EconSouth (Fourth Quarter 1999)
Latin America Hopes for
Brighter Prospects in New Year
While 1999 was a tough period for Latin America, the region looks to improve economically in the year 2000.
t's been a tough year for most Latin American countries. For the region as a whole, 1999 was the worst year in terms of real GDP growth since 1983 (see the chart). But the outlook for Latin America in 2000 is cautiously optimistic as conditions throughout the region are expected to improve.
Not least among the reasons for this optimism are the improved political stability in many of these countries and the success many of them had in dealing with real or threatened economic and financial crises during the past year or more. Continued progress by Latin American governments in working toward economic reforms may be important to improving the region's performance.
The great diversity among Latin American economies makes it difficult to provide a unified forecast for the region. But by analyzing the major countries' individual economies and the interactions among them it's possible to identify some common factors that signal an improved outlook for the region in 2000.
Containing the crisis in 1999
After months of global financial crisis that had begun in Asia in 1997 and then quickly spread throughout Latin America, the Brazilian central bank announced in January 1999 that the nation's currency, the real, would be allowed to float. The real had been closely managed from mid-1994 as part of the Real Plan, which introduced the new currency and was designed to stabilize Brazil's exchange rate and promote economic stability. While the Brazilian devaluation was widely viewed as a spillover from the Asian crisis and the Russian default in August 1998, it had more to do with Brazil's domestic economic and financial conditions — most important, the government's growing fiscal deficit.
Events in Brazil prompted speculation about a "contagion effect" that might harm other Latin economies. But, for a number of reasons, Brazil's crisis did not spread throughout the region and was contained with considerably less cost than was feared in January. While Brazil is the largest economy in the region, its connection to other Latin economies has perhaps been overstated, particularly as related to trade. Barring Argentina and the small bordering economies of Uruguay and Paraguay, trade ties between Brazil and the rest of Latin America are limited, suggesting that the devaluation in Brazil was unlikely to have had a severe impact on regional trade balances.
Perhaps the greatest fear raised by Brazil's crisis was that financial contagion could cause rapid capital flight not only from Brazil but from other Latin markets as well if investors saw Brazil's neighbors as vulnerable to the type of crisis it was experiencing. To counter these fears, many Latin countries were able to draw upon credibility gained over the previous several years by maintaining solid economic policies. In Argentina, for example, that credibility was based on the maintenance of its "convertibility plan," which links Argentina's peso to the U.S. dollar and prohibits money growth not backed by foreign reserves. Argentine authorities could also point to a greatly strengthened banking system with significant foreign participation.
The Argentine case is one example of how policy credibility and sound economic management allowed international investors to make important distinctions among Latin markets. This differentiation can be seen not only in the fact that the Brazilian crisis was contained but also in the spreads between U.S. and Latin American bonds, which did not move uniformly throughout 1999, indicating investors did not treat all counties the same.
Building on policy credibility in 1999 was perhaps the most noteworthy development in the region. Policymakers throughout Latin America acted quickly to stem the threat of contagion by implementing sound adjustments to fiscal and monetary policies. In most countries, budget deficits were trimmed and interest rates were increased to prevent capital outflows. The move toward a more balanced budget was part of a longer-term approach toward policy credibility, and interest rate hikes were a short-term policy adjustment. While interest rates have since been relaxed as the threat of financial crisis has waned, the effort to bring fiscal accounts more in balance has remained a cornerstone of many Latin American economic policies.
It can also be argued that multilateral financing, coordinated by the International Monetary Fund, helped stem the spread of Brazil's troubles. Although IMF funds were not enough to prevent Brazil's difficulties, the IMF had led the establishment of lines of credit to Mexico and Argentina that were available in the event of a run on these countries' assets. IMF backing may have assured investors that Brazil would be able to meet its commitments and therefore helped prevent massive capital outflows that otherwise might have occurred.
In addition, investors' realization that the problems leading to the real's devaluation were specific to Brazil helped prevent a general flight from Latin investments in the wake of the devaluation. The IMF is forecasting a rise in capital flows into Latin America in 2000.
Recession and recovery
Despite the region's ability to avoid a generalized financial crisis, economic conditions were nevertheless negative throughout most of Latin America in 1999. Growth had begun to weaken in mid- to late 1998 as a result of the Asian crisis' effects, including, most notably, rising interest rates, weak commodity prices, declining export demand and weakening banking sectors in some countries.
In Argentina, real GDP began to decline in the third quarter of 1998 and continued through the second quarter of 1999. Chile's economy also contracted from mid-1998 through mid-1999. Venezuelan output was hit by low oil prices and weak domestic demand, and Ecuador was also affected by low oil prices and the floods and poor fishing caused by the El Ni–o weather phenomenon. Meanwhile, Colombia fell into its worst recession since the 1930s and allowed its currency to float in September. In contrast to most of Latin America, Mexico and Peru have ridden out the international financial turbulence over the past two years; output in both these countries continued to expand in the first half of 1999 after a brief dip in the last quarter of 1998.
In Brazil, real GDP, after contracting in the second half of 1998, began to recover in the first half of 1999. Several factors account for this improved performance. Inflation remained relatively contained, reaching 6.4 percent in September 1999, and the government maintained policy credibility by controlling its spending. By controlling inflation and spending, the government was able to lower interest rates and thus fuel the recovery. Finally, Brazil's banking system was strong enough to withstand the negative effects of the devaluation, preventing the kind of generalized financial meltdown that had occurred in several Asian countries in 1998.
Real GDP Growth in Latin America
By mid-1999, signs began to emerge that an economic recovery was under way in other Latin American countries as well. Throughout the region, the nascent recovery has been spurred by declining interest rates, a pickup in commodity prices, rising capital inflows, an improving export picture and the implementation of stabilization policies in many countries.
Cautious optimism for 2000
Because of the divergent trends in recent Latin American economic developments, forecasts have shifted somewhat. For the region as a whole, a mild contraction was predicted earlier in the year, but real GDP is now expected to be flat in 1999; the projection for growth in 2000 has been revised up slightly to 4 percent. The positive outlook for the region is dependent on several country-specific developments, described below; the latest forecast data are shown in the table.
Argentina should benefit from the end of political uncertainty brought by October elections; incoming president Fernando de la Rua has pledged to continue the economic policies of his predecessor, a development that has calmed markets. Industrial production, which had been declining since mid-1998, began to rise in the third quarter of 1999, and the positive effects of the weaker dollar on Argentine exports should also provide some support. (Since Argentina's currency is pegged to the dollar, a depreciation of the dollar results in a depreciation of the peso.) The IMF is forecasting real GDP growth of 1.5 percent in 2000, following an estimated 3 percent contraction in 1999. The upturn in growth is dependent on firm policy responses to the challenges posed by Argentina's fiscal deficit and structural imbalances, especially in the labor market. Unemployment is not expected to worsen in 2000, so consumption should remain steady.
Although Brazil's government has made short-term adjustments, its lack of a long-term strategy to deal with its fiscal difficulties continues to dog the outlook. The IMF is forecasting real GDP growth of 4 percent in 2000 after a 1 percent contraction in 1999.
The recent rebound in copper prices — up 25 percent from summer 1999 lows — has improved conditions in Chile. Copper accounts for 40 percent of Chile's exports. Recoveries in Chile's Asian export markets and the effects of stimulative fiscal and monetary policies should also boost growth prospects in 2000. The IMF forecasts Chile's real GDP to expand by 5.5 percent in 2000 after experiencing a modest decline in 1999.
Colombia continues to suffer a decline in GDP. The fiscal imbalance has worsened, with the deficit accounting for nearly 5 percent of GDP, and the nation's banking sector has been weakened by the ongoing recession. The strength in oil prices in 1999 (up more than 111 percent since December 1998, from under $11 per barrel to over $23 dollars per barrel) should provide support given the growing importance of the oil sector in Colombia's economy. The IMF forecasts 2.6 percent real GDP growth in Colombia in 2000 following flat growth in 1999.
The rise in oil prices should also boost Ecuador's economy, but its economy is currently so damaged that higher prices for its chief export provide little solace. Ecuador continues to be mired in recession, and there is little chance of recovery until some time in 2000. The country's August default on its Brady bond obligations means that little in the way of capital flows will be coming into the economy until new repayment terms are worked out. Ecuador's government has not developed a sustainable set of economic policies, and this lack of progress has also hurt their economic performance. The IMF forecasts real GDP growth of 1.5 percent in 2000 following a 7 percent contraction in 1999.
Venezuela will also benefit from higher oil prices although the uncertainty surrounding the current government's economic policies, especially those dealing with foreign investment, continue. Low real interest rates are helping support the economy. The IMF is forecasting growth of 1.6 percent in 2000 after 1999's 7.6 percent decline. Strong oil prices should prevent a renewed downturn.
Mexico continues to set the economic pace for Latin America, posting positive GDP throughout 1999. Growing ties with other strong North American markets have helped Mexico over the past few years, so the outlook for the United States in particular has become particularly important. The IMF predicts Mexican growth of 5 percent on the heels of 1999's 3 percent growth. The August 2000 presidential election in Mexico may cause some nervousness because recent presidential elections in Mexico have been followed by financial crisis. But the kind of economic and financial imbalances that surrounded these earlier elections are considered to be much less of a concern this time around, and economic policy appears likely to remain stable regardless of the election's outcome.
Peru's economy appears to have slowed a bit in the third quarter of 1999 because of weak fishing and construction activity, but its outlook remains positive. The IMF sees real GDP growth in Peru of 5.5 percent in 2000 after 1999's 3 percent growth. Presidential elections scheduled for April 2000 should not alter Peru's outlook since the major candidates support Peru's current economic regime.
The inflation outlook in Latin America is positive, with only a few countries expected to register double-digit inflation rates for 2000. Economic stabilization programs, like Argentina's Convertibility Plan and Brazil's Real Plan, have helped bring consumer price increases down from over 1,000 percent annually in the early 1990s to an estimated regional average of between 8 percent and 9 percent in 1999. The devaluations in Brazil and Colombia in 1999 did not lead to a spike in inflation, a result, in part, of weak economic activity and tight monetary policies. Ecuador's inflation rate did jump in 1999 partly because of that currency's devaluation but also because a serious stabilization program has not been implemented.
Every forecast incorporates possible developments that can derail it, and there are several key caveats to the generally positive outlook for Latin America in 2000. The strength of the U.S. economy has been an important counterweight to the recent recessions in Latin America; trade and financial flows between the United States and Latin America were an important stabilizing factor in 1999. In 2000, most forecasters predict the U.S. economy will slow somewhat from the 3.5 percent to 4 percent growth rate of 1999. One risk to the positive Latin outlook lies with the possibility that the U.S. economy may slow more than expected or that the slowdown may begin before the predicted Latin recoveries are fully under way.
Perhaps the most significant risk to the forecast revolves around the ability of Latin American policymakers to maintain (or, in some cases, establish) credible economic policies. The last few years have been quite trying for the region; economic stabilization and restructuring were supposed to bring widespread benefits to Latin citizens. Economic and financial difficulties during these years have hampered this goal, but policymakers have for the most part stuck to the path of economic reform.
Still, in spite of these uncertainties, the outlook for most Latin American countries is that 2000 will be a much better year than 1999 has been. An important factor for all Latin American countries in achieving a positive performance in 2000 will be continued progress toward developing open, market economies.
This article was researched and written by Mike Chriszt, Stephen Kay and Elizabeth McQuerry in the Atlanta Fed's Latin America Research Group.