Latin America in a Global Context - Economic Briefing April 2003

War Over But Concerns Over Global Economy Remain (continued)

United States economy to grow at slower pace than last year
The IMF also lowered its projection for US output growth, although by a much more moderate 0.4 percentage points to 2.2%. However, compared to the 2.4% growth rate recorded last year this actually represents a further slowdown, as a number of factors that boosted economic performance last year are unlikely to be repeated. The mortgage refinancing boom, which has provided additional spending power and buttressed private consumption, is likely to draw to an end. Moreover, the boom in vehicle purchases propelled by attractive incentives cannot be sustained forever, while increasing unemployment is eating away at consumer confidence. If consumption weakens, investment would have to assume the function of the driving force behind economic growth. However, the IMF states that first data for 2003 suggest a sluggish pickup in capital spending. On the upside, the IMF notes that the stimulus from monetary and fiscal policy is likely to help bolster the economy. However, while the Fund claims that a monetary response is appropriate, officials note that the administration’s tax measures may prove pro-cyclical and will significantly worsen the country’s medium-term fiscal position if enacted in full. In response to mounting concerns over the current fiscal trajectory, the Consensus for the United States’ fiscal deficit has deteriorated sharply over the past months (see chart) to a current forecast of 2.6% of GDP.

Japan remains deeply entrenched in deflation
Japan’s outlook was lowered even less in percentage point terms but the 0.3 percentage point cut applied to the already ailing economy translates into a paltry 0.8% growth rate for 2003, the lowest growth rate in the advanced economies, apart from Germany. Japan remains deeply entrenched in deflation, as consumer prices of goods and services have now fallen for the four consecutive years, which is unprecedented in industrial countries over the past half century, according to the IMF. The Fund believes that deflation is hazardous since it increases real debt burden and provides an incentive to delay spending, which can lead to a deflationary spiral. The IMF also highlights the well-known importance of inflationary expectations for future price developments and points to the fact that deflationary expectations are becoming more widespread, a fact also reflected in the current Consensus (see chart), which anticipates deflation to persist into 2004. The IMF is urging the Bank of Japan to adopt an even more aggressive policy stance and to target a sufficiently positive inflation rate to reverse the deeply ingrained deflationary expectations. That said, looking ahead, the IMF believes the economy is unlikely to gain much momentum in the short term, with the risks to the outlook predominantly on the downside.

Forecasts for Latin America cut sharply amid devastating development in Venezuela
In the developing world, the IMF’s cuts were most pronounced in Latin America, where 2003 estimates dropped from 3.0% to 1.5%. The forecast for Latin America contrasts sharply with the outlook for developing Asia, which was left unchanged at a buoyant 6.3%. However, the recent outbreak of Severe Acute Respiratory Syndrome (SARS) poses a risk to activity in several Asian countries. Following on the worst downturn in two decades in the two-year period from 2001 to 2002, the IMF sees the economic outlook for Latin America as fragile and largely dependent on a still uncertain recovery in the United States. The risks of deterioration in external financing conditions, slowing global growth and higher energy costs, emanating from a prolonged war in Iraq, will not serve as an impediment to this year’s recovery. However, vulnerabilities in a number of Latin America countries remain high, according to the IMF. While financing conditions have recently improved, the Fund sees the possibility that the recent improvement in risk appetite may wane and that a further reduction in spreads, which is necessary to ensure debt sustainability in a number of countries, may depend primarily on strengthened economic fundamentals, rather than on improving external factors. Even though contagion has been low in the recent past, the IMF notes that heightened difficulties in one country may have a significant impact on other countries. Finally, severe impediments remain in individual countries, most notably in Venezuela, where the IMF anticipates a contraction of 17.0% this year, even higher than the current Consensus Forecast which envisions a 13.2% contraction. The IMF states that a resolution of the political crisis is vital in order to restore consumer and investor confidence. Moreover, the IMF claims that the government has to address a large borrowing requirement and needs to remove the recently imposed exchange and price controls in order to restore macroeconomic stability.

Argentina will grow again although the rebound will remain moderate this year despite the low comparison base
In Argentina, the worst seems over although output is still almost 20% lower than in 1998, unemployment is 17.8% and poverty rates remain extremely high. However, the IMF sees economic activity rising by 3.0% -- somewhat more pessimistic than the current Consensus which was raised 0.7 percentage points since last month to 4.1%. In Brazil, uncertainties in financial markets about the macroeconomic policy setting, which destabilised the economy in 2002, have subsided, as the government of President Lula da Silva has convinced markets that it will maintain macroeconomic stability. However, the IMF states that external financing conditions remain difficult due to the large public debt rollover requirements, which underscores the importance of fully implementing the government’s economic program, including disciplined fiscal policy. At 2.8% growth anticipated for 2003, the Fund’s forecast is substantially more optimistic than the current Consensus of 2.0%.

For Mexico, the Fund sees fiscal planning for this year to be reasonably consistent with a lowering of public debt in the medium term, although the IMF is concerned that weak economic activity has moderated the pace of fiscal consolidation. To foster economic growth over the medium term, the government should implement additional structural reforms, including reforms to the value added tax, electricity sector, and labour laws. In addition, the IMF believes that the banking system’s regulatory oversight should be strengthened.