Brazil, Mexico & Rest of Latam - Economic Outlook (June 11th)

Brazil | Economic Outlook

Close to stalling

External uncertainties and negative growth in investment will likely send 2012 growth to below 2%, despite strong monetary and fiscal stimuli. We expect some improvements in 2013.

Activity: The Brazilian economy had a fairly poor start to the year, with Q1 GDP growing merely 0.8% y-o-y, and investment falling 2.1% y-o-y. The central bank has slashed the policy rate, Selic, by 250bp so far this year, and signalled more cuts are on the way. With sluggish growth at home, major uncertainties abroad, and a belief that real rates in Brazil should continue to fall, policymakers are determined to keep easing and boost economic growth. The government also rolled out a series of stimulus measures aimed at the industrial sector. Nonetheless, given the ongoing drags from credit markets and a still troubled international environment, GDP growth will likely remain sluggish at 1.9%. Assuming a gradual recovery in conditions, we should see more robust growth in 2013, reaching 4.1%.

Inflation: Inflation has fallen rapidly since last September‟s peak, and has now stabilized around 5.1%. Non-tradable goods inflation has started to fall recently, though it is still at an elevated level of above 7%, owing partly to the buoyant labor market as unemployment has been hitting several record lows. Tradable goods prices, after falling below the 4.5% target, are now on the rise, and we believe the almost depreciation in BRL since late-February should gradually feed into higher commodity prices, in local currency terms. As the Brazilian economy will likely produce very weak growth this year, we expect inflation to stabilize slightly below 5.0% by December. We think inflation will likely accelerate to 5.5% next year, as a result of faster GDP growth, a low base of comparison, and the lagged effects of a weaker exchange rate and a lower policy rate.

Policy: The announcement of rule changes governing the “poupança” savings account has effectively removed the floor for Selic, which has already hit a historic low of 8.5%. We now expect Selic to close the year at 7.5%.

Risks:  We see the slowdown in credit and labor market expansion as the first warning sign that the credit-driven, consumption-led growth model, which has served Brazil fairly well over the past couple of years, has gradually exhausted itself and is now hitting the limits. In order to sustain the economy‟s growth potential, boosting the level of investment has become a major challenge. Replacing consumption with investment as the new growth driver means less government expenditure and more willingness on the part of policymakers to undertake difficult yet necessary structural reforms.

Mexico | Economic Outlook

Growth supported by domestic demand

Export growth to the US is falling, but growth is increasingly supported by domestic demand.

Activity: The Mexican economy is on track to expand above potential. However, there are risks to growth associated with a decelerating outlook in the US and the eurozone, which are Mexico’s largest trade partners. On the positive side, domestic demand in Mexico has finally started to pick up, evidenced by strong private consumption and investment. Consumption has been supported by credit and the stabilization of remittances from workers in the US.

Inflation: So far in the year inflation has surprised on the downside; however, we expect inflation to be around the 4% upper bound of the target band in H2 2012. While the labor market continues to indicate that there is slack in the economy, we estimate that the output gap has already closed. The combination of a low base of comparison and a positive, albeit small, output gap, should put upward pressure on inflation. Gasoline prices, expanding at 5-10% y-o-y, should be another source of inflation pressure.

Policy: We forecast the central bank of Mexico (Banxico) to keep the policy rate unchanged at 4.50% until 2014. Although decreasing in the last 10 years, there remains a pass-through of the depreciating exchange rate into inflation. We forecast that under most scenarios of the exchange rate, Banxico’s reaction function will remain unaffected in the coming 24 months. A policy rate cut is still possible, particularly if the economy expands by less than 2%, if the MXN appreciates significantly or if there are further quantitative easing measures in the US and Europe. We find it difficult to envisage a tighter policy rate this year unless US economic activity accelerates significantly.

Risks: The main risk to Mexico is a double-dip recession in the US economy, which seems unlikely. In terms of inflation, we see the following risks to our call: (1) pass-through effects due to a sizable MXN depreciation; and (2) increases in gasoline prices. In terms of fiscal policy, the main risk stems from a protracted (more than year-long) downward correction in oil prices that would put pressure on fiscal revenues.

Rest of Latin America | Economic Outlook

Argentina: Old habits die hard

Policy moves after the Presidential elections damage economic performance.

- The authorities continue to pursue expansionary fiscal and monetary policies.

- Exchange controls are effectively segmenting the FX market, with heavy damage to economic activity and microeconomic efficiency.

- Locals are rushing to purchase USDs, as high inflation, policy missteps and other mixed signals sap domestic confidence in the ARS.

- We expect faster ARS depreciation, but without a supportive macroeconomic framework, we fear that a necessary real depreciation of the currency will be difficult to achieve.

Colombia: Growing amidst a complicated external backdrop

Mostly supported by domestic consumption, we expect the economy to expand at potential in 2012 and 2013.

- We forecast 2012 and 2013 GDP to expand at its potential growth rate. The current strength of domestic consumption contrasts with the risks to growth in the global economy.

- We now see BanRep keeping the policy rate at 5.25% throughout 2012 with a small deficit in the current account being financed through FDI and a stable COP.

We expect the government to meet the fiscal deficit rule of 2.3% of GDP by 2014.

- If commodity prices plummet, growth would collapse to near zero, the current account deficit would widen and FDI inflows would decelerate. Under this scenario we would expect BanRep to lower rates to below 3.0% and intervene in the exchange rate to stabilize COP.

Chile: Between rock and a hard place

Domestic demand remains strong in Chile, with wages rising and unemployment falling. Global uncertainties, however, are putting policymakers on hold.

- Chile’s economy has exhibited strong resilience into 2012, as robust domestic consumption continues to support strong economic growth.

- Core inflation is now below target (3%) and headline inflation slightly above target. The recent plunge in oil prices should help further improve the inflation outlook. We expect end-2012 CPI inflation to be around the target.

- We expect the central bank (BCCh) to keep the policy rate (TPM) on hold at 5% for the rest of 2012, barring the materialization of any tail event in Europe. Strong domestic demand, especially rising nominal wages and falling unemployment, prevents the BCCh from cutting the TPM, while global uncertainties from Europe and China reduce the likelihood of TPM hikes.  

Authors: Tony Volpon, Benito Berber and Boris Segura (Nomura)