09 Feb 2023 Latin American Economic Outlook
By Amanda Perez
Over the past year, the global economy, already weakened under the lingering effects of the COVID-19 pandemic and the war in Ukraine, has suffered further from consistent inflation, tightening monetary conditions, and rising costs. The continuation of this global economic slowdown, in conjunction with the expectation that the United States and China will undergo recessions in the next 12 months, presents challenges to Latin America’s economic growth prospects in 2023. The tapering of global demand, potentially depressed commodity prices, and internal political and social pressures from recent elections in key countries present risks to the region. Thus, after an estimated 3.9% gross domestic product (GDP) growth in 2022, growth in Latin America is set to slow to 1.8% this year.
Despite this anticipated slowdown, the region stands to benefit from certain external factors. As investors pull out of Russia due to the war in Ukraine, bankers predict M&A volumes in Latin America will increase up to 20% in the next year amid easing of monetary policy. Sanctions on Russia will also position the region to benefit as a supplier of select commodities such as oil and natural gas. Additionally, strained global production chains over the course of the pandemic have led companies to adopt the practice of nearshoring, putting Latin America in an especially beneficial position given its proximity to the United States. Furthermore, as the world undergoes a transition to clean energy, natural resources such as lithium and copper have become hot commodities, particularly in the electric car and consumer product industries. Latin American countries containing large quantities of these substances are poised to profit off this new trend in consumption, with the potential of becoming the world’s leading exporters of these items. As such, hope does exist for the region, although dynamics will vary widely on a country-by-country basis.
Brazil’s GDP growth is forecasted to reduce to 1.2% this year from 3.1% in 2022. The overall economic outlook for the country remains uncertain due to the country’s fiscal imbalances and unpredictable policies. While the central bank of Brazil, Banco Central de Brasil (BCB), managed to lower inflation rates to 5.79% by the end of 2022, these disinflationary pressures were largely due to aggressive monetary policy tightening and impermanent fiscal policy interventions. Tax cuts and subsidies for fuel were also enacted to lower transportation costs, but these policies may end, thus removing these key sources of disinflation. However, the taxes on fuels may be reinstated to help pay for extra spending measures under the newly elected President Luiz Inacio Lula da Silva as he plans to increase the size of the welfare programs. While this large fiscal stimulus will give the economy a short boost, it may also re-grow inflation rates. Many investors also fear that this new wave of spending-planning under Lula may leave Brazil’s debt on an unsustainable path. This derailing of fiscal consolidation evokes the fear of unsound fiscal policy, further deterring investments and hurting economic growth prospects. Lula’s presidency has also sparked an increase in the already existing sentiments of political instability, as supporters of his opponent former President Jair Bolsonaro took to the streets in Brasília and ransacked the Superior Federal Court, National Congress, and the presidential palace on January 8th. Although many fear his leftist ideologies, his selection of Geraldo Alckmin from the center-right as his vice-president and the relatively moderate proposals in his government plan published in August signal that Lula may have become more centrist, which has helped to calm investors.
Despite the political uncertainty, Brazil remains a major force in the region. The country has recorded sizeable trade surpluses over the years, and with the current prices of commodities, Brazil’s export revenues have been supported on items such as iron ore, soybeans, and corn. Although the impending global recessions may lower demand for all of Brazil’s exports, domestic activity should remain strong. Brazil’s economy should be positioned for growth.
Mexico proved to be more resilient than anticipated in 2022 with an estimated annual GDP growth of 3.1%, higher than originally forecasted. This growth can largely be attributed to manufacturing activities bolstered by improved trading conditions, U.S. demand, and private consumption. However, this growth is expected to decelerate next year to 1.7% as an economic slowdown is predicted to hit the country. As an impending recession looms over the U.S., previously high demand for Mexican commodities is expected to drop. The Bank of Mexico (Banco de México [Banxico]) increasing the policy interest rate to 10.99% in January of 2023 may also reverse the previous trend of credit expansion for business and individuals. Regulatory actions favoring state-owned companies have created an atmosphere of distrust surrounding the country, dissuading foreign investors from pursuing business activities in the region. Additionally, risks to policy contingency are arising as President Andrés Manuel López Obrador (ALMO) may attempt to backtrack reforms; however, he is not expected to gather enough support from Congress to do so.
Nevertheless, opportunities for growth still exist for Mexico. Due to its direct geographical connection to the United States, and heightened by trade tensions with China, the practice of nearshoring poses large-scale potential economic benefits. Mexico has already reaped the benefits from this development as foreign direct investment (FDI) for the northern states bordering the U.S., Baja California, Chihuahua, and Nuevo León recorded increases of 54%, 6%, and 4%, respectively. Light vehicle sales are predicted to increase 6.9% in the U.S., thus placing Mexico’s auto export industry in a favorable position. Electrical equipment, computer and electronic products, and plastics are also set to drive growth this year as a product of nearshoring. Although security risks and corruption persist, seasoned investors should have a good sense of how to navigate through this market.
Regardless of local and international analysts’ broad differences on projected 2023 GDP growth rates for Argentina, ranging from 0.4% to over 3%, the country’s growth is set to slow from last year’s rate of 4.6%. This decline in growth can be attributed to a myriad of factors both internal and external. Internal issues such as wide fiscal and external deficit, high inflation, depreciation of the peso, and issues with implementing policy changes to comply with the Extended Fund Facility agreement with the IMF keep the country on a financially unsustainable track beyond 2023. External problems such as the decline of agricultural commodity prices and persistently high energy prices are working against Argentina’s economic growth.
Nevertheless, the country retains a huge potential for growth. Sanctions on Russian products open the door for Argentina to become one of the world’s top oil-exporting countries; however, the country does need more infrastructure spending to fully realize its potential. Argentina could also become the world’s leading exporter of lithium as the demand for lithium-ion batteries increases. With annual inflation rates decelerating due to fiscal spending retrenchment implemented by authorities, labor and production costs have declined significantly. This industry is forecasted to generate US $4 billion in exports annually for the country.
Colombia has been recovering remarkably well from the COVID-19 crisis with an estimated GDP growth of 8.1% in 2022, outperforming almost every other country in Latin America. However, like the rest of the region, the country’s growth is set to slow to 1.1% in the coming year. While domestic consumption bolstered last year’s growth, this demand is expected to plummet as surging food and fuel prices exacerbated by the war in Ukraine are leading to higher inflation and interest rates. At the end of 2022, the inflation rate reached 13.1%. In response, the central bank of Colombia, Banco de la República, raised the benchmark interest rate to 12.75% on January 27th.
Uncertainty around President Gustavo Petro’s policy agenda is clouding the economic outlook for the country, as his new vision for the economy may trigger a large-scale capital flight and rapid currency depreciation. Petro proposed a tax reform bill that will increase corporate taxes for extractive industries, instate a new “carbon tax” on oil companies, increase taxes for financial and hydroelectric companies, instate a new personal wealth tax, increase income taxes, and increase taxes on sugary drinks, ultra-processed foods, and single-use plastics tax. While the government retains a need to raise tax revenues to combat a sovereign risk downgrade, which would limit the ability of the country to borrow at low rates, there is concern that this tax reform will limit investment growth. In his push for a green transition, Petro is attempting to move away from the oil industry. While reducing dependence on oil and gas would lower emissions, the economy may lag as oil makes up a third of the country’s exports.
Although Chile initially made impressive leaps in recovering from the COVID-19 crisis, the country has been experiencing a decline in its economy as GDP growth for 2022 is estimated at 2.7%. The economic outlook for this year is, waning as GDP growth is forecasted to turn negative, contracting by 1.5%. Household consumption is expected to decline as supportive government programs are adjusted down and high inflation persists. Social instability remains a looming concern for Chile as the country faces simmering anger around the issue of worsening economic inequality and stagnant living standards. Chile has been wracked with protests over the past three years as a response from the population’s dissatisfaction with the current socioeconomic structure, which weakened Chile’s position as one of the most stable markets in Latin America. Although this issue has largely been contained in recent months, Chile could experience further demonstrations should this situation become aggravated. Additionally, President Gabriel Boric has fanned the flames of this social unrest, supporting reforms to the country’s constitution, and promising to raise taxes on corporations and wealthy Chileans. While ostensibly promoting social progress, these actions have been bolstering political instability and dissuading foreign investments into the economy.
Growing demand for clean energy, however, may provide the country with opportunities, given the right circumstances. Chile is currently the world’s largest producer of copper and second largest producer of lithium. Although Chile’s mining sector remains weak, additional investments in infrastructure in this sector could position the country as a leading exporter of both substances. As long as demand for these exports continues, the economy could reap the benefits of this new trend in consumption.
Peru experienced an estimated 2.6% growth in GDP supported by growth in the agriculture, commercial, and construction sectors last year. The country’s growth is projected to grow by 2.5% this year, maintaining the trend from 2022. The greatest risk Peru faces right now is political instability, which has been mounting over time as the country has had six presidents in the past five years. The last president, Pedro Castillo, attempted to seize dictatorial powers in a coup that ultimately failed. Castillo was impeached and removed from office and is currently undergoing multiple criminal investigations for corruption and a constitutional compliant for conspiracy. Following his removal, Castillo’s former Vice-President Dina Boluarte has assumed the presidency; however, in the eyes of many Peruvians, her presidency is illegitimate. Since Boularte took office, violent protests have wracked the country leaving a total of 58 people dead, most of which were civilians in clashes with the police and army. Protesters are demanding Boularte’s resignation, a new election, and changes to the constitution. The current political climate is detracting from crucial policy making and economic/structural reform implementation.
If a solution to the political crisis is reached, opportunity could lie within the mining sector. The Quellaveco copper mine is set to improve Peru’s total copper output by approximately 12%. This boost in copper mining is forecasted to support the country’s export sector and overall GDP growth in 2023, irrespective of the fluctuations in copper prices. Foreign-exchange earnings from copper exports could also support an appreciation of the sol as they historically have during periods of elevated copper prices. Additionally, corporate taxes and royalties generated through the copper industry historically constitute an estimated 11% of annual tax revenues collected by the Peruvian government. Thus, an increase in copper production would bolster government consumption.
Puerto Rico rebounded from its 2021 economic contraction with an estimated GDP growth of 4.8% for 2022. However, growth is projected to slow to 0.4% in 2023, as an expected U.S. recession threatens to drag down the local economy. Although the U.S. continues to provide the island with federal assistance, Puerto Rico still faces daunting reconstruction difficulties after various natural disasters wreaked havoc on local infrastructure. The governor, Pedro Pierluisi, must recommend policy changes to guide these reconstructive efforts. However, Governor Pierluisi lacks a majority in the bicameral Legislative Assembly, creating challenges in governability.
With the lifting of COVID-19 restrictions, opportunities lie in the tourism sector, as ample fiscal support for tourism should buoy the local economy. Additionally, public funds recently freed by debt restructuring and funding from the U.S. should further support growth. In terms of support from the U.S., a Biden-Harris administration meeting with the government of Puerto Rico on December 6, 2022, set expectations for both governments to take steps together in strengthening human capital and workforce development, investing in infrastructure, energy, and resilience, building a diversified economy, and improving governance and data collection and analysis on the island.