Recent data releases indicate that the U.S. economy is headed for a hard landing and some analysts even speak of a downright recession in the first half of 2001.  Forecasts for GDP growth in the United States now range from as low as 1% to 3% at the upper end.  Given the massive weight of the US in the global economy, growth in other countries will no doubt suffer from the increasingly subdued outlook in the world’s leading economy.  Furthermore, since some of the key Latin American countries maintain close ties with the United States, the region also is likely to be affected by the slump of the US economy.  The anticipated slowdown is reflected in the downward revision in this month's LatinFocus Consensus Forecast for regional economic growth this year.  However, the interdependence of the Latin American economies with the United States varies greatly among the seven countries surveyed and hence the impact of a slowdown in the US will be felt differently across the region.  In fact, some countries may even stand to profit.

The most direct impact on Latin America will be felt via the trade channel where Mexico stands to loose most.  Institutional links to Canada and the United States within the North American Free Trade Agreement (NAFTA) have substantially raised trade flows to the country’s northern neighbours.  In fact, in 1999, more than 90% of total exports were directed to NAFTA partners.  Furthermore, the contribution of exports to GDP has also risen over the years and should have reached 29.0% in 2000.  On the other end of the spectrum, Argentina directs only 13.4% of its exports to the United States and Canada.  In addition, Argentina also is the country with the lowest Export/GDP ratio within the region, with less than 10% of its GDP stemming from exports.  Thus, the share of exports to the US as a percentage of GDP is barely more than 1% compared to 25% for Mexico.  Brazil, Chile and Peru also seem less threatened by the potential weakening of US demand for their products with a dependence ranging from 2.3% in the case of Brazil and 4.6% in the case of Chile.

Even though some of the region’s key economies are sheltered from the fallout in external demand, countries may suffer from drying up of foreign capital inflows as global economic activity slows down.  The 4.5% current account deficit in Brazil, which so far has been financed by strong capital inflows, makes it the most vulnerable economy in the region with regards to drying up of foreign direct investment.  In addition, the current account deficits in Argentina, Mexico and Peru all exceed 3% of GDP and also presage potential financing difficulties.

Since the United States figures as the world’s number one energy consumer, a significant drop in economic activity also threatens to lower demand for oil.  If lower demand is not met by equivalent oil production cutbacks by OPEC, oil prices could come down significantly, affecting Latin American oil exporters Colombia, Mexico and Venezuela.  In addition, a weakening of the oil price also threatens the currencies of the oil exporters.  Venezuela’s Bolivar is overvalued by more than 30%, according to the most conservative estimates.  So far, abundant oil exports have provided the country with sufficient reserves to fend off any speculative attack.  A harsh and protracted downturn in oil prices, however, could alter this situation.  The Mexican Peso also displays sensitivity to oil price movements.  A weaker peso could wreak havoc in the Central Bank’s ambitions to further lower inflation or, alternatively, prompt the Bank to further tighten its policy and thus further choke off economic growth.

The anticipated slump in US growth also bears some positive aspects:  The buoyant state of the U.S. economy leading to ever tighter labour markets has prompted the Federal Reserve Board to maintain a tight policy to counter inflationary pressures.  With recession threatening, the Federal Reserve Board has acted by cutting the federal funds rate target by 50 basis points to 6% in early January and is expected to further ease its policy.  This is good news for the Latin American economies, which have suffered from the tight monetary policy in the past.  Particularly Argentina with its huge financing requirements and its inability to pursue an independent monetary policy due to the currency board should benefit from further easing.

Note:  The above text is an abridged version of the LatinFocus Consensus Forecast briefing for Latin America.  For more details please click here.

For five-year forecasts, please click here.