Oxstones Investment Club™By Nouriel Roubini’s team of analysts at RGE.
In our 2011 Outlook, we revised up our growth forecasts for Latin America, in anticipation of resilient domestic demand, improved external conditions and elevated commodity prices. We now envision annual growth rates of 4.7% in 2011 (compared to the forecast of 4.1% we set in September) and 6.1% in 2010 from 5.7% previously. If we are correct, 2010 will mark Latin America’s strongest economic performance of the last decade and its fastest growth since 1980.
The probability of a double dip in the U.S.—a more material risk to this region than any other—has decreased significantly, due in part to quantitative easing together with extensions of unemployment benefits and the Bush-era tax cuts and the introduction of a 2% payroll tax cut. Plus, a deep European crisis has ceased to be an immediate risk. In this context, we maintain the view that Latin American countries will fare well if the U.S. avoids a sharp slowdown, global distortions caused by a potential EU crisis remain manageable and advanced economies keep macroeconomic conditions accommodating. We reiterate that some countries (Brazil, Chile, Colombia, Mexico and Peru) would likely perform better than others (Argentina and Venezuela) in adverse circumstances, given their strong fundamentals, sound balance sheets and hard-won credibility in terms of macroeconomic policy making.
In 2010, regional economic activity was mainly driven by solid domestic demand, though better-than-expected external economic and financial conditions provided an extra impulse. We saw most of the gains in H1 2010 and a deceleration toward more sustainable levels of economic growth in H2 2010, in line with RGE’s “Year of Two Halves” theme. While Brazil, Argentina, Chile and Peru have continued to deliver solid performances and Venezuela surprised to the upside (though it is still in recession), Mexico and Colombia have disappointed somewhat.
In 2011, stabilizing domestic demand due to tighter macroeconomic conditions (except in Argentina and Venezuela) and somewhat slower global growth—together with high base effects—will bring regional growth toward more sustainable levels and closer to average trend growth of around 4.3%. Moreover, net exports will remain a drag on economic activity not only because of the growth gap but also because the terms of trade might not be as benign as in 2010.
We maintain our view that inflation will be somewhat lower in 2011 than in 2010 and that countries with inflation-targeting regimes—such as Brazil, Chile, Colombia, Mexico and Peru—will meet their target ranges. The main risks to this forecast are stronger-than-expected inflation pressures from abroad—from a combination of higher commodity prices and stronger global aggregate demand—and policy complacency to avoid worsening the currency outlook.
Favorable growth gaps and strong currencies should continue to widen current account deficits and narrow surpluses in 2011. Meanwhile, Latin America’s growth and interest rate differentials should keep the region attractive for capital and financial inflows, limiting balance of payment risks. Moreover, elevated international reserve levels, strong balance sheets, policy flexibility and well-regulated and mostly domestically funded financial systems will likely buffer Latin America from the effects of excessive external volatility. However, as current account conditions deteriorate, countries will become more vulnerable to sudden changes in risk appetite and global liquidity conditions. In this regard, the destabilization of financial and fiscal conditions in the EU is the more immediate threat, but the U.S. monetary tightening cycle also should be kept in mind—both will have negative global economic and financial repercussions, which in turn will affect Latin America’s export revenues, domestic sentiment and capital and portfolio flows.
As reiterated in RGE’s Emerging Markets Quarterly, we believe that wide growth and interest rate gaps, coupled with still-favorable terms of trade and ample global liquidity, will keep regional currencies attractive. However, a volatile external environment, intervention risks and stretched valuations, among other factors, might temper optimism and limit the appreciation trend.
Finally, the presidential electoral cycle continues with Peru’s polls in April and Argentina’s in October. In Peru, policy continuity is the most likely outcome, as market-friendly candidates are leading the polls. In Argentina, the death of former President Nestor Kirchner has created political space within the Peronist Party for a more conciliatory candidate. Although the current administration is now less confrontational, the opposition is still weak and fragmented, so we do not expect any meaningful change in macroeconomic policy before elections.
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