Another Year of Negative Growth for Latin America
Roubini views on the global economy and asset markets for 2016-17.
2016 will be another year of negative growth for Latin America given the unsupportive external environment and the prospect of pro-cyclical policy moves. But the beginning of the year was even bumpier than we imagined, with a number of macro risks—falling commodity prices, heightened concerns about China’s growth/rebalancing challenge, fears of a U.S./global recession—surging to the fore.
These shocks carry negative consequences for the region, but exposure levels vary. Broadly, those that prudently managed the commodity-boom cycle (Mexico, Peru, Colombia, Chile) are better able to cope with the prospect of deceleration, likely avoiding recession; those guided by populist instincts (Brazil, Venezuela, Argentina) are sure to remain in recession this year and will have to undergo sharp, painful adjustments to redress accumulated micro and macro imbalances.
China and Commodities Are Biggest Sources of External Risk
China and commodities stand out as the biggest sources of external risk for the region. China’s economy is not only decelerating but also rebalancing, shifting focus from investment/infrastructure toward consumption/services. In Latin America, this process implies greater suffering for mineral producers (Chile, Peru) than soft commodity exporters (Argentina, Brazil). Low commodity prices will continue to drive down foreign direct investment in resource-related projects, with deteriorating confidence also taking a toll on non-resource investment.
Even countries that do little trade with China, like Mexico, are exposed to the effects of China’s slowdown via the fiscal (commodity revenues) and currency channels. The Mexican peso is one of the most liquid emerging-market currencies, making it a preferred hedging tool when “risk-off” sentiment hits emerging market assets (as seen in the beginning of 2016 amid concerns about China). Weaker regional currencies will also affect the inflation outlook and will potentially have spillover effects on monetary policy across the region.
Low oil prices continue to batter Colombia, Ecuador, Venezuela and, to a lesser extent, Mexico. The latter is in a better position to cope with this terms-of-trade shock, but the low prices have also hit fiscal revenue. Despite higher non-oil revenue, Mexico responded with further fiscal cuts.
Colombia has chosen to respond with a slow fiscal adjustment, supporting domestic demand in the short run, but implying a slower external adjustment; as a result, its fiscal and current account deficits will take longer to adjust and will become more challenging to finance, as rates and spreads are rising and net capital inflows are receding. Debt levels and spreads will continue to edge higher in Colombia and its currency may weaken more than those of its peers.
Ecuador is in a more difficult position since it cannot deploy monetary policy (it uses the U.S. dollar) and faces a more urgent fiscal adjustment. In Venezuela, the macroeconomic, social and political situation is becoming more unstable, and a credit event is only a matter of time.
Weaker U.S. Growth
Our lower U.S. forecast has particularly negative implications for Mexico (its northern neighbor buys around 80% of its exports) and Colombia (36% of total exports). For the rest of the region, financial linkages are the dominant tie to the U.S.
In this regard, our call for delayed—and more gradual—U.S. Federal Reserve rate hikes would partly offset the effects of lower U.S. growth, as it would grant more breathing space to some central banks. A slower pace of Fed tightening would also help contain the deceleration of net portfolio inflows and currency-depreciation risks.
Moreover, our analysis indicates the odds of a U.S. recession triggered by financial stresses have increased significantly (to 42%). Such an unraveling would not only affect Latin America (and the rest of the world) via the trade channel; a U.S. recession would also trigger a flight to quality, further undermining the region’s declining net portfolio inflows. In such a scenario, commodity prices may weaken further, affecting fiscal revenue and currencies; spreads would widen, and growth would weake.