Economic Analysis - Key Themes For Latin America In 2018 - FEB 2018

Latin America will see stronger economic growth in 2018. Stabilising labour markets and moderating inflation will support consumption, while lower interest rates and a broad shift toward more orthodox economic policies will bolster investment. That said, the region's political environment will remain volatile, suggesting substantial downside risks to economic growth and policy continuity.

We have identified five key themes that will drive outcomes in the region in 2018, each of which is fundamentally political:

  • Corruption investigations could upend political establishments

  • Efforts to diversify trading partners will pick up speed

  • Venezuela set for a change in government

  • Argentina rebound will take off

  • Shift in US policies will undermine Central American economies

Corruption Investigations Could Upend Political Establishments

In 2018, elections in Brazil, Mexico, Colombia, Paraguay and Costa Rica will be significantly influenced by voters' frustration with the political establishment, regardless of political ideology. Nearly every country in the region has been touched by corruption investigations into Brazilian construction giant Odebrecht, and allegations of bribery have implicated current and former leaders across the political spectrum ( see ' Odebrecht Fallout Brings Threats, Opportunities ', May 23). Simmering public anger due to corruption, as well as wide income inequality and weak economic growth, have translated into a rejection of established parties and leaders that is driving political discourse.

Leveraging this frustration, anti-establishment candidates are set to run competitive campaigns that raise significant uncertainty about the region's policy outlook post-2018 ( see 'Discontent With Established Politicians Opens Door For Outside Candidates', September 20). While the most prominent of these candidates can be broadly described as populist, their political ideologies vary widely and their economic policies are often vague. In Mexico, Andres Manuel Lopez Obrador has become a leading candidate on a broadly leftist populist platform heavy on criticism of the US. In Brazil, Jair Bolsonaro has risen toward the top of early presidential opinion polls on a platform of anti-corruption policies, social conservatism and a hard line on security, while being of admittedly uncertain economic views.

Faith In Government At Rock Bottom
Latin America - Opinion Poll: % Of Respondents Who Believe Government Works For The Majority Of People
Source: Latinobarometro, BMI

Even if these candidates lose in their respective general elections, the movements they are building will likely lead to more difficult policymaking environments. For example, in the first round of Chile's general election, held in November, candidates on the furthest edges of the political spectrum gained vote share and a left-wing coalition posted the strongest performance of any third coalition in the modern era, with the potential to be a decisive voting bloc in the second round ( see 'First Round Election: Pinera Disappoints, But Still Slight Favourite', November 21). Stronger fringe parties will make it more difficult for leaders to manage their coalitions and develop pragmatic legislation, potentially undermining the shift toward more orthodox, pro-investment policies seen in much of the region over the last two years.

Corruption investigations will also pose a threat to political leaders not up for re-election. In Peru, President Pedro Pablo Kuczynski has been implicated in an investigation involving Odebrecht. The investigation has threatened to worsen his already strained relationship with the opposition-dominated legislature, which could stymie the development of legislation around key economic priorities and pose downside for growth ( see 'Odebrecht Probe Will Threaten Political Stability', November 30). Similarly, in Ecuador and Uruguay, corruption charges have led to rifts within ruling parties, undermining leaders' control over the legislative process.

Efforts To Diversify Trading Partners Will Pick Up Speed

Trade negotiations meant to diversify Latin American countries' trading partners will be a priority in 2018, as governments seek to encourage export-led growth and, in Mexico's case, reduce its reliance on the US. While unlikely to have a material impact on the region's economic performance in the immediate term, these efforts will lay the groundwork for stronger trade ties, primarily with Asia but also potentially with the European Union over the coming years. In these efforts, Latin America will exemplify a broader emerging market trend toward trade integration, even as many developed markets move toward greater protectionism ( see ' Global Trade: What Could Go Right? ', March 9).

Mexico will be at the forefront of trade diversification efforts, as the uncertainty surrounding NAFTA's future encourages it to develop new sources of imports and markets for exports outside of the US ( see 'NAFTA: Scenarios For A Trade Deal In Crisis', November 14). In the past year, Mexican officials have moved to facilitate agricultural trade with Argentina and Brazil to reduce dependence on grain imports from the US. Although logistical obstacles will reduce the immediate impact of the efforts on trade, the move is symbolically significant, underpinning what we believe to be the start of a longer-term trend. Mexico, Chile and Peru have also remained party to the Trans-Pacific Partnership agreement as its signatories seek to move forward without the US, raising the prospect of greater trade with Asian markets over a multi-year timeframe ( see ' Signatories To Pursue Alternative Trade Deals Following TPP's Demise ', March 24).

Pacific Alliance More Open Than Mercosur
Latin America - Exports, % of GDP (Ave)
Note: Mercosur figures exclude Venezuela; Source: National Sources, BMI

Additionally, the ascension of pro-trade leaders in Mercosur has created a broad pro-trade consensus among leaders of the region's major economies ( see 'Mercosur-Pacific Alliance: The Time Is Ripe To Strengthen Ties', March 22). The region's largest trading bloc by population and GDP, Mercosur has long retained stronger trade protection measures than the Pacific Alliance. However, over the last year Mercosur has taken a more proactive stance toward trade promotion, holding summits with the Pacific Alliance to explore strengthening ties and restarting long-stalled talks with the European Union.

Venezuela Set For A Change In Government

Venezuela's economic crisis is likely to continue unabated through 2018, which will most likely lead to a hard default on its sovereign debt obligations that will precipitate President Nicolas Maduro's ouster. In November, Venezuela technically defaulted on a portion of its debt, though it belatedly made the payments. While the country has declared its intention to renegotiate its debt payment schedule with its creditors, US sanctions effectively eliminate the possibility of a traditional restructuring. As a result, we see Venezuela facing a rising likelihood of creditor actions to seize its offshore assets and oil shipments, which could effectively cut it off from its only source of hard currency.

As hard currency inflows come to a near standstill, Venezuela's political elite will likely fracture and Maduro will lose support, in line with our long-held view ( see 'Maduro Unlikely To See Out Term', March 24 2016). Clearly concerned about the military's loyalty, Maduro has steadily granted more privileges to its leaders, including giving generals control of the oil ministry and state-owned oil company PdVSA in November. The ruling PSUV is also likely to fracture. The supra-legislative Constituent Assembly raises the risk of intra-party tensions spilling open as factions of the PSUV jockey for power ( see 'Constituent Assembly Makes Regime Change More Likely', July 31). The Assembly is dominated by Maduro's loyalists, potentially alienating other power centres within the party. Hints of this have become visible in recent weeks as Maduro has sought to purge perceived threats from the government.

A Long Way From Improvement
Venezuela - Real GDP Growth, %
e/f = BMI estimate/forecast. Source: BCV, BMI

Our core scenario is that the military will break with the PSUV, forcing out the current government and installing a transitional government that would be able to credibly negotiate with the country's creditors. Power will eventually be passed to a democratically elected government, although recent examples, such as Egypt and Thailand, suggest a transition could take a year or more. A transitional government would need to start debt negotiations, secure humanitarian support, and begin unwinding government interventions in currency and capital markets, all of which would take years to result in substantial improvements. As such, Venezuela is likely to remain unstable for the foreseeable future.

Argentina Rebound Will Take Off

Argentina's liberalisation under President Mauricio Macri will support accelerating economic growth, led by investment and consumption. After liberalising currency and capital controls and regaining access to external capital markets in 2016, reform efforts slowed in 2017 ahead of legislative elections. Having secured a strong mandate in the vote in October 2017, Macri will pick up the pace of reform efforts in 2018, focusing on lowering the cost of doing business by reforming the tax code, reducing the state's role in the economy and easing regulations. At the same time, businesses' concerns over the durability of reforms will fade and investment into a broad range of sectors will pick up, bolstering the economy's already robust recovery ( see 'Improving Confidence Supports Growth Outlook', November 29).

Investment & Confidence Rising
Argentina - Activity Indicators
Source: INDEC, BMI

Our industry teams have identified the agriculture, oil & gas, pharmaceuticals and food & drink sectors as holding region-leading growth and investment potential ( see 'Six Sectors To Watch In Latin America', February 1 and 'Latam: Which Industries Are Most Attractive?', August 23), reflecting our view that regulatory reforms will allow sectors with strong fundamentals to rebound following years of stagnation. Reforms have focused on reducing the state's role in the economy, opening up opportunities for investors and improving access to capital.

Shift In US Policy Will Undermine Central America n Economies

US President Donald Trump's more restrictive immigration policies will generate headwinds to economic growth, macroeconomic and political stability and, potentially, efforts to improve the security situation across Central America. Over the last year, the Trump administration has granted federal immigrations officials greater latitude to detain and deport undocumented immigrants, which could disproportionately affect migrants from Central America. In November, the administration terminated Temporary Protected Status (TPS) for Nicaragua and signalled its reconsideration of the status for Honduras. TPS allows immigrants from designated countries to remain in the US in light of instability in their home countries. El Salvador is currently also covered by TPS, but that status appears likely to be revisited within the coming quarters as well.

The administration will most likely continue to reduce Central Americans' ability to reside and work in the United States. Over time, this will weigh on migrants' ability to send remittances to their home countries, which will lead to weaker private consumption given the large number of households that are supported by remittances. It could also drive downside pressure on external accounts. Should these policy changes also result in a wave of returning migrants, domestic stability could suffer, as the region's elevated unemployment rates suggest its economies are ill-prepared to absorb substantial numbers of additional workers.

Additionally, Central America is likely to see cuts in financial assistance from the US. The administration originally proposed a 40% cut to funding for Guatemala and a 33% cut to Honduras and El Salvador. While Congress has largely rolled back those cuts thus far, that willingness to maintain financial assistance to Central American countries may falter. Some members of Congress have begun discussing cutting aid to Guatemala in light of corruption investigations surrounding President Jimmy Morales, which would likely widen the fiscal deficit. Separately, Nicaragua will see external funding dwindle, driving wider fiscal deficits over the coming years, as the US Congress appears likely to pass legislation that would require the US to veto international aid to President Daniel Ortega's government ( see ' NICA Act To Widen Deficit From 2018 ', October 16).