Sustaining Growth in Latin America: 2014 and beyond (an EIU webinar)


1.  Introduction

On Wednesday, December 11th, the Economist Intelligence Unit presented a webinar on the outlook for Latin America in 2014 and beyond.    Irene Mia, the regional director for Latin America and the Caribbean, presented the webinar.    She presented the webinar in three sections:   first, a discussion of the global economy, second, a focus on the economy of Latin America, and third, a focus on two of the key regional markets in Latin America, Mexico and Brazil.

2.   The state of the world in 2014 and beyond

The United States

In the United States, better growth is forecast IF another fiscal crisis is avoided.    The forecast for GDP growth is 1.6% in 2014, and 2.6% in 2015.

The limiting factor for global growth is the largest fiscal drag experienced in decades, which the economy is still recovering from.   On the plus side, wages and manufacturing are competitive, and housing is supporting the recovery.   The US has energy supply and cost advantages, which boost industry.   If the budget being proposed passes, this bodes well for the medium term as the deficit is declining.    However, the health care burden in the US remains a long-term problem which the Affordable Care Act addresses, but does not completely solve.

European Union

The recession has officially ended, since the Euro zone as a whole grew in the second quarter of 2013 for the first time in six quarters, led by the German economy.   But growth will be no better than 1% in 2014.   Long-term growth has been constrained by the austerity measures adopted by many countries in the Euro zone.

China

Recent economic data have been mixed.   This year there was 7.7% growth, but the long-term outlook is closer to 6-7% growth per year.    The economy is opening up to the world, as the government wants to encourage domestic consumption in order to lead growth in the coming decades.

3.  Latin American Market

Although the boom years may be over, the outlook remains positive.    In 2013, the region grew 2.7%.    There has been sound macroeconomic management, and there have been competitiveness-enhancing reforms and investment. If strong economic demand continues, it will mean that growth will pick up to an average of 3.6% from 2014-17.

Growth will vary from the low end (Venezuela 1.5%, Jamaica 1.6%, El Salvador 2.0%) to the high end (Panama 5.5%, Paraguay 5.8%, and Peru 5.9%).    There has been a lot of infrastructure investment.

The Latin America market will go from 589,000,000 to 614,000,000 million people by 2017.

The Rise of the Consumer Market

There has been a rise of the middle class through greater economic stability, increases in minimum wages and conditional cash transfer programs.   The GINI index of economic inequality has fallen over the past decade, with 41 million people falling out of poverty and 18 million people falling out of extreme poverty.

The median age is relatively young compared to the rest of the world (in Brazil, the average age is less than 30 years, with 30% of the population being 14 years or younger), but is aging nonetheless.   The urbanization rate is up to 79% for the region (above 85% for Brazil and Chile).

The emergence of the middle class is interesting from a political point of view:  it is politically well-informed, and is demanding greater services from the government.

FDI Continues Upward Trend

Annual average Foreign Direct Investment or FDI inflows (US$bn) have increased whereas it has been decreasing in other areas of the world.

Integrated Regional Market, Diversified Export Markets

Latin American markets have been increasingly integrated by a series of trade agreements (Mercosur, Andean Community, the newly signed Pacific Alliance, Caricom).   And Latin America is stretching out to other regions using its strategic location close to the US and with a Pacific outreach:

–US (NAFTA, CAFTA-DR, trade agreements with Chile, Colombia and Panama)

–Asia (APEC, Trans-Pacific Partnership Agreement, several bilateral agreements between Mexico, Chile and Peru notably with Asian countries).

China-Latin America:  A Problematic Relationship

China has increased its share in Latin America’s trade from 1% in 1880 to 15% in 2012, becoming the third largest trading partner after the US and the EU.    Trade between Latin America and China has expanded exponentially in recent years (faster than with the EU and the US).   China was the third largest investor in the region in 2010 (mostly extraction and natural resources but also diversifying into infrastructure and manufactures).   China has also been an increasing source of funding:  Chinese banks have lent more than US$75bn in 2005-12 to the region.

However, a few challenges remain … The region has currently a trade deficit with Asia, and would benefit from further trade diversification beyond commodities and towards higher value-added products (especially through business initiatives to promote intra-industry trade between the two regions).   Opportunities for greater cooperation on innovation and development of human capital, and to attract more foreign direct investment based on knowledge.

External Risks

The current account will remain in deficit (2.4% in 2014-2018, from 1.2% in 2012), and this means that capital inflows will continue to affect currencies in the region.    For example, the winding down of QE3 in the US in the 3rd quarter of this year had an effect on many Latin American markets.    But both the competitiveness of the manufacturing sector and stronger internal demand both will end up strengthening regional currencies.

Global growth has gone South in the past few years, but Latin America will grow less than other emerging areas of the world, such as Africa.

Business Enrivonment:  Lagging Behind in Reforms

Among the six various regions of the world (North America, Western Europe, Asia & Australasia, Eastern Europe, Latin America, and Middle East & Africa), Latin America comes fifth, only ahead of Middle East & Africa.   There is some change expected in 2014-2018, but many problematic areas remain, such as:   poor infrastructure, rigid labor markets, insufficient funding, cumbersome fiscal systems, availability of skilled labor, poor competition, and red tape.

4.   Brazil:  Hitting a BRIC wall?

Economic Challenges

Growth decelerated to 0.9% in 2012 and we expect it to average 3% in 2013-2018, better than the developing world but quite low compared to peers in Latin America.    Inflation is persistently above Brazilian Central Bank’s 4.5% central target.   Itt decelerated to 5.9% in mid-September helped by transitory factors, with higher readings expected in the remainder of the year.   There is weaker investor confidence, affected by uncertainties on macroeconomic policy framework, as well as creeping government interventionism and protectionism.   Brazil’s comparatively large combined current account and fiscal deficit leaves it vulnerable to future tapering of the Fed’s current quantitative easing (QE3 program).   For example, the real was hit particularly hard in July/August after the announcement of an imminent tapering of that program.

Political Challenges

There has been fallout from June mass protests over poor public services.    Corruption will continue to dominate the political scene and shape government agenda.   Social unrest has exposed the wider crisis of political representation and leadership, but also reflects an increasingly assertive middle class and the success of Dilma’s anti-poverty policies.

Although Dilma’s approval rates have partly recovered since the 30% low in July, she remains in a delicate position as she tries to address protesters’ demands amid tensions with political parties in ruling coalition, a tepid economy and fiscal constraints.

There is a need to address issues raised by June protests, including political reforms and initiatives to improve health, education and public transport services.   This will further divert government’s attention from ambitious structural reforms (including fiscal reform) and will have an expansionary effect;  however, they could improve governance and start addressing competitiveness shortcomings.

Political Opportunities

Brazil is blessed with favorable demographics with a growing middle class (48.7m Brazilians have moved into the upper and middle class categories since 2003).    There is an abundance of strategic natural resources (including new oil reserves) and diversified export markets and products.   There are record FDI inflows (US$65.3 bn in 2012, which represents 38% of the FDI going to Latin America).   The unemployment rate is at a record low (5.9% in the 2nd quarter of 2013).    In short, Brazil has a dynamic private sector which is rapidly internationalising.

5.   Mexico:  Structural Changes

A busy agenda

The dynamism of the administration of Pena Nieto since he came into power has been surprising/   The reform agenda has advanced very rapidly after 12 years of legislative gridlock, with the support of the “Pact for Mexico”, which is a political agreement between the PRI and the two main opposition parties on a cross-party reform agenda.

The reform agenda addresses the structural weaknesses in the businsess environment and tries to reinforce the country’s competitiveness.  If fully implemented, it should lead to high growth rates in the medium and long term

After approval of the controversial tax reform, all eyes are on energy reform:  the final form of the reform will be a key test of the seriousness of the government’s structural agenda and essential for attracting foreign direct investment to the country.

There have been reforms on the following:

  • Labor
  • Education
  • Amparo (constitutional reforms)
  • Telecoms
  • Financial reform
  • Energy
  • Fiscal
  • Social security
  • Political

All of these except for the social security reform have been presented to and approved by Congress.

SEE LIST OF REFORMS ON SLIDE

More Growth on the Way

Growth has slowed to 1.2% in 2013, the worst result since 2009.   But we expect an annual growth of 3.7% in 2014-18, based on the impact of the implementation of the recent reforms and the government’s commitment to increase investment levels in the course of its mandate.

An even better performance in 2014-18 is possible if the reform program will manage to eliminate or reduce infrastructure bottlenecks (such as limited competition in key sectors, poor infrastructure and poor education standards).  Reforms could add 1-2 % to annual GDP growth, pushing the rate of structural growth of the country from current level of less than 3.5 to at least 5.4%.

Despite occasional spikes, inflation will remain below the target ceiling of 4% set by the central bank.  Monetary authorities will prioritize growth and the competitiveness of the peso.

Political Outlook:  Complicated

Opposition to structural reforms by segments of the population has been demonstrated in repeated episodes of CNTE protests related to the education reform.  The government will face more protests related to energy reform.  Social mobilization may complicate the government’s agenda in a context of weak growth and the need for an economic program of social inclusion.

The greater willingness of the government to take action against entrenched interest groups has sent a strong signal that it is determined to regain the ability to direct national policy.   While this is positive for the effectiveness of the government, it could lead to a degree of discretion as to how the rule of law applies.

However, poor governance practices continue to reduce the effectiveness of the state.  According to a recent survey conducted by Transparency International, 915 of Mexicans believe the political parties as the most corruption-prone institutions, 79% believe that corruption is a serious problem and 43% believe that government efforts to eradicate it are ineffective.

Economic Outlook:   More Challenges Ahead

2013 will be rough:   there is only 1.2% growth expected.   Social unrest may limit the extent of energy reform.   The stimulus will offset the benefit of fiscal reform in 2014.    The monetary outlook is positive, however:   inflation is near the target, and the peso is competitive.     More FDI is needed to increase growth.   There is moderate exposure to fiscal shocks from abroad.   Poverty is still high; with over 45.5% at the poverty level, it is not yet a middle-class country.    The Pact for Mexico is not expected to last beyond 2014.

In the long term, fiscal and social security reforms may help bring down informality.   The labor market is still inefficient, and reform won’t help much in this area.   There are deficiencies in infrastructure that need to be addressed.    Manufacturing will produce increasing value goods, but Mexico is still dependent on US exports.    There is a gap between effective governance of federal and local governments.   More revenue is needed than what is being offered by fiscal reform.

6.   Conclusion

This was a fascinating look at one of the regions that has turned around in so many ways during the past decade.   The gradual improvement in the global economy will help growth, but not as much as the improvement in the economic and political climate due to internal reforms.

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