LatAm Outlook: Putting the Gears Down

Our Forecasts

Risks to Our Views

Source: Continuum Economics

Brazil: Handbrakes on

The Brazilian economy has begun to show signs of deceleration as the effects of the contractionary policy are starting to be felt. Q4 GDP (here) has marginally contracted (-0.2% q/q), and the strong impetus that the services sector had been showing has weakened. We believe this outlook is set to continue during the next few months as the Brazilian Central Bank (BCB) is likely to keep interest rates high in the next months to ensure that inflation converges to target. We see the Brazilian economy growing 0.8% during 2023, mostly due to a recover during the second half, when monetary policy will be less contractionary. 

Figure 1: Brazil’s GDP by Sectors (2019 = 100, Seasonally Adjusted)

Source: IBGE

The theme for 2024 is how disinflation will play out, and how less contractionary monetary policy will impact growth. We still see a cautious BCB which will not cut interest rate strongly. Thus the outlook is that monetary policy will be kept restrictive in 2024, closing the year at 9.25% SELIC rate, which of course will be a headwind to strong growth of the Brazilian economy. We foresee the Brazilian economy growing only 1.7% in 2024.

The key for the BCB now is whether this magnitude of tightening will be able to put inflation back in control. We believe it will but it will not be as quick as previously thought. The elevated number of inflation in 2022 (9.3% y/y average) will certainly add inertia for the inflation for 2023 and 2024. Additionally, unemployment is at 7.9% which is low when we look atBrazil, which has been registering above 10% unemployment levels during the last 5 years. This indicates the economy is running with little idleness, which is likely to add demand pressures toinflation. 

Add to the inflationary cocktail, that inflation expectations have been rising since Lula has begun his third term as Brazil’s President on Jan. 1^st. Most of this deterioration is related with fears that Lula would repeat the same policies applied during the catastrophic second term of Dilma Roussef between 2014-16. Higher inflation expectation adds persistence to the inflation which makes the BCB’s job difficult to ensure inflation convergence. Finally, fuel taxes have been reintroduced by the federal government (here) in an attempt to increase government revenues. This measure will generate a rise on gasoline prices which is likely to spread among other CPI basket in the short term, which will momentarily interrupt the disinflationary process.

Figure 2: CPI Inflation (y/y, %)

Source: IBGE

That’s why we believe the BCB will take a bit longer to start cutting rates, although there have been signs that the contractionary effect has started to be felt in the economy, through lower growth rates. We believe the CPI index (y/y) will stop falling during the first half of 2023, and then starting to fall again strongly in the second half, closing the year at 5.3% (y/y average). This would allow the BCB to cut rates on October. We see, the policy rate closing 2023 at 12.25%, with two 75bps cuts in 2023. Then, inflation will continue to fall in 2024, as monetary policy will continue to be tight, but not as tight as 2023. We see inflation closing 2024 at 3.9% (y/y average).

What about Lula’s policy? Well for the moment we have seen little from his economic team. Finance Minister Fernando Haddad, announced the re-introduction of fuel taxes and he has been showing desire to reduce the budget deficit. We believe the fiscal result in 2023 will be a deficit at 0.9% of GDP from a 1.5% surplus in 2022. Most of the surplus in 2022 was due to oil revenues and inflation higher than salaries growth. The new government is set to readjust public servants’ salaries and oil revenues will be lower and those would be the main driver of this retraction on the fiscal result. 

We believe Mr Haddad will succeed in the next years to reduce the fiscal deficit and thus guaranteeing fiscal sustainability. However, the biggest tool to achieveis that the fiscal rule that will substitute the “Expenditure Ceiling”. This one is yet to be presented but Mr. Haddad has been visiting several market economists that have called for a credible rule. Finally, Lula’s team have been clashing with the BCB over the level of interest rates and the inflation target. We believe that rather than seeking to substitute him, which would violate the BCB independency, Lula’s team is trying to put the blame of 2023 poor growth on the only person in the government he had not appointed, which is BCB President Roberto Campos Neto. 

Mexico: Additional Tightening and What about the Nearshoring?

Mexican economy continued to surprise in the last quarter of 2022 (here) and closed the year with positive 2.9% growth. The difference for Mexico in relation to other economies is that Mexico’s recovery from the pandemic has taken a while to materialize, especially due to the low level of supportive COVID measures in the Mexican economy. This have given a buffer of growth during the last half of 2022. Additionally, Mexican fiscal discipline continues strongly providing an important macroeconomic stability for Mexico.

Figure 3: Mexico GDP (Q4-2019 = 100, Seasonally Adjusted)

Source: INEGI and Continuum Economics

Inflation persistence is the big issue nowadays for Mexico. Inflation number have not fallen as the central bank (Banxico) expected amid the recently tightening. Inflation is running at 8.5% (y/y) in February and the persistence of core inflation, which are yet to register a major fall have been reasons for concerns for Banxico. Additionally, the unemployment rate is at low levels, which suggests the Mexican economy is running with little idleness and increase of minimum wages above the inflation rate is likely to increase inflation inertia. 

Figure 4: Mexico CPI Inflation (y/y, %)

Source: INEGI

At their last meeting (here), Banxico surprised the market by rising the interest rate by 50bps to 11% and signalled they will continue to hike at their next meeting, mostly due to the unfavourable inflation dynamics. We are seeing additional two 25bps hikes and Banxico will likely close the hiking cycle at 11.5%. The contractionary effects of the monetary policy will be felt more strongly in the second half of the year as monetary policy acts with lags. During this year we foresee inflation showing persistence in the first half of 2023 and starting to fall more strongly in the second half, closing the year at 6.2%.

For 2024, inflation is likely to continue to ease as interest rate will be kept at contractionary levels. We are seeing Banxico starting to cut interest rate in May 2024. We forecast the policy rate to end 2024 at 8.5% with some ground to reach its neutral level (6%-7%) and inflation ending this year at 4.2% (y/y average), a bit above the Banxico target (3%).

One of the hottest themes for Mexico in the next few years is the prospects for nearshoring. We have a deep look on the prospects of U.S. companies nearshoring their Asian supply-chains to Mexico (here), and we remain skeptical whether nearshoring will be able to increase foreign direct investment and generate a new wave of industrialization in Mexico. At least not at the same force of 1990’s. We do believe that some companies are nearshoring to Mexico and this will add some FDI figures in the next couple years but not as significantly. Most of the supply chains U.S. wants to nearshore requires high level of technology and Mexican labor force is running tight at the moment, which would mean that enterprises might need to pay higher salaries for new workers. Additionally, construction of new manufacturing plants would take at least a year.

We are not incorporating a strong nearshoring on our forecast for Mexico and we see a timid effect in the next two years. We believe Mexico will grow 1.3% in 2023, still affected by level of tightening and the slowdown on U.S., and then with the easing of the monetary policy in 2024, growth should come closer to its long-term level at 1.5%.

At 2024, Mexico will hold general elections. The outlook is that incumbent ruling Party (MORENA) elects the next President, which will not be incumbent Manuel Lopez-Obrador as re-elections are vetoed by the Constitution in Mexico. During his term, Lopez-Obrador has failed to impose important reforms on the electoral sector, which although were approved it was ruled out by Mexico Supreme Court. However, his fiscal policy have been pretty disciplined even during the pandemic. It will be interesting to see the profile of his successor which we will only have information in 2024, as there is no clear candidate to be appointed by MORENA.

Argentina: Living on Inflation

Argentina inflation have surpassed the triple digits reaching 102.5 %( y/y) during February and it has been one of the main problem Argentine authorities have at the moment. Despite several unorthodox measures to tackle inflation such as the “Fair Prices Measures” (here), inflation has been on the rise, and as the Argentine Central Bank (BCRA) refuses to rise interest rate to contractionary levels, which disincentives saving in Pesos, the outlook looking forward is not that bright. We believe the BCRA will continue to avoid putting interest rates to contractionary levels. Only a marginally rise the BADLAR rates, which is now at 75%, to 80% during 2023 is set to occur, which is quite below the current inflation rate.

To this cocktail, we add several reports of droughts in Argentine rural areas indicating that the harvest during this year is going to be weaker than in 2022. This will reduce the grain exports which are one of the main sources of dollars’ accumulation by the BCRA. Therefore, the low levels of reserves will continue to be a source of volatility for the Argentine economy, which will them led to new Pesos devaluation and as pass-through is pretty high in Argentina will be translated on new inflationary pressures. We are seeing inflation finishing 2023 at 99%.

In terms of GDP, Argentina have seen a strong growth on 2022 in which Argentina has grown 5.2%, this growth was led by the recovery of services sectors in a context of the reopening of the economy after COVID. For 2023, we believe Argentina growth will be constrained by high inflation rate, which will erode the purchase power of consumption.Lower exports and imports restriction are also likely to affect several activities in Argentina. We forecast Argentina to register 0% growth in 2022.

Recently, the IMF have approved a new USD 5Bln disbursement (here), which will give some breath to Argentine reserves. However, the net accumulation reserves target is set to be reviewed due to the droughts in rural areas and it is yet to be seen whether the government will be able to reduce the fiscal deficit from 2.5% of the GDP in 2022 to 1.9% of the GDP during an electoral year. We believe that independently of the fulfilment of the IMF target, the deal is set to go on with the IMF being flexible.

In October 2023, Argentina will face a general election in which the Argentine President will be chosen. The candidates both from the ruling coalition and the opposition are not yet decided. However, due to the situation of the economy, we expect the ruling coalition to lose the elections in October and the opposition to revert to orthodox measures of the economy. We are expecting inflation to decelerate back to 70% levels, the real interest rate to be kept at clear positive levels and growth to be led by some optimism around the new policies which would lead to a 1.3% growth in 2024.