Latin America: The shadow of China

Latin America: the shadow of China

Juan Ruiz

BBVA Research│Chief Economist for South America

Latin America Outlook – Second Quarter 2014│ Madrid, 13 May 2014

Latin America Outlook / May 2014

Page 2

The global cycle remains robust, especially in developed economies, while China is slowing down. The world economy growth will increase from 3% in 2013 to 3.4% in 2014 and 3.8% in 2015.

Latam’s financial markets recovered in March and April. Looking ahead, they will be shaped by the effects of the Fed’s withdrawal of monetary stimulus and the pattern of growth in China.

Latam will grow by 2.3% in 2014 and 2.5% in 2015, similar to 2013. Growth will be below the region’s potential and very heterogeneous, with the Pacific Alliance countries performing well above the regional average.

External deficits remain high and the fiscal perspective worsens, but both deficits continue to be manageable, on the whole.

An unlikely scenario of sharp deceleration in China would have a substantially negative effect on South America. The shock would be absorbed better by the Andean countries, which have more scope for countercyclical policies.

Key messages 1

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1 Global economy: the recovery continues, hand in hand with developed economies

2 Moderate growth in 2014 and 2015, below the region’s potential and very heterogeneous across countries

3 A faster deceleration than anticipated in China would have a significant impact on South America

Contents


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World GDP growth (% QoQ) Source: BBVA Research

Global cycle: growth remains robust at a quarterly 0.8% in the first half of the year

Growth is still solid and financial conditions have improved in emerging economies, but

world GDP is not accelerating

Higher growth in developed economies partly offsets lower growth in emerging economies

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Tensions have fallen in financial markets since the beginning of the year

BBVA financial tensions index in developed and emerging economies Fuente: BBVA Research

Markets have moved to the tune of expectations of rises in US interest rates …

The Fed’s communication policy and forward guidance has side-stepped further increases in

long-term interest rates and has reduced financial tensions

… and growth expectations in China, as well as idiosyncratic factors.

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Deceleration in China is confirmed, although growth is still above 7%

China: GDP growth (% YoY) Source: BBVA Research

Doubts about the cyclical strength of the Chinese economy have made themselves felt

in 1Q14, but less than anticipated

In turn, the authorities are taking measures to contain the vulnerabilities caused by the

boosts in 2008-09

Greater loss of cyclical inertia in investment than in consumption

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Forecasts in May 2014

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Raw material prices adjust downwards, especially industrial metals

Brent Crude (USD/bl) Source: Bloomberg and BBVA Research

Soy bean (USD/mt) Source: Bloomberg and BBVA Research

Copper:(USD/lb) Source: Bloomberg and BBVA Research

Adjustments in the medium- and long-term growth scenario in China are impacting on long-term price changes in copper and oil

This adjustment is limited as long as the production costs continue to set a lower limit to prices Soy bean prices are higher than expected because of the poor harvest in Brazil, while convergence to the

downside is expected in the medium-term

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Aceleration in world activity in 2014 and 2015, with the help of developed countries

World growth forecasts (% YoY) Fuente: BBVA Research

Forecasts in US and Europe remain steady. Growth is on an upward path

Revision to the downside of growth forecasts in the main emerging economies

Greater contribution to world growth from developed economies than in 2013, but

emerging markets still make up 2/3rds of growth

EAGLEs is the group of emerging economies which will contribute most to world GDP in the next 10 years. The group is composed of: China, India, Indonesia, Brazil, Russia, South Korea, Turkey, Mexico and Taiwan.

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Forecasts in May 2014 Forecasts in Feb 2014


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1 Global economy: the recovery continues, driven by developed economies



Contents


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After the idiosyncratic shocks of January-February, there has been a widespread

recovery in asset prices in Latam

Capital flows to Latam are back on track, after the weakening in January

Asset price recovery has virtually recouped the losses since January, but not since May 2013

In Latin America, the markets forget (for the time being) about tapering

Sovereign differentials in emerging markets (EMBI, index January 2013=100) Source: Haver and BBVA Research

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Latin America will grow 2.3% in 2014 and 2.5% in 2015, rates similar to 2013

Internal demand has moderated in the last few quarters, particularly investment

Activity will gradually recover in 2014-15, supported by an increase in world growth

Latam*: GDP growth (% YoY) Source: BBVA Research

* Weighted average of Argentina, Brazil, Chile, Colombia, Mexico, Paraguay, Peru, Uruguay and Venezuela

Increasing heterogeneity: the Pacific Alliance will grow around 4% in 2014 and 2015, well

above the region as a whole

In the longer term, regional growth will start converging towards its potential, at around

3.5%

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Peru, Paraguay and Colombia will continue to grow the most

Mexico’s growth will rise strongly in 2014, after the rough patch in the

construction sector in 2013

Brazil will show moderate growth, of 2% in 2014, held back by monetary tightening and structural problems

Latam countries: GDP growth (% YoY) Source: BBVA Research

*MCS: Mercosur. **PA: Pacific Alliance.

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ARG BRA CHI COL MEX PAR PER URU Latam MCS* PA**

Forecasts in May 2014

Forecasts in Feb 2014


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Box 2: Highly dynamic house prices , but no significant risks

Steep increase in housing prices in the region. Signs of overvaluation in Brazil and,

to a lesser degree, in Colombia

All in all, higher housing prices have been closely linked to improved income and, in

some countries, land supply problems

Housing affordability: Price to family income ratio Source: Global Property Guide and BBVA Research

Macroeconomic risks in the event of a price adjustment are low. Mortgage lending is

very limited (except in Chile) 0

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Adjusted price to income ratio* Median


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Fiscal outlooks worsen in the region, but deficits will be manageable

Fiscal balances pressured to the downside by moderation in internal demand and lower raw

material prices

Latam: Fiscal deficit (% GDP) Source: Haver and BBVA Research

Public debt is at sustainable levels

Fiscal deficits in some cases will not go down until after 2015

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ARG BRA CHI COL MEX PAR PER URU Latam



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External deficits are high, but will start to diminish in 2014

Deficits will start to fall, especially in countries with a larger external gap (Peru, Uruguay)

Worse terms of trade and less demand from China…

Latam: Current account balance (% GDP) Source: Haver and BBVA Research

… are partly offset by less dynamic internal demand and increased growth in the US

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ARG BRA CHI COL MEX PAR PER URU Latam



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Inflation in line with central bank targets, apart from Brazil and Uruguay

Inflation driven by shocks to food prices and depreciation in the exchange rate

Inflation will converge on central bank targets at the end of 2014, with the exception of

Uruguay and (although less so) Brazil

The depreciation in the exchange rate will generate a generally limited pass through to

inflation

Inflation driven by shocks to food prices and depreciation in the exchange rate

Inflation will converge on central bank targets at the end of 2014, with the exception of

Uruguay and (although less so) Brazil

Deviation of YoY inflation from central bank target (pp) Source: Haver and BBVA Research

The depreciation in the exchange rate will generate a generally limited pass-through to

inflation

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Monetary pause in Latam for the rest of 2014, apart from Colombia and Chile. Generalised tightening in 2015

Heterogeneous monetary policy in the region conditioned by inflationary pressures (high in

Brazil and Uruguay)…

Official interest rates in countries with inflation targets (%) Source: Haver and BBVA Research

… and economies’ different positions in the cycle, with Colombia and, to a lesser degree,

Mexico, on the rising part of the cycle

Increased interest rates in Colombia and cuts in Chile in 2014. Stability in the remaining

countries for the rest of 2014

Rises in interest rates across the board in 2015, due to inflation (Brazil & Uruguay),

improvement in the cycle (Pacific Alliance) and increases by the Fed

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Exchange rates will depreciate in 2014 and 2015, with very heterogeneous intensities

Variation in the exchange rate against USD in countries with inflation targets (% Jan-Dec) Source: Haver and BBVA Research Greater depreciation in countries with:

1. Greater inflationary pressure (Brazil, Uruguay)

2. Greater exposure to fall in raw material price (Chile, Peru)

3. Greater exposure to China (South America)

4. Less central bank intervention (Chile)

5. Higher external deficits (Peru, Uruguay)

Among countries with floating exchange rates, the greatest exchange depreciations in the

future will be in Brazil and Uruguay ….

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BRA CHI COL MEX PAR PER URU

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Page 19

1 Global economy: the recovery continues, driven by developed economies



Contents


Page 20

A sharp deceleration in China is one of the principal risk scenarios for Latam

A very significant risk for Latam is a possible scenario of sharp deceleration in China,

although it is unlikely

This could be the result of excessive pressure on the parallel banking system, or a sudden

tightening in lending conditions

China: baseline and risk scenarios (% YoY) Source: BBVA Research

Main impact on investment, but also negative effects on consumption 4

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A negative shock in China would affect Latam through three channels

Lower external demand

Heavy impact on Chile, Peru and Brazil. Residual in the case of Mexico

Lower raw materials prices

More pronounced effect on industrial metals, linked to investment. Lower impact on

foodstuffs

Effect of the risk scenario in China on the price of raw material exports (% change from the baseline scenario) Fuente: BBVA Research

Drop in household and business confidence

This was one of the main transmission channels after Lehman Brothers went bankrupt

Transmission channels to Latam

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The impact on South America would be substantial, better weathered by the Andean countries

Substantial impact in the region, apart from Mexico. Reduction in South American growth

of around 1pp in 2014 and 2015

Internal demand strongly affected by the fall in confidence. Effect mitigated in countries with leeway for countercyclical policies (Colombia,

Chile, Peru)

Latam: impact on growth of the risk scenario in China (difference in pp from baseline scenario) Source: BBVA Research

Relatively low impact in Argentina because of the smaller drop in foodstuff prices compared

to metals and energy


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The global cycle remains robust, especially in developed economies, while China is slowing down. The world economy growth will increase from 3% in 2013 to 3.4% in 2014 and 3.8% in 2015.

Latam’s financial markets recovered in March and April. Looking ahead, they will be shaped by the effects of the withdrawal of monetary stimulus by the Fed and the pattern of growth in China.

Latam will grow by 2.3% in 2014 and 2.5% in 2015, similar to 2013. Growth will be below the region’s potential and very heterogeneous, with the Pacific Alliance countries well above the regional average.

External deficits remain high and the fiscal perspective worsens, but both deficits continue to be manageable on the whole.

An unlikely scenario of sharp deceleration in China would have a substantial negative effect on South America. The shock would be absorbed better by the Andean countries, which have more scope for countercyclical policies.

Key messages 1

2

3

4

5

Latin America: the shadow of China

Juan Ruiz

BBVA Research│Chief Economist for South America

Latin America Outlook – Second Quarter 2014│ Madrid, 13 May 2014


Page 25

Appendix: Growth forecast in Latin America

Source: BBVA Research. *Forecasts

2011 2012 2013 2014* 2015*

Argentina 8.6 0.9 3.0 2.8 2.1

Brasil 2.7 1.0 2.3 2.0 1.6

Chile 5.8 5.4 4.1 3.4 4.3

Colombia 6.6 4.0 4.3 4.7 4.8

Mexico 4.0 3.7 1.3 3.4 3.0

Paraguay 4.3 -1.2 14.4 5.3 4.2

Peru 6.5 6.0 5.6 5.2 5.6

Uruguay 7.3 3.7 4.4 3.2 3.3

Mercosur 3.5 1.3 2.3 1.1 1.5

Pacific Alliance 4.9 4.2 2.6 3.8 3.7

Latam 4.1 2.6 2.4 2.3 2.5

GDP growth (% YoY)

Latin America: The shadow of China

Economy & Finance

fiscal perspective

central bank

generally

exchange rate

world economy

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