LatAm Outlook: Lower Inflation and Growth above Expectations
- Brazil and Mexico have both registered growth above expectations during the first quarter of the year. We expect both economies to decelerate in the upcoming quarters but statistical carry-over will warrant a 2.2% growth for Mexico and 2.3% for Brazil in 2023. Both countries will register lower growth in 2024 mostly due to higher basis of comparison in 2023. Argentina will see a contraction of 2.0% this year followed by a 1.3% recovery in 2024.
- Inflation start to give signs of more control in Brazil and Mexico. In Brazil, where the fall of inflation was stronger due to government intervention on fuel prices, we see CPI inflation ending the year at 4.9% and, for Mexico, we see inflation ending 2022 at 5.8%. In 2024, both countries will see inflation continuing to falling to 3.8% for Brazil and 3.9% for Mexico. Argentina will not control the inflation problem registering a 111% increase in 2023 and 81.5% in 2024.
- In terms of interest rates, Brazil’s policy rate (SELIC) is expected be kept at the 13.75% level until November, when the BCB will start cutting rate. For Mexico the policy rate finally reached its peak and it is forecast to be cut only in the second quarter of 2024. In Brazil and Mexico, we expect both central banks to reduce the degree of monetary tightening in 2024 as inflation is controlled but neither country will achieve neutral policy rate levels during that year.
- Forecast changes: From our March outlook we have increased the growth forecast both for Brazil and Mexico reflecting the higher than expected growth seen during the first quarter and changed the 2024 forecast due to base effects. We have also marginally reduced the inflation forecast both for 2023 and 2024. In Argentina we have reduced our growth forecast for 2023 as we now see Argentina facing a recession.
Our Forecasts
Risks to Our Views
Source: Continuum Economics
Brazil: Higher Agricultural Production and Lower Inflation
The Brazilian economy experienced robust growth in the first quarter of 2023, with a notable expansion of 1.9% quarter-on-quarter (here). This growth was primarily driven by a remarkable 21% increase in the agricultural sector, particularly soybean production, which saw significant investments in 2022 due to the higher prices of this commodity seen during last year. As result, the soybean production is expected to grow 25% in 2023. while the current lower soybean prices will impact profitability, we anticipate a strong growth rate of approximately 15% in the agricultural sector for 2023. However, the industrial and service sectors showed signs of stagnation, with reduced growth rates of 0.1% and 0.6%, respectively.
Figure 1: Brazil's GDP (2019 = 100)
Source: IBGE
On the demand side, the Brazilian economy faces challenges, as consumption is growing at a slower pace and investments have drastically reduced due to tight monetary policy. We anticipate this trend to continue in the upcoming quarters, and as the agricultural sector's growth will compensate the weaker demand, we are seeing the Brazilian economy growing 2.3% during 2023. Looking ahead to 2024, we anticipate a more relaxed fiscal and monetary policy, which is likely to stimulate internal demand. However, we do not expect the agricultural sector to replicate the strong growth seen in 2023, leading to a deceleration in growth to 1.4%.
Inflation has shown signs of responding to the contractionary monetary policy, with a modest 0.2% month-on-month growth and a year-on-year rate of only 3.9% in May (here). This is significantly lower than the peak of 12.1% reached in April 2022. While the drop in fuel prices influenced this reduction, core measures indicate a more favorable inflation trajectory aligned with weak demand. Due to base effects, we anticipate a slight increase in inflation in the coming months, reaching 4.9% by the end of the year.
Looking ahead to 2024, the inflation outlook appears more positive. We expect most of the inflationary pressures witnessed in the past two years to dissipate, although food inflation may reappear as production stabilizes and demand recovers. We anticipate inflation to end 2023 at 3.8% on a year-on-year average, which exceeds the Central Bank of Brazil's target of 3% but remains within its bands of 2.5% to 4.5%.
Figure 2: CPI and Policy Rate (%)
Source: IBGE and BCB
The Central Bank of Brazil (BCB) has been swift and aggressive in raising interest rates, currently standing at 13.75%. The ongoing discussions in Brazil are not about whether there will be another hike, but rather when the BCB will begin to ease monetary tightening. While the BCB's communication has maintained a hawkish tone, emphasizing the monitoring of disinflation processes and the possibility of further rate hikes if needed, we anticipate a shift towards more dovish language and discussions of rate cuts.
As we expect inflation to resume its growth in the second half of the year, primarily due to base effects, the BCB will likely wait to assess the magnitude of this increase before announcing any rate cuts. Therefore, we believe the first rate cut is likely to occur during the November meeting, with the policy rate expected to end 2023 at 12.25%. In 2024, the BCB is likely to continue cautiously reducing interest rates, initially at a pace of 50 basis points and then, towards the end of the year, at a pace of 25 basis points. As a result, we anticipate the policy rate to finish 2024 at 8.5%, which aligns closely with its neutral rate (estimated to be around 7.5%).
Recently, the Brazilian Real (BRL) has appreciated strongly and we believe this effect occurred due to the strong interest rate differential with U.S., a more positive view of Lula’s economic policy and lower current account deficit. Compared to the levels seen during the pre-pandemic the BRL still depreciated but as the BCB is likely to soon start to cutting interest rate, we don’t see much ground for the BRL to continue appreciating. However, in case it occurs we do not see the BCB intervening to restrain the BRL and just keep the exchange rate to float.
The approval of a new fiscal anchor in Brazil is anticipated in the coming months. This rule, similar to the expenditure ceiling, restricts expenditure growth to 70% of revenue growth, ensuring long-term fiscal consolidation. We believe this measure will alleviate market concerns regarding unsustainable policies under a potential Lula administration. However, fears remain regarding potential changes to the independence of the BCB, especially in 2024. The current BCB President, Campos Neto, appointed by former President Bolsonaro, has faced criticism from various government officials, particularly regarding high interest rates. To enact any changes to the BCB's independence, Lula would require the support of the Congress, which he currently lacks. Therefore, we expect President Campos Neto to remain in charge of the Bank until the end of his mandate in December 2024, when policy rates and inflation will be lower. The actions of Lula's potential appointee for the BCB remain uncertain.
Mexico: Inflation easing and Mild Growth
Figure 3: Mexico GDP (Seasonally Adjusted, Q4-2019 = 100)
Source: INEGI
The Mexican economy has exceeded expectations in recent quarters, displaying an upward growth trend that sets it apart from previous years. During the first quarter of 2023, the economy grew by 1.1% (quarter-on-quarter), primarily driven by the services sector and to some extent, the industry. This growth can largely be attributed to the delayed recovery from the pandemic. As the Mexican government provided minimal support to offset the effects of the pandemic, the recovery process has been more protracted compared to other countries. Some service sectors, which were severely impacted, are still in the process of regaining their pre-pandemic levels.
However, we anticipate a deceleration in the Mexican economy in the coming quarters due to contractionary monetary policies and reduced demand from the United States. Despite this, the strong statistical carry-over effect leads us to forecast a 2.2% growth rate for the Mexican economy in 2023. Looking ahead to 2024, we expect domestic demand to be the primary driver of economic growth, supported by lower inflation but an increased demand from the United States will also help growth. However, the lagged effects of contractionary monetary policies may slightly hinder growth. Consequently, our forecast for the Mexican economy in 2023 is a growth rate of 1.7%.
Regarding the prospects of nearshoring, we maintain a sceptical view of this phenomenon. Foreign Direct Investment in new projects has not displayed significant growth recently, and it is possible that existing industries are expanding their capacities rather than new industries being established. If there is a relocation of high-tech industries from Asia to Mexico, this process may be prolonged, and its effects may only become evident in 2024 and 2025.
Inflation in Mexico has been decreasing in recent measurements, indicating a response to the significant degree of monetary tightening. The moderation of U.S. inflation, which has strong ties with Mexico, along with the appreciation of the Mexican Peso (MXN), and a reduction in food inflation, have all contributed to the reduction in inflation. However, Mexico still has a long way to go to reach its target inflation rate of 3%. Currently at 7.4% (year-on-year), core inflation continues to show persistency, and there are signs of tightening in the labour market. For 2023, our forecast indicates that the Consumer Price Index (CPI) will continue to decrease gradually and end the year at 5.8% (y/y average).
Figure 4: Mexico CPI Inflation (y/y, %)
Source: INEGI
Looking ahead to 2024, we anticipate that many of the inflationary pressures seen in 2023, such as inertia from the previous year, reopening effects, and food and fuel inflation, will have dissipated. Combined with the contractionary policy implemented during this year, we believe this will allow Banxico to bring inflation closer to its target. Our forecast for year-on-year inflation in Mexico is that it will reach 3.9% by the end of 2024.
In terms of interest rates, Banxico has completed its hiking cycle, reaching 11.25% after a 700 basis points increase. We expect Banxico to maintain the interest rate at this level until inflation falls closer to its target and inflation expectations align with Banxico's objectives. Due to the persistence of core inflation, we believe this phase is likely to last approximately 12 months. Therefore, the policy rate is expected to remain at 11.25% until the end of 2023. Looking ahead to 2024, we anticipate the first rate cut to occur at the beginning of the second quarter when core inflation will have significantly reduced and inflation expectations align with the 3% target. Subsequently, interest rates will slowly return to their neutral level. Our projection suggests that the policy rate will end 2024 at 9.0%, slightly above its neutral level of around 7%.
In 2024, Mexico will hold general elections. Incumbent President Lopez-Obrador is unable to participate, as presidential re-elections are prohibited by the Mexican Constitution. Nonetheless, his party MORENA continues to garner significant support, as indicated by opinion polls. The candidate from the party has not yet been determined, but it is highly likely that MORENA candidates will outperform traditional parties such as PAN and PRI. The crucial question is whether the next President will adopt a more moderate or radical approach compared to Lopez-Obrador. During his term, several reforms were hindered by the legislature or the Supreme Court, and Lopez-Obrador has generally respected their decisions. We will observe whether the next President deviates from the current policies implemented in Mexico in any significant way.
Argentina: Affected by Droughts
The Argentine economy is set to face challenging times ahead. The primary source of dollars for the Central Bank of Argentina (BCRA), which is grain exports, will be significantly impacted by severe droughts in rural areas this year. Early estimations by the IMF suggest that the harvest losses could reach a staggering USD 3.5 billion, further straining the BCRA's already depleted reserves and leading to limitations on imports in an attempt to control the shortage of dollars. Additionally, the purchasing power of salaries will continue to erode due to high inflation, resulting in weaker internal demand. We anticipate a 2.0% contraction in the Argentine economy for 2023. However, we expect a recovery of 1.3% in 2024, driven by stabilization efforts from the winners of the upcoming elections.
The inflationary outlook has worsened in recent months, with inflation rates exceeding 7% on a month-on-month basis. Year-on-year figures have already surpassed triple digits, reaching 108%. The BCRA has resumed monetary financing of the fiscal deficit, adding fuel to the inflation fire. We foresee limited improvement in the coming months, with inflation projected to reach 111% by the end of 2023. In 2024, we anticipate some reduction in inflation, primarily due to new government measures and the stabilization of agricultural production. We predict inflation will end 2024 at 81.5%.
Regarding interest rates, we believe the BCRA will maintain a slightly positive real interest terrain, aligning with the IMF's recommendations. We expect a slight increase from the current 97% BADLAR rate to 102% (effective money market rates are higher producing positive real rates). As inflation eases, we anticipate this rate falling to 85% in 2024.
In terms of the IMF deal, Argentina is expected to receive an additional USD 8 billion this year, which will help address its dollar shortage issues to some extent. However, we believe there is a significant chance that the quantitative targets of the deal may not be fulfilled. Nevertheless, the IMF has displayed flexibility in the past and is likely to continue with the deal even if the targets are not met.
The upcoming elections in October are likely to bring a change to the Presidential chair. The incumbent President Alberto Fernandez has already withdrawn from the Presidential race due to his low chances of winning. The ruling coalition has not yet finalized its candidate, and it is probable that the final decision will be made after the National Primaries in August. The main opposition force, "Frente de Todos," has yet to present its candidate and is likely to decide during the national primaries as well. Another candidate with significant chances of winning is Javier Milei, a radical from the Libertarian Party. Often compared to figures like Bolsonaro and Trump, Milei is viewed by Argentine voters as an anti-establishment candidate. Given the low popularity of prominent political figures, a radical change in Argentine politics is possible. Our prediction is that the ruling coalition will lose the elections either to the opposition coalition or to Javier Milei.