Deficits cloud Latin America outlook

03/10/2009 | Thierry Ogier

Rising current account deficits and falling foreign direct investment flows, combined with deteriorating fiscal positions, could dampen Latin America’s economic feelgood factor.

Most Latin American countries in the region expect to return to growth next year after muddling through the global financial crisis – but Brazil, Argentina, Mexico, Chile and Colombia are all due to register larger fiscal deficits next year, according to the International Institute of Finance (IIF).

This suggests that long-term sustainable growth will only be achieved if some of the pitfalls that have marred public policy in Latin America in the past can be avoided.

Brazil’s fiscal deficit is expected to grow from 1.5% of GDP this year to 3.5% in 2010, the IIF estimates. Standard & Poor’s, the credit rating agency, has hinted at a possible sovereign downgrade in Mexico, as the fiscal deficit may hit 4% of GDP next year. Argentina is also expected to register a fiscal gap in 2010, following a surplus of 0.8% of GDP this year.

Latin America’s performance in difficult times has also benefited from the rebound in commodity prices and capital flows, and general policy trends have been positive, the IMF has said. The Fund is forecasting a 2.5% average drop in GDP this year, followed by a 2.9% rebound next year. The IIF forecasts are -2.4% and 3.9% respectively.

Joerg Decressin, head of the World Economic Studies Division at the Fund’s Research Department, said: “Latin America has come through this crisis much better than they did during previous crises. That is a testament to the strength of the macroeconomic framework that you have in many Latin American economies.

“We see just a modest current account deficit emerging in the future,” he said.

Nevertheless, a deterioration in the global environment, or even a sluggish recovery in the developing economies, would have an adverse effect.

Nicolas Eyzaguirre, Western Hemisphere director at the Fund, said that a double dip recession in the US “would be a mess” – although he rates the probability of such an event as low. “Latin America is better prepared than in the past, but Central American countries and Mexico are more exposed.”

Daniel Volberg, Latin America economist at Morgan Stanley in New York, said: “With final demand in advanced economies still weak, relying on export-driven growth may be a risky bet for Latin America.”

There are also conflicting views regarding the inflation outlook, which reflects the degree of uncertainty about the global economy. While the IMF has forecast declining inflation amidst renewed growth – with some notable exceptions, such as Venezuela – the IIF has forecast “higher inflation next year with a measured tightening of monetary policy”.

Interest rates are expected to go up during the first half of 2010 in Mexico and Colombia, and in Brazil and Chile by the end of that year, according to the IIF.

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