Latin America in a Global Context - Economic Briefing September 2008

Inflation Outlook Deteriorates Further

The global outlook remains subdued, despite the fact that the United States recorded stronger than expected growth in the second quarter, supported by strong exports and additional spending power from the tax rebate check. However, despite the support from an accommodative fiscal policy, the housing market has not yet bottomed out. Moreover, although consumer confidence has rebounded in July and August, the overall confidence level remains low and is still pointing towards slower spending throughout late 2008 and early 2009. Meanwhile, the outlook for the Euro Area is increasingly sombre, as the economy contracted in the second quarter for the first time in a decade, dragged down by negative growth in the three major economies in the region. In addition, Eurozone inflation remained at an all-time high in July, restricting possibilities for the European Central Bank to bolster the economy. Similarly, the Japanese economy registered its first contraction in a year in the second quarter, fuelling concerns that the country may be heading for a recession. The Latin American region will grow at the slowest pace in three years. However, growth will remain positive, as the area continues to benefit from strong domestic demand and high commodity prices. On a negative note, high oil and food prices are likely to push regional inflation to the highest level in six years despite the monetary tightening enacted across the region.

Outlook stable despite downward revision to Mexico

The outlook for Latin America remains stable.  Consensus Forecast panellists have left their 2008 output growth forecast for Latin America at 4.4% for the third consecutive month.  Upward revisions to three of the seven major economies (Argentina, Peru and Venezuela) compensated for a downward revision to one country (Mexico).  Consensus Forecast panellists maintained forecasts unchanged for the remaining three major economies (Brazil, Chile and Colombia).  Venezuela experienced the strongest upward revision, as panellists raised their GDP growth forecast by 0.3 percentage points over last month to 5.7%.  The outlook for Venezuela improved after GDP expanded more than expected in the second quarter, mainly as result of a recovery in investment.  However, important economic imbalances persist, including soaring inflation as well as a combination of price and currency controls, which limit the upward potential of the Venezuelan economy.  For Peru, the Consensus Forecast panel increased the growth forecast by 0.2 percentage points, from the 8.1% expected last month to the current 8.3%.  The growth outlook for Peru continues to improve after the economy expanded at the fastest pace in 13 years in the second quarter.  At the currently projected growth rate, the country maintains its position as the fastest growing economy in the region for the second consecutive year.  Meanwhile, Argentina experienced an upward revision of 0.1 percentage points to its growth forecast.  Panellists raised the growth forecast for Argentina from the 6.1% expected last month to the current 6.2%, following on the resolution of the farm conflict.  However, foreign investor confidence is declining, which could pose a serious threat for the economy in the medium term.  In the same vein, international rating agencies Standard & Poor’s and Moody’s recently downgraded their assessment of the country.  On the downside, Mexico experienced the only downward revision, as panellists cut their GDP growth forecast by 0.1 percentage points over last month to 2.4%.  The Mexican outlook remains sombre, as several indicators for the domestic economy, which has been the main support to the current economic cycle, are showing increasing signs of weakness.

Inflation expectations reach new six-year high

According to this month’s poll, average regional inflation will reach 8.5% by the end of the year, which is up 0.2 percentage points from last month’s projection and, if attained, would represent the highest rate observed in six years.  This month, Consensus Forecast panellists raised their inflation forecasts for five of the seven major economies in the region; with Argentina and Brazil, where the inflation forecast was revised downwards and left unchanged respectively, marking the only exceptions.  Chile and Venezuela experienced the strongest upward revisions to their inflation forecasts, as panellists lifted their estimates by 0.9 percentage points for both countries.  In the case of Chile, panellists lifted their inflation estimate from the 6.8% expected last month to the current 7.7%.  Although in August Chilean inflation declined for the first time in seven months, inflation more than triples the Central Bank’s target rate.  As a result, the Central Bank decided to raise interest rates to the highest rate in almost a decade.  Furthermore, the government recently announced a US$ 1.0 billion package of anti-inflationary measures, including a temporary reduction on fuel taxes.  In the case of Venezuela, panellists lifted their inflation estimates from the 30.2% expected last month to the current 31.1%.  While Venezuela is notorious for its persistent inflation, the current year-end forecast would mark the highest rate in six years and could pose a serious threat to economic stability if monetary authorities fail to rein in inflationary expectations.  The government has been trying to curb inflationary pressures by selling debt in order to soak up liquidity.  Next to curbing consumer demand, the measure has also relieved pressures on the bolívar in the parallel exchange market.  As a result, the currency has been appreciating steadily during the past months.  However, while trying to contain inflation by decreasing liquidity and raising interest rates, the government is failing to rein in public spending, which constitutes a key element behind the inflationary pressures.