In some countries it is because of inflation, in others it is about commodity exports and in others it is about a combination of financial money inflows (Uruguay’s president has just said that his country cannot cope with so many dollars) and foreign direct investment making its way through the border. Apart from reducing inflation, there is not an awful lot that governments can do. Most Central Banks are conducting FX interventions, putting in place macro-prudential measures to discourage banks from taking foreign credit lines, increasing the limits for local pension funds to invest abroad (as Peru just did taking the ceiling to 36% of portfolios - potentially good news for the City of London). But the economic literature (and real experience) shows that these measures cannot fundamentally change the direction of a market. Macro-prudential measures tend to be more useful to prevent bubbles than to depreciate FX, for instance.
And appreciation has political effects. Manufacturers and their circles of influence are good lobbyists. Commercially, the appreciation of the currency has to be positive for British goods exports and for attracting visitors and students to the UK. The truth is that for an upper middle class family in Latin America the UK is no longer that unaffordable a destination (in some places there remains the cliché of London being too expensive, though). All 10 South American economies saw British exports rise in the first 2 months of the year (see end chart for more data). Economically, processes of growth with strong currencies tend to be accompanied by current account deficits. And this is exactly what we are seeing. Current account deficits of 1.6% with 8 out of 10 in the red. This is not really pressing at the moment but it is something to monitor if winds change. Reserve accumulation decelerated lately but Latin America seems to be well endowed anyway, perhaps with the exception of Ecuador. Also, most countries (again with the exception of Ecuador and Venezuela) have flexible exchange rates that can be employed.
There is nothing that Central Banks and Treasuries can do about the world. But the reduction in gold and copper prices and the danger of lower food prices (if the US harvest is as good as promised) can have effects on growth, probably mostly felt in 2014 but it is something to consider. Likewise, the day that G7 countries exit ultra-loose monetary stances, Latin America will suffer. Not just that there will be less risk appetite and fewer financial flows. Most observers also note that the boom in FDI is in part a function of easy money.
Longer term challenges
Some of the long term challenges of Latin America are infrastructure, education, innovation (i.e. reaching Asian productivity), improving income distribution, formalising labour and so on. Some countries have taken these issues seriously, others simply talk about all or some of the items in the shopping list in a more “wishful thinking” approach.. In terms of labour formality, the average for Latin America is a shaming 44%, according to IADB. Chile, Uruguay, Brazil and Argentina are the ones above the average but Chile is the only one where the bottom 20% is better than the regional average. Bolivia, Paraguay and Peru are the South American champions of informality with their richest 20% still below the regional average.
This laundry list will become more and more critical when the commodity tail wind recedes and the financial bonanza borne out of the QE in the North finishes. But given that reforms take time, there is a need to start now. The IADB estimates that growth in Latin America in 2013-17 will be one full percentage point lower than in 2003-7. Terms of trade would not be as good and that would be accompanied by a fall in investment. And while there is space for economic stimulus, the capacity is on average lower than before according to IADB. Another factor to bear in mind is that growth processes in Latin America tend to hammer the external front instead of the Asian way of “export-led growth”.
Most of this growth was based on incorporating more people into the work force (unemployment fell from 11.2 to 6.4% in 10 years and participation rose a full percentage point even with high population growth). So the key is how to increase productivity. And here Latin America features badly in all comparisons; against Asia, Latin America lost out 40% in 30 years. Against the USA only Chile and Panama increased productivity more in the last 50 years. Three pieces of evidence that point to the same side: labour, education and innovation. Labour reforms in the region have largely lagged behind those on trade and financial markets. Another good indicator flagged by the World Bank is how poorly Latin American does in services. In Eastern Europe exports of services (ex tourism) are 12% of GDP, in South East Asia over 8% and in Latin America 2.5%. Services tend to have higher education intensity. At the high end of this market (skilled services) Argentina and Uruguay do quite well and Chile and Brazil come in the second tier. But the rest of the countries are several orders of magnitude below.
Colombia is one of the stars of the region with good macroeconomic management and opportunities. However, growth has never been as high as the other Pacific countries and some indicators have been disappointing.
The government has taken action with its programme to boost productivity and employment (PIPE in Spanish) and is also looking to contain appreciation. Measures include lowering tax rates (and anticipating planned lapses of taxes), acceleration of infrastructure projects including roads and housing ones and a little bit for agriculture. Depending on how it is implemented, the PIPE plan could unlock public funds worth USD 2.8 billion.
Venezuela is living through difficult times. Inflation shot up to 4.3% in April alone taking the 12-month figure to 29% and with very high chances of going over 30% next month. The shortage index is close to its all-time high. This is due to the fact that CADIVI (the foreign exchange agency) is not giving out dollars for importers. And reserves are not increasing either, a sign of the deterioration of the economy. All this is due to have an impact on output. The IMF expects Venezuela to grow close to zero. Others are more in the 2-3% camp. To achieve the latter, the government will have to make more dollars available. In the meantime the market exchange rate is 4 times more expensive than the artificially low official rate. Presient Maduro has pledged to address the economic challenges while keeping up with growth. Both together may not be possible, unless there is a completely different approach, which is not expected.
Uruguay coped reasonably well with the downturn of Brazil and Argentina in 2012 growing 3.9%, more than its 2 neighbours combined. This year with Brazil growing three times faster Uruguay should take a push. But the rise in the parallel dollar in Argentina hits Uruguay in two ways: reducing tourism inflows (Argentina is over 50% of total tourism revenue) and making it more attractive for Uruguayans to cross the river. With a good market for getting pesos at cheap rates, Uruguayans love Argentina be it for shopping or leisure. Uruguay is one of the countries most badly affected by having a strong currency because being small means being more open. Also Uruguay’s fiscal accounts have deteriorated quite significantly leaving it with less space for reaction and any correction of the deficit may well cut growth, expected to remain steady at around 4%. Debt is not a pressing problem but what normally is considered a healthy policy of borrowing in your own currency has backfired for Uruguay, as a strong peso also means strong debts.
Ecuador is analysing issuing bonds again. The fundamentals are good, but the record isn’t. Ecuador defaulted 5 years ago while having the money to pay on grounds of “illegitimacy of the debt”. Given that they bought back most of that at a fraction of its value, the market may not be so keen to buy Ecuadorian debt. For Ecuador such a deal would be good. With a debt ratio of roughly 20%, Ecuador hardly owes money to the markets. China, IADB and CAF are by far the largest creditors. Ecuador is also far more robust than the last time it tapped the markets: it has political stability, state revenues jumped from 22 to 40% (including oil) and the economy is twice the size. The only bad news is that the new regime for banks (heavy taxes) is generating a deceleration of loans.
Peru continues to be the best performer in South America. While some analysts recently corrected the growth projection from 6.3 to 6.0-6.2%, the short term outlook continues to be positive. The decrease in metal prices is clearly not great news. In the past turmoil often meant a surge in gold prices that could offset other bad news. Now both copper and gold are falling and that could have negative effects on investments. Still the survey of forecasters tracked by the Peruvian Central Bank has not moved from their magic number of 6% for 2014 and 2015. Currency appreciation is an issue. Partly as a result exports fell by 16% in Q1. The Central Bank of Peru has been amassing reserves to curb this, though it has stopped doing so in recent weeks.
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