Latin America in a Global Context - Economic Briefing January 2003

Outlook for Global Growth Continues to Deteriorate (cont.)

Europe lacks impetus as neither fiscal nor monetary stimulus possible
In Europe, current economic indicators point to a slump in the economy and the continent lacks the toolsto implement a policy stimulus that the U.S. economy enjoys. The purchasing manager index for the Euro Area dropped steeply from 49.5 to 48.4, the lowest level since January 2002. The index is now well below the neutral line of 50, suggesting that manufacturing slipped back into recession late last year and is likely to remain subdued in the near future. In Germany, unemployment shot through the psychologically important 10% threshold and reached a new four-year high. On 10 January, the government admitted that the already moderate growth estimate of 1.5% for the Euro Area’s largest economy seems overly ambitious and that growth around 1.0% is more realistic. The lower growth acknowledgment comes at an unpleasant moment, as the European Commission has just launched proceedings against Germany over its excessive budget deficit. Fiscal deficits in other large Euro Area economies, such as France and Italy, are also close to the 3.0% threshold of the Stability Pact. Consequently, fiscal stimulation to rekindle growth is not an option in Europe leaving monetary authorities with the task to spur the sluggish economy. However, even though the European Central Bank (ECB) recently lowered interest rates, the move pales in comparison to the aggressive stance of U.S. monetary authorities, who have cut interest rates twelve times since January 2001 to just 1.25%, compared to Europe’s 2.75%. The ECB faces the dilemma that inflationary pressures remain present despite the lagging economy. Moreover, the Bank is bound by its statutes to pursue price stability and lowering interest rates may jeopardise its credibility.

Sentiment for Latin America deteriorates but recovery scenario remains intact
Latin America is in for a recovery. After a virtual standstill of the regional economies during the past two years, Consensus Forecast panellists see economic growth to average 2.5% in 2003. While this is well below potential growth, it is welcome for a region that has been subject to significant shocks in the recent past, including strong currency depreciations in Argentina, Brazil, Ecuador and Venezuela and deep political crises in Argentina, Peru and Venezuela. Moreover, with the exception of Uruguay and Venezuela, all countries will experience positive growth this year. Nevertheless, compared to last month sentiment deteriorated a notch. The downward revision was concentrated in Mexico and Venezuela. Mexico suffered from disappointing economic data in the recent past and the necessity of the Central Bank to adopt a tighter monetary policy in order to rein in rising inflationary expectations. Not surprisingly, the events unfolding in Venezuela are taking a heavy toll on the growth projection, which was lowered 1.9 percentage points reverting a 0.9% growth forecast last December into a 1.0% contraction outlook. Moreover, the risks are clearly to the downside, as a reconciliation of the government and opposition is not in sight and even once the strike has come to an end, the all-important oil industry will take months to recover fully.