World economies
Latin America
The Latin American economy has entered the fourth consecutive year of business expansion. The driving force for the growth has shifted from exports to equipment and construction investments. Most economists expect that the growth pace will decelerate because the US economic growth will be gradual in 2007 and because energy prices as well as prices of mineral resources will shrink. Brazil and Chile will accelerate economic growth because positive effects of monetary relaxation measures will take form. Meanwhile Venezuela and Argentine will decelerate growth due to limited supply capacity.
Mexico will also slow growth due to decreasing demand of the US. Turning our eyes to external sectors, the aggregate current account surpluses of seven major countries in Latin America for 2006 reached a record high level in reflection of the following factors: expansion of trade surpluses against the backdrop of rises in prices of materials; and increases in incoming remittances from labors working abroad. Foreign currency reserves have accumulated to a great extent, partly due to dollar-buying market intervention to limit currency appreciation. It is expected that current account deficits will shrink due to price falls of primary goods and to a slowdown of global demand.
The region has weathered the financial market turbulence in global markets well so far. Initially, asset markets throughout the region did experience volatility, but since then, stock prices have recovered, exchange rates have generally recovered, and in both cases, these are now at or above their pre-turbulence levels. As a result, growth in the region will remain at a relatively strong 5 percent in 2007, this year, and the reduction in growth next year should be fairly modest. At this point growth of about 4.25 per cent is anticipated for 2008. So, the region has come out of the initial turbulence rather well, attributable to the strengthening fundamentals in many countries in the region.
Stability: There is a much deeper and wider consensus on macroeconomic stability and on keeping inflation low. In recent years, most countries have shown declining public debt; they have strengthened their fiscal and external position, financial systems are also sounder, and there is generally greater exchange rate flexibility in many countries. Inflation remains low by historical standards. It continues to bear out a greater commitment in the region to keeping inflation low. However, it has edged up in some countries, and this has been for a number of reasons, including some shocks from food prices, and more volatile oil prices.
In Argentina and Brazil, there have been very significant reductions in poverty. Argentina has cut its poverty rate by more than half in the last few years, compared with the peak at the crisis in 2002. Brazil’s poverty rate is now down to 27 percent. But the challenge remains to sustain and to build on the recent developments, to ensure that the Region remains resilient to shocks that may still well occur. In the global outlook overall, risks are still on the downside. So the challenge for the region is in the first place to increase even further its resilience so it can withstand these shocks; and an equal challenge is to raise investment and productivity so that the region can raise its growth rates in the coming years.
Mexico does not agree with the projections of the IMF for growth this year for Mexico. The government still thinks that growth will be around 3 percent this year and may be 3.7 for the next year. That is in contrast with the IMF projection of 2.9 per cent for this year and three per cent for next year. In Latin America, Mexico obviously is the most closely aligned with developments in the US economy. So Mexico will be affected by the US economy, which is slowing to around two per cent or just under two per cent. In 2006, Mexico’s growth was close to five per cent. So, Mexico’s growth will remain close to around 3 percent in the coming year.
According to the IMF Staff, Latin America has strengthened its fundamentals in the last five years. The region has demonstrated a much greater political commitment to macro stability and low inflation in every country. And this is good news for future growth in Latin America. Meanwhile, according to other international economists, following 5½ per cent growth in 2006, the pace of expansion in Western Hemisphere countries is projected to moderate to five per cent in 2007 as a whole and to 4.3 per cent in 2008.
This easing would reflect in part spillovers from the slowdown of activity in the United States on Mexico and Central America, mainly through trade linkages as well as somewhat slower growth of remittances from migrant workers. In a number of commodity-exporting countries in South America—including Argentina, Colombia, Peru, Uruguay, and Venezuela—growth is expected to come down from very high rates in 2006, in part because of increasing supply constraints.
Argentina
Latin America’s number-three economy is in its fifth straight year of expansion at about eight per cent. Argentina’s economy will grow by 7.6 per cent in 2007 down from 8.5 per cent in 2006. The economy continues to benefit from strong demand for the country’s primary commodities. The Argentine Central Bank will continue to issue Argentine pesos in order to keep the value of the peso low. This intervention has boosted exports and helped fuel economic growth; however, it has also led to increasing inflationary pressures. Bottlenecks and scarcity of financing will likely cause GDP growth to decrease substantially beginning in 2008.
As the economy slows into 2008, the government will come under greater pressure to resolve day-to-day issues. The government will run a primary fiscal surplus (before interest) of three per cent of GDP in 2008-09. As imports continue to outpace export growth, the current-account surplus will narrow as a percentage of GDP. The next government is likely to continue to pursue a weak currency policy, unless inflation concerns lead policymakers to allow the currency to strengthen.
According to official statistics, annual inflation was at 8.6 per cent in September; according to independent estimates, it is actually running at closer to 15-20 per cent. Efforts will have to be made to tame inflation while also eliminating price distortions and easing price controls that have discouraged investment in areas such as energy and utilities. Fiscal spending should also be reduced to prevent an erosion of public finances, and private investment encouraged to fill the gap as economic growth slows.
In the country’s 2007 budget bill, the government had also underestimated growth. The strategy has allowed the government to announce economic results that have exceeded the budget’s stipulations. Argentina’s 2008 budget bill, presented to Congress sees inflation of 7.7 percent and calculates gross domestic product growth at 4 percent.
Growth outlook: A central bank survey carried out among analysts last month gave a median outlook for 2008 growth of 6.2 per cent with inflation for the year estimated at 10 per cent. High inflation has dogged the government. Last year’s budget included estimates for inflation in a range of 7-11 per cent. Inflation has come in below market expectations since January, when the government replaced the head of the consumer price unit at INDEC, the national statistics unit, with a political ally, prompting fears of government meddling with the data.
As a result, investors have become increasingly wary of the country’s inflation-indexed bonds, which account for more than 40 per cent of total public debt. Inflation in the first eight months of the year stands at five per cent, with 12-month inflation through August of 8.7 per cent. Argentina’s current policy goals are largely incompatible: maintaining strong economic growth, holding on to the twin (fiscal and current-account) surpluses, keeping inflation at single-digit levels, maintaining a weak currency and minimising rises in interest rates. Changes will be needed if Argentina is to avoid a hard landing for the economy in the medium term. But this could prove tricky. The budget bill for next year envisages an exchange rate of 3.21 pesos per dollar, a primary budget surplus of 3.15 per cent of gross domestic product and a $10.06 billion trade surplus.
Chile
Chile’s economy is likely to grow 5.3 per cent in 2008, slowing from 2007 when the government expects growth close to 6.0 per cent. Chile’s gross domestic product (GDP) expanded 6.1 per cent in the second quarter of 2007, compared with a year earlier, speeding up from 5.8 per cent growth in the first quarter. Domestic demand would grow 6.5 per cent in 2008. Predictions are in line with estimates given by the International Monetary Fund (IMF) projecting Chilean economic growth to slow to 5.3 per cent next year from 5.8 per cent in 2007.
Chile is the world’s largest producer of copper, churning out nearly a third of global output each year, and has seen record trade surpluses on the back of sustained high prices for the red metal. The government anticipates average prices for copper, Chile’s No. 1 export and a driver of the economy, falling to about $2.50 per pound, compared to levels near $3.20 per pound for the year to date The government’s average copper outlook for 2008 is conservative compared to industry estimates and Chile’s own central bank, which predicts an average copper price of $2.70 a pound for next year.
Copper output in Chile, the world’s largest producer of the red metal, should come in at 5.539 million tonnes in 2007 and rise to 5.757 million tonnes next year. Chile, which produces about a third of the world’s copper, produced 5.374 million tonnes of the metal in 2006. Chile’s state copper commission expects average copper prices of about $3.10 per lb in 2008, well above a forecast in August for $2.70 copper next year. Dynamic demand from China, higher than expected, together with difficulties in the industry to achieve production plans, generated a deficit situation in 2007. However a balanced market is projected in 2008.
The supportive external environment enjoyed by Chile over the past few years would continue into 2008. Chile has been cruising along at a reasonably high altitude, building neither much inflationary pressure nor external (negative) imbalances, with the government maintaining solid fiscal positions and the Central Bank enjoying a high and growing stock of foreign reserves, we should have some reasons to be upbeat. The projections for the Chilean economy in 2008 revolve around an environment of steady trend-like growth, gradually moving toward the 5.5% handle as the re-acceleration from the sharp slowdown registered in 2006 continues.
The recovery of investment demand in 2007 seems to be partly aided by the sharp rise in fiscal spending. It is expected to consolidate into 2008 as the global economy begins to turn around. The UBS forecast assumes that the government will successfully tackle the energy issues it currently faces. The 2008 story remains one of domestic demand, but private consumption plays a lesser role than in 2006 and 2007 as employment growth peaks and monetary stimulus remains restrained in 2007.
On the external front, total exports will decline slightly in 2007 but copper prices will keep the trade balance at a wide surplus. In 2008, a quantity-effect shift is expected to make up for deteriorating terms of trade, while a pickup in growth from other export sectors receives support from the plethora of free trade agreements signed by Chile, most recently with China. The current account will deteriorate in 2007 and recover slightly in 2008, with the trade balance continuing to come off its 2006 peak.
The Economist Intelligence Unit expects the finance minister to maintain a prudent policy mix. Given Chile’s political stability since the return to democracy in 1990 a smooth transition of power in 2010 and little change in macroeconomic policy direction before or after the elections is expected. Macroeconomic policies will remain sustainable in 2008-09 with an open economy, an independent Central Bank pursuing inflation targeting and floating exchange rate policies, and a fiscal policy based on a structural fiscal surplus rule.