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Economic Research: Latin America's Economic Recovery From The Pandemic Will Be Highly Vulnerable To Setbacks

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Economic Research: Latin America's Economic Recovery From The Pandemic Will Be Highly Vulnerable To Setbacks

There are no major changes to our macroeconomic assumptions for Latin America this quarter. Among emerging markets, Latin American economies were some of the worst hit by the COVID-19 downturn, and we expect they will also be some of the slowest to recover.

The low or inefficient government support to labor markets and business in most of the region's countries--combined with economic weaknesses that preceded that pandemic--are the main reasons why we expect below-average growth. Our working assumption remains that a COVID-19 vaccine will be widely available around the middle of 2021, which will help improve activity in some of the sectors that have been hardest hit the by the pandemic-related social distancing. We forecast that GDP in the six largest economies in the region will grow 4.1% in GDP in 2021 after falling an estimated 7.7% in 2020. This implies that the level of GDP in the region by the end of 2021 will still be roughly 3% below its pre-pandemic level (fourth-quarter 2019). We expect most Latin American economies will return to their pre-pandemic GDP level in the second half of 2022, with Mexico toward the end of our forecasting horizon in 2023 and Argentina beyond that.

Table 1

Latin America's GDP Growth And S&P Global Ratings' Forecasts
(%) 2018 2019 2020F 2021F 2022F 2023F
Argentina (2.6) (2.1) (11.7) 4.0 3.0 2.5
Brazil 1.2 1.1 (4.7) 3.2 2.6 2.6
Chile 4.0 1.0 (6.4) 5.2 3.9 3.2
Colombia 2.5 3.3 (7.8) 5.1 4.6 3.8
Mexico 2.2 (0.3) (9.3) 3.9 2.9 2.2
Peru 4.0 2.2 (13.5) 10.0 5.3 4.2
LatAm 6 1.5 0.6 (7.7) 4.1 3.1 2.7
LatAm 5* 1.4 0.5 (7.3) 3.8 3.0 2.6
*LatAm 5 is the LatAm 6 but excluding Peru. The LatAm GDP aggregate forecasts are based on PPP GDP weights. F--S&P Global Ratings' forecast. Source: Oxford Economics.

Table 2

Change In Base GDP Forecasts From Third-Quarter 2020
(%) 2020 2021
Argentina 0.8 (0.8)
Brazil 1.1 (0.3)
Chile 0.1 (0.3)
Colombia 0.2 (0.4)
Mexico 1.1 0.2
Peru 0.0 (2.5)
LatAm 6 0.8 (0.4)
LatAm 5* 1.0 (0.2)
*LatAm 5 is the LatAm 6 but excluding Peru. The LatAm GDP aggregate forecasts are based on PPP GDP weights. F--S&P Global Ratings' forecast. Source: Oxford Economics.

The recovery so far is unbalanced; manufacturing and commodities are outperforming services.  The initial GDP rebound in the third quarter from the slump in economic activity that took place in the second quarter (when lockdowns domestically and abroad were harshest) was generally stronger than expected. The region expanded slightly more than 50% in quarterly annualized terms in the third quarter after declining 45% in the second. Our expectation for third-quarter GDP growth was roughly 40%. In the third quarter, the average economy in Latin America recovered two-thirds of the loss in GDP suffered in the second quarter--but with significant variation across countries (see Chart 1). As a result, we adjusted our 2020 GDP estimate for the six largest Latin American economies to negative 7.7% from negative 8.5% previously. This implies the region will still be about 6% below its pre-pandemic GDP level by the end of this year.

Chart 1

image

Given the reasons for the stronger-than-expected third-quarter GDP, some caution is warranted about the trajectory of future growth. The main reason for the outperformance was robust goods exports. However, the services sector, which is the largest in most Latin American economies, remains very weak. This means that in the absence of a recovery in services, the region will remain highly vulnerable to swings in external demand.

Exports were most notably strong in manufactured goods to the U.S. and commodities to China. By September, Mexico's manufacturing exports were up 4% compared to the previous year, and Brazilian soy bean exports, mostly to China, were up 20% in the third quarter from the previous year. Mexico is a good example of the divergence in the performance of the manufacturing and services sector: In the third quarter, its manufacturing sector recovered 90% of what it lost in the second quarter, but its services sector only recovered half.

Chart 2

image

Mobility data suggest fourth-quarter GDP is on track to continue to expand in quarterly terms (see Chart 3), albeit moderating from the pace seen in the third quarter. Mobility in the average Latin American economy is still about 25% lower than before the pandemic, but this is a significant improvement from 60% lower in April. The recent uptick in COVID-19 cases in several major economies globally does not seem to have much of an impact on Latin American activity so far. This is in contrast to what has happened in other emerging markets, especially those with close ties to Europe, where the re-imposition of lockdown measures has been more drastic. The difference stems from Latin America's relatively low trade exposure to Europe and higher exposure to China and the U.S., where new lockdown measures have been more limited.

For now, we expect positive quarterly growth in Latin America in the first quarter of 2021 as well. However, any further worsening of the COVID-19 situation that prompts stricter lockdowns, especially in the U.S., is an important downside risk. Despite the recent increase in new infections in some Latin American countries, most notably in Brazil, we see the risk of new wide-scale lockdowns as low due to rising political opposition. Therefore, those measures are not part of our baseline.

Chart 3

image

Challenges to the next stage of the recovery include the removal of fiscal stimulus, high joblessness, and weak investment.  While Latin American economies will remain exposed to potential swings in external demand, the speed of the next stage of the economic recovery will depend largely on how quickly sectors that were heavily affected by the pandemic return to normal. Sectors that have experienced outsized declines in activity due to lockdown measures--such as those related to travel and leisure--will start to improve more noticeably as a vaccine becomes widely available around the world. (Our view is this will start around the middle of next year.) However, several factors will mean that the overall economic recovery in Latin America will be generally slow and highly vulnerable to setbacks. Three stand out: the removal of fiscal stimulus, high joblessness, and unfavorable investment prospects.

Fiscal stimulus varied widely across Latin America, being as high as 12% of GDP in Brazil and as low as 1% of GDP in Mexico. However, such stimulus is set to expire in most countries late this year. Given that domestic demand is still very fragile (see Chart 4), the impact of less fiscal support on economic growth could be quite noticeable.

In Brazil, for example, the government's monthly emergency stipend program, which reached 67 million people and was key in supporting stronger consumption during the downturn than its regional peers, is one of those set to expire at year end. While there has been some debate on extending the program, the constitutional spending cap and the recent sharp deterioration in debt-to-GDP ratio, which is above 90% in gross terms, mean that extending it would likely have negative implications for Brazilian asset prices. Brazil's monetary policy will likely remain accommodative, however, as large output gaps should keep demand-side inflation pressures low. This will encourage most central banks to keep interest rates near their current all-time lows.

A favorable factor for all of Latin American is that monetary stimulus abroad is further lowering borrowing costs, a dynamic that is likely to remain in place into 2021 and for some time beyond that. However, fiscal stimulus has a much larger impact than monetary stimulus on the average Latin American household's propensity to spend.

Chart 4

image

High unemployment is also a big challenge to Latin America's economic recovery. Some countries in the region have introduced measures to support labor markets, such as partial compensation to those who were laid-off and credit support to companies that kept employees on their payroll. However, the level of support has generally been low compared to that in other parts of the world. As a result, the region's joblessness has risen significantly: The unemployment rate is, on average, about 50% higher in the major Latin American economies than its pre-pandemic five-year average. Furthermore, the labor force has also shrunk significantly, as many individuals have stopped looking for work, and some could stay out of the labor market for some time until economic prospects improve more significantly.

Accounting for this drop in the participation rate makes the labor market picture more dire. The unemployment rate would, on average, be 1.5 times higher after factoring in the participation rate. And in places such as Mexico, where government support has been minimal, the unemployment rate would be 2.5 times higher (see Chart 5). Importantly, this doesn't account for the rate of underemployment. In Mexico, for example, the underemployment rate is about 15%, which is more than double what it was at the end of 2019. Clearly, there will be a recovery in labor markets as several sectors of the economy re-open, but given the extent of the damage done to labor, returning to the pre-COVID-19 levels of employment will take several years and hamper the recovery in consumption.

Chart 5

image

Also impeding the recovery are the structural weaknesses in investment that have plagued most of the major economies in Latin America over the greater part of the last decade. Real fixed investment growth in Latin America has averaged just 0.3% since the global financial crisis compared to 5% for emerging markets overall (see Chart 6). The reasons for such low investment in the region are well known and include high unpredictability in government policies, heavy regulatory burdens, large informal sectors, and low public investment. Moreover, some of these have worsened since the pandemic. For example, policy unpredictability is now higher given the rise in social unrest, and public investment is under pressure as governments attempt to lower the fiscal deficits they accumulated through the pandemic.

Latin American investment is not only low but also relatively inefficient. On average, one needs about 50% more units of investment to produce the same one unit of GDP than in other emerging markets (for more details, see "Latin America’s Pre-COVID-19 Growth Challenges Won’t Go Away Post-Pandemic," Sept. 24, 2020).

Mexico stands out as a country where the post-COVID-19 investment picture is particularly negative due to unfavorable trends that were in place before the pandemic. Private investment in Mexico has declined in eight out of the last 10 quarters, partly due to lack of government support toward the private sector in recent years, and that dynamic has deteriorated throughout the pandemic.

Chart 6

image

As a result of weak labor and investment dynamics, GDP in Latin American economies will be among the last emerging markets to return to their pre-COVID-19 levels. We expect that most will return to those levels in the second half of 2022. However, economies that had severe economic weaknesses that preceded the pandemic will take longer. Mexico, for instance, will likely return to its pre-pandemic GDP level until 2023, in large part due to the already mentioned unfavorable investment dynamics. For similar reasons, we don't expect Argentina to recover within our forecast horizon, which extends through 2023.

All economies in the region are highly vulnerable to setbacks due to the fragility of the recovery. Moreover, given the sharp deterioration in fiscal dynamics as a result in the pandemic, if the region were to suffer another severe shock to growth, governments would likely face significant constraints on their fiscal response. On the upside, the rising prospects of a COVID-19 vaccine being widely available in the near term could increase confidence and result in a faster-than-expected economic recovery. For those reasons, at the moment we see the risks to our growth outlook for Latin America as balanced.

Chart 7

image

Our GDP Forecasts

Argentina:  We lowered our 2021 GDP forecast to 4% from 4.5% due to a deteriorating outlook for domestic demand. The economy continues to face severe economic constraints, which have worsened in in recent months. These include persistently high inflation, a heavy foreign-currency debt burden, and low foreign-exchange reserves, which leads to a scarcity of U.S. dollars in the economy. In light of these dynamics, economic growth will remain susceptible to large swings, which will keep investment weak and the recovery from the pandemic downturn slow. We expect Argentina to have the weakest economic recovery among the major Latin American economies, not returning to its pre-pandemic GDP level until beyond our forecast horizon, which extends through 2023.

Brazil:  The performance of Brazil's economy has been better than we anticipated, with second-quarter GDP having one of the mildest contractions in emerging markets outside of Asia. Moreover, the third quarter (results for which are not yet published) will likely to show a strong recovery. The upside surprise to growth has been due to three factors: large government transfers to informal and low-income workers, less-stringent lockdown measures than many of its peers, and strong exports to China, especially of soybeans. That said, amid a challenging fiscal scenario, which includes a constitutional requirement to keep primary spending flat in real terms, stimulus measures will likely have to be unwound rapidly next year. This will be a significant headwind to growth. We forecast growth of 3.2% in 2021 compared to negative 4.7% in 2020.

Chile:  We kept our 2020 and 2021 GDP projections broadly unchanged at negative 6.4% and positive 5.2%, respectively (we'd projected negative 6.5% and positive 5.5% previously). Chile's third-quarter GDP was among the weakest in the region, growing only 22.6% in quarterly annualized terms following a 43.9% decline in the second quarter. However, the weakness in the third quarter was broadly anticipated amid a re-tightening of lockdown measures during that period. We expect Chile to have some of the strongest fourth-quarter GDP performance in the region due to the unwinding of lockdown measures, strong government support, and a new program that allows individuals to withdraw funds from their pension accounts. However, Chile is still undergoing significant political change, including a process to re-write its constitution, which poses downside risk to our longer-term growth outlook.

Colombia:  We have kept our 2020 and 2021 GDP growth projections for Colombia broadly unchanged at negative 7.8% and positive 5.1%, respectively (compared to negative 8% and positive 5.5% previously). The collapse in exports in the second quarter was among the most severe in the region, declining nearly 70% in quarterly annualized terms due to the sharp drop in demand for oil, Colombia's largest export. The recovery in the third quarter was also relatively weak, as exports grew less than 8%, which means they remain 24% below their pre-pandemic level. A re-tightening of lockdowns in August in certain parts of the country, including Bogota, also weighed on economic activity. (In major cities, demand for intensive care units surpassed capacity.) However, lockdowns were relaxed nationwide in September, and as a result, we expect the recovery to firm up in the fourth quarter. Colombia's oil exports will likely recover more rapidly next year as services that rely heavily on energy--such as travel--normalize once a vaccine is widely available.

Mexico:  Our 2020 GDP growth estimate for Mexico improved to negative 9.3% from negative 10.4% due to the strong performance of the manufacturing sector, especially in the third quarter. However, our projections for 2021 remained broadly unchanged at 3.9% (3.7% previously). We still expect Mexico to have among the weakest economic recoveries in emerging markets from the COVID-19 pandemic. One reason is the economy had structural weaknesses before the pandemic, with a mild contraction in 2019 due to unfavorable investment dynamics. Furthermore, the government's policy response has been relatively small, with fiscal stimulus so far amounting to about 1% of GDP. And most of this was focused on direct transfers, with limited support to small and medium enterprises.

Peru:  We lowered our 2021 GDP growth forecast for Peru to 10% from 12.5%, but we kept our estimate of a 13.5% contraction in 2020 unchanged. The recent political turbulence, following the impeachment of President Vizcarra in early November, will likely slow down or even halt investment until policies are more certain. That would be after the general elections that are scheduled for April of next year. The Peruvian economy has been among the hardest hit this year globally by the fallout of the pandemic, with second-quarter GDP falling at a quarterly annualized pace greater than 70%. This has been due to the temporary halt in metals production, the stalling in the country's key fishing season, and one of the lengthiest and more stringent lockdowns. However, in the third quarter, the economy recovered nearly 80% of its second-quarter GDP decline, one of the strongest recoveries in the region. Despite the recent increase in political uncertainty, we expect the government's strong stimulus measures and robust Chinese demand for metals to result in very fast GDP growth rates in the next couple of years.

Appendix: Additional Tables

Table 3

Latin America: CPI Inflation And S&P Global Ratings' Forecasts (Year-End)
(%) 2018 2019 2020F 2021F 2022F 2023F
Argentina 47.6 53.8 37.0 45.0 35.0 30.0
Brazil 3.7 4.3 3.2 3.7 3.5 3.5
Chile 2.1 3.0 3.0 3.2 3.0 3.0
Colombia 3.2 3.8 1.7 2.7 3.0 3.0
Mexico 4.8 2.8 3.9 3.6 3.3 3.0
Peru 2.2 1.9 1.6 2.4 2.0 2.0
F--S&P Global Ratings' forecast. Source: Oxford Economics.

Table 4

Latin America: CPI Inflation And S&P Global Ratings' Forecasts (Average)
(%) 2018 2019 2020F 2021F 2022F 2023F
Argentina 34.3 53.5 43.0 41.0 40.0 32.5
Brazil 3.7 3.7 3.1 3.9 3.5 3.5
Chile 2.3 2.3 3.1 3.2 3.1 3.0
Colombia 3.2 3.5 2.6 2.3 3.0 3.0
Mexico 4.9 3.6 3.5 3.8 3.5 3.1
Peru 1.3 2.1 1.8 2.0 2.2 2.0
F--S&P Global Ratings' forecast. Source: Oxford Economics.

Table 5

Latin America: Central Bank Policy Interest Rates And S&P Global Ratings' Forecasts (Year-End)
(%) 2018 2019 2020F 2021F 2022F 2023F
Argentina 59.25 55.00 33.00 38.00 30.00 25.00
Brazil 6.50 4.50 2.00 3.00 4.50 5.50
Chile 2.75 1.75 0.50 1.00 2.00 2.50
Colombia 4.25 4.25 1.75 2.25 3.50 4.00
Mexico 8.25 7.25 4.25 4.25 5.00 5.50
Peru 2.75 2.25 0.25 1.00 2.00 2.50
F--S&P Global Ratings' forecast. Source: Oxford Economics.

Table 6

Latin America: Year-End Exchange Rates And S&P Global Ratings' Forecasts (Versus U.S. Dollar)
2018 2019 2020F 2021F 2022F 2023F
Argentina 37.70 59.89 85.00 125.00 135.00 140.00
Brazil 3.87 4.03 5.40 5.20 5.15 5.15
Chile 696 745 765 760 755 755
Colombia 3,250 3,277 3,650 3,675 3,650 3,650
Mexico 19.65 18.93 20.50 20.50 21.00 21.00
Peru 3.37 3.31 3.65 3.50 3.45 3.45
F--S&P Global Ratings forecast. Source: Oxford Economics.

Table 7

Latin America: Average Exchange Rates And S&P Global's Forecasts (Versus U.S. Dollar)
2018 2019 2020F 2021F 2022F 2023F
Argentina 27.81 47.97 71.00 105.00 130.00 137.50
Brazil 3.65 3.94 5.15 5.30 5.17 5.15
Chile 641 703 792 760 755 755
Colombia 2,956 3,281 3,705 3,670 3,660 3,650
Mexico 19.23 19.25 21.50 20.50 20.75 21.00
Peru 3.29 3.34 3.50 3.58 3.48 3.45
F--S&P Global Ratings' forecast. Source: Oxford Economics.

Table 8

Latin America: Average Unemployment Rate And S&P Global Ratings' Forecasts
(%) 2018 2019 2020F 2021F 2022F 2023F
Argentina 9.2 9.8 12.3 11.4 10.1 10.0
Brazil 12.3 11.9 13.0 12.1 11.3 10.8
Chile 7.4 7.2 11.0 10.4 9.1 8.6
Colombia 9.7 10.5 16.1 14.7 13.2 12.5
Mexico 3.3 3.5 5.1 4.8 4.4 4.2
Peru 6.7 6.6 13.1 9.2 8.1 7.6
F--S&P Global Ratings forecast. Source: Oxford Economics.

A Note On Our COVID-19 Assumptions

S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic. Reports that at least one experimental vaccine is highly effective and might gain initial approval by the end of the year are promising, but this is merely the first step toward a return to social and economic normality; equally critical is the widespread availability of effective immunization, which could come by the middle of next year. We use this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

This report does not constitute a rating action.

Latin America Senior Economist:Elijah Oliveros-Rosen, New York + 1 (212) 438 2228;
elijah.oliveros@spglobal.com

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