Latin America in a Global Context - Economic Briefing January 2004

Higher Growth in U.S. and Japan Provide Year-end Boost (continued)

Brazil sets path for credibility on economic policy but economy sputters
Last year, was a year of stabilizing the economy following the election-induced volatility at the end of 2002.  The incoming Lula government embarked on a path of monetary and fiscal stabilization.  High interest rates and tight credit stopped short economic activity for a good part of the year as the economy entered recession.  Simultaneously, the government made rapid progress on implementing important structural reforms. The combination of improved investor sentiment about the government’s commitment to economic policy continuity, a stronger currency, declining inflation and lower interest rates are likely to give a good push to the economy this year.  Nevertheless, some shadows remain, as the president’s progress on economic policy has come at the expense of support within his own party and many Brazilians will be looking for concrete progress on Lula’s elections promises for social policy.

Currencies appreciate as Argentina and Brazil bounce back from earlier overshooting
With regards to currencies, Latin America did not present the usual picture of depreciation versus the US$.  In 2003, the currencies of three major economies appreciated by more than 10% in nominal terms versus the US$.  In the case of Argentina and Brazil, the strengthening of the exchange rate represented a partial bounce back from overshooting depreciations in the previous year and increased international investor appetite for emerging market assets.  In Chile, the peso strength observed towards the second half of the year reflects increasing optimism about the country’s economic outlook and rising copper prices.  In Mexico, the currency experienced a year of volatile swings, as hopes of a recovery rose and fell.  The Venezuelan bolivar constituted the weakest currency.  After years of a crawling exchange rate band regime, President Chávez opted for a liberalization of the exchange rate in February 2002.  When the currency dropped to values beyond 1,800 bolivares per US$ early last year, the government backpedaled and installed a fixed exchange rate at 1,600.  Moreover, the government imposed severe restrictions on foreign exchanges, which further crippled the economy.  

Argentina successfully steers clear from excessive inflation
Argentina also surprised in the monetary area.  At the beginning of the year, the market anticipated that the devaluation would continue to fuel inflation, which was expected to reach 30.3% by the end of the year.  However, the appreciation of the peso and the government’s decision to keep a freeze on public utility tariffs has resulted in a year-end inflation of only 4.0%.  The lowest inflation rates were registered in Chile with 1.6% and in Peru with 2.0%.  However, in neither case was such a low inflation the result of overly ambitious central banks.  In both cases, the actual rates are below target and both run the risk of entering into a deflationary bout.  Once again, Venezuela carries the red lantern.  The year-end rate of 27.1% is almost three times the rate of second place Brazil.