Itaú BBA - Global Soft Patch, Effects in Latin America

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Global Soft Patch, Effects in Latin America

May 8, 2013

There are signs of a slowdown in the world economy in the short term.

You can watch our LatAm Macro Monthly in video. Ilan Goldfajn, Itaú's chief economist, talks about the outlook for Latin America and the global economy. Watch the video here.

Global Economy
Transitory Weakness
Global economy has disappointed, leading central banks to keep expanding monetary stimuli. We expect the global economy to improve in 2H13

Brazil
Lower GDP Growth, More Fiscal Stimulus
We reduced the forecast for the fiscal primary surplus and GDP growth in 2013. Inflation will likely slow down temporarily, but core inflation should remain high  

Argentina
Under Pressure
The peso continues to depreciate fast in the “blue” market, and international reserves have dropped further

Mexico
Is There a Threat to Reforms?
We now expect the central bank to lower interest rates in 3Q13. We are still confident that the current administration will approve at least the key reforms in congress

Chile
Dealing With Lower Copper Prices
Weaker export prices will likely drag down activity, but only in 2014. We lowered our 2014 GDP growth forecast to 4.8%

Peru
The Impact of Lower Metal Prices on the Economy
We increased our forecast for the current account deficit and reduced marginally our forecast for GDP growth

Colombia
Will the Package of Measures Work?
Growth remains weak, but the government’s stimulus package reduces the risk of the economic recovery ahead

Commodities
Metal Prices to Stay at Low Levels
Commodity prices declined in April, led by disappointing global activity and U.S.-dollar appreciation. Fundamentals for base metals are consistent with lower prices throughout the year  

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Global Soft Patch, Effects in Latin America

There are signs of a slowdown in the world economy in the short term. The United States and China posted worse-than-expected results in the first quarter, and in Europe leading indicators suggest that the recession is not yet over. But the signs do not significantly alter our global GDP forecast for this year. We expect growth recovery in the second half. Although temporary, this weakness is leading to more monetary stimuli, including the vast expansion carried out by the Bank of Japan, lower interest rates at the European Central Bank, and the continuation of the quantitative easing by the Fed (we expect the tapering to start only in the fourth quarter of 2013).

Commodity prices have suffered as a result of the slowdown scenario, especially metals, which may affect some Latin American economies. Chile and Peru, major exporters of metals, tend to see slightly higher current account deficits and less strong economic growth. In Colombia, economic growth continues to disappoint, which has prompted the government to launch a new stimulus package.

In Mexico, the continuity of reforms has created expectations for favorable economic performance. Recent conflicts in the coalition add uncertainty to the outlook, but not enough to divert the country from the reform path. The maintenance of monetary stimuli globally reinforces the exchange rate appreciation and falling interest-rate scenario in Mexico. We are bringing forward our forecasted drop in interest rates to the third quarter of this year.

Brazil has been adopting stimulative policies – mainly fiscal – to promote growth recovery, which continues to disappoint. We are reducing our growth forecast to just below 3% in 2013. Meanwhile, the economy has been facing persistent inflation. How will monetary policy react? Our scenario is a 1.0 percentage point rate hike in 2013, but some of the members of the monetary policy committee may vote for stronger hikes.

In Argentina, pressure on the economy is building up: strong depreciation of the peso in the parallel market, falling international reserves and more price controls. The government has seen its approval ratings falling further and is now facing new popular demonstrations.

Global Economy
Transitory Weakness
 

  • Global economic indicators have weakened and disappointed recently

  • We see this as a transitory period of low growth before the global economy improves in 2H13

  • The weakness, even if transitory, further delays discussion of reducing monetary stimuli

  • In Japan the aggressive quantitative easing could well keep the Yen weak in the medium term.

Global economic indicators have weakened recently. The U.S. GDP expanded at a 2.5% seasonally adjusted annual rate (SAAR) in 1Q13, weaker than our forecast of 3.1%. We expect further moderation to 1.3% in 2Q13. In China, GDP expanded 7.7% yoy in 1Q13, also below the 8.0% we expected. And leading indicators suggest that the recession in the euro zone will extend into 2Q13. We lowered our 2013 GDP forecasts for these three economies (see below).

We believe the weakness will be transitory, and we continue to expect better growth in 2H13.  We already expected a slowdown in the U.S., given the fiscal contraction in the economy. Overall, we see the U.S. in soft patch for the next couple of quarters rather than in persistent slowdown. In China, growth in 2Q13 will already likely be better than in the first. Only in Europe does the economic situation remain more delicate, with persistent downside risks to recovery in 2H13.

What does the soft patch imply for policy?

We see only small changes to the already expansionary monetary policies across the globe. The European Central Bank (ECB) has cut its main rate to 0.5% from 0.75%. In the U.S., the last FOMC meeting statement has already shown some flexibility. We believe this is consistent with our call that the QE tapering will happen in the 4Q13, instead of mid-year as suggested by the minutes of the March meeting.

For emerging markets this means an extension of the low interest rates, capital inflows and exchange-rate appreciation.

In terms of fiscal policy, the debate is intense, but we don’t forecast a change in direction.  In our scenario, the fiscal drag remains an important headwind this year, but it will decline substantially in 2014.

In China, policymakers appear comfortable with the 1Q13 deceleration. They emphasize the ongoing economic restructuring, which sometimes is not in lockstep with growth. Hence, we don’t see strong stimulus ahead. 

Finally, base-metal commodity prices have fallen in response to weaker global data and some idiosyncratic shocks. We are lowering our year-end forecasts.

U.S. – Soft patch ahead

Activity indicators in the U.S. have turned south. The softening is consistent with our scenario, in which after expanding at a 2.5% (SAAR) in 1Q13, the U.S. economy will go through a soft patch during the next few quarters. We have revised our GDP forecast slightly downward, to 1.8% from  1.9% in 2013 due to lower-than-expected 1Q13 growth.

Transitory factors that boosted growth and are now wearing off explain part of the slowdown. Inventory accumulation contributed 0.8 percentage points to GDP growth last quarter (see graph). This pace is inconsistent with current data, and the ISM Manufacturing index already points to a deceleration.

Consumption grew 3.2% (SAAR) in 1Q13, financed by a decline in household savings to 2.6% from an average of 3.6% in 2012. We believe this drop in savings is not sustainable. Core retail and vehicle sales have decelerated recently, indicating that the savings rate is converging back to 3.0% and slowing down consumption.

In addition, the federal government’s spending cuts (known as the Sequester) are to take place gradually in 2Q13 and 3Q13, leading to a deceleration in GDP growth.

Finally, with the soft patch ahead, we expect the FOMC to postpone any tapering of its Asset Purchase Program to the 4Q13, instead of mid-year as suggested by the March minutes. We already saw the Fed more flexible in the May meeting statement, saying it is "prepared to increase or reduce the pace of its purchases", depending on the "outlook for the labor market or inflation changes".

Europe – Recession goes on; ECB responds with a small rate cut

Leading indicators suggest that the euro area remains in recession in the second quarter of 2013. The composite Purchasing Managers Index (PMI) stayed at 46.9 in April, well below the 50 threshold that separates recession from expansion. The data is consistent with the -0.15% quarterly pace we forecast for the first and second quarters of 2013.

We still expect GDP to resume expansion in 2H13, but downside risks remain high. Households and non-financial corporations on the periphery continue to pay elevated interest rates when borrowing from banks. Outstanding bank loans to the private sector in countries like Spain and Italy maintain a downward trend (see graph). Business and consumer confidence are recovering very slowly from the lows reached last year.

As a consequence, we expect slightly lower growth in 2H13. For the full year, we reduced our GDP forecasts to -0.7% from -0.6% in 2013 and to 0.7% from 0.9% in 2014.

The ECB responded to the weakness in activity by reducing the main refinancing rate to 0.50% from 0.75% in May.  In our view, the change signals willingness to do more but provides very little boost to the economy. If growth does not resume in the second half of 2013, we believe that the central bank will eventually expand its balance sheet to facilitate credit to small and medium enterprises in the periphery, or take the deposit rate, currently at 0%, into negative territory.

China – Slowdown in 1Q13

Sluggish manufacturing and a softening in investment slowed GDP growth from 7.9% in 4Q12 to 7.7% yoy in 1Q13, lower than our forecast of 8.0%. The move halts the rebound seen in the Chinese economy during the second half of 2012.

The weakness in activity continued in March. Industrial production was 8.9% higher than one year ago, down from an average of 9.9% in the first two months of the year. Nominal fixed-asset investment weakened to 20.7% yoy, from 21.2%. Real Estate investment, reflecting government restrictions, plunged to 17.6%, from 22.8% earlier. The positive exception was nominal retail sales, which was up 12.6%, compared with 12.3% in the previous two months.

We don’t expect a further slowdown in the next few quarters. The quarterly GDP expansion will likely increase from 6.8% (qoq, SAAR) in 1Q13 to 7.8% in 2Q13 and 3Q13. Hence, we have mainly incorporated the lower-than-expected 1Q13 growth and revised downwards our 2013 GDP forecast to 7.7% from 8.0%. For 2014, we kept our forecast of 7.7%.

We don’t foresee strong policy reactions in response to weaker data.  Government officials have said GDP and employment were still within a “reasonable” range. They highlight the country should prioritize economic reforms and rebalancing over short-term growth. First-quarter data show some tentative signs of progress in this regard, with consumption contributing 4.3 percentage points to GDP growth, more than the 2.3 p.p. from capital formation.

Japan – Will Japanese investors flood the world with financial flows?

The BoJ announced on April 4 a new and much more aggressive asset purchase program. Japan’s central bank aims to defeat deflation and raise inflation to its new 2% target. The BoJ will mostly purchase Japanese government bonds and bills.

Since the announcement, we have being asking ourselves whether Japanese investors would boost purchases of overseas portfolio assets. Lower real yields domestically could make foreign bonds more attractive. Japanese investors seeking yields abroad could impact financial flows across the globe.

But rather than outflows, recent data show that Japanese investors continue to repatriate funds. Weekly data for international securities transactions show that residents sold, in net terms, about ¥186 billion (US$ 1.9 billion) and ¥1.2 trillion, respectively, of foreign equity and debt assets in the two weeks following the April meeting (see graph).

Anecdotal evidence, however, suggests that Japanese outflows could still happen. Part of the continuing inflow is due to portfolio-rebalancing and profit-taking after the sharp depreciation of the yen. And the BoJ policy change is too recent to have generated significant asset reallocation by Japan’s big institutional investors. Still, many of the major Japanese life insurance companies and pension funds have suggested in their investment plans for the 2013 fiscal year that they will consider increasing foreign bond investments.

Commodities – Metal prices set to stay at low levels

Commodity prices fell 4.0% (according to our Itaú Commodity Index, or ICI) in the April average, as a result of a combination of shocks. First, inventory estimates released at the end of March suggested a weaker-than-expected demand for grains and oilseeds, leading to a fall in agricultural prices (chiefly corn). Second, a selloff in precious metals affected other asset classes, like futures contracts for base metals and energy. Finally, Chinese growth in the first quarter disappointed, leading several forecasters (including us) to revise GDP estimates downward for this year.

Given the deteriorating outlook for demand, what are the changes in our year-end forecasts?

The main revision is for base metals, as slower expansion in China and sluggish supply growth force prices down throughout the year. We revised our year-end forecasts for the ICI base metals sub-index to -4.2% yoy (previously: 5.1%). We haven’t changed our view for iron ore, though. We still expect prices to fall to around $125.0 per ton by December, from an average of $137.7 in April.

We revised our year-end forecasts for the ICI energy sub-index upward, to 3.7% yoy from 2.6% previously, despite the notable drop in crude oil prices caused by a weaker macro outlook and looser short-term balances. This adjustment reflects lower natural gas inventories in the U.S., leading to higher gas prices. We also maintained our Brent year-end price forecasts at $110/bbl, as refinery operating capacity recovers and oil supply is affected somewhat by geopolitical issues.

Prices and fundamentals evolved roughly in line with our scenario for agricultural prices, as we had already incorporated the impact of lower demand in our last report. However, two risks must be monitored in the coming weeks. First, corn planting in the U.S. is long overdue. It could start in the following weeks, but the crop may be less resilient to adverse weather. Another possibility is a shift of planted area to soybeans, which would change the supply outlook for both commodities. The second risk is the development of bird flu in China and its effects on demand for corn and soy meal.

Brazil
Lower GDP Growth, More Fiscal Stimulus
 

  • We reduced our forecast for the fiscal primary surplus this year to 1.5% from 1.9% of GDP. For 2014, we maintained our forecast at 0.9% of GDP.

  • We reduced our GDP growth forecast for this year to 2.8% from 3.0%. The expansion in the first quarter was probably somewhat lower than we expected, and there are signs of further moderation at the beginning of the second quarter. For 2014, we reduced our GDP forecast to 3.3% from 3.5%. 

  • Inflation will likely slow down, but the scenario of high core inflation will probably remain unchanged. Our forecasts for the IPCA are at 5.6% this year and 6.0% in 2014.

  • We maintained the forecast of a 1 percentage point increase in the Selic rate in 2013. However, the existing stimulus and persistent inflation will likely lead some of the members of the Monetary Policy Committee (Copom) to vote for larger rate hikes.

  • We reduced our forecast for the trade balance in 2013 to 6 billion dollars from 10 billion dollars. We raised our forecast for the current account deficit to 3.0% from 2.9% of GDP in 2013. We expect the exchange rate at around 2.00 reais per dollar by the end of this year and 2014.

More fiscal stimulus in 2013

Recent decisions confirm the intention to promote a more accommodative fiscal stance (at least) in 2013. The data for March showed a worse fiscal performance, offsetting the unusually strong result posted in January. Year to date figures point to a lower primary surplus in 2013, mainly due to tax cuts. Signals of new tax cuts and lower budgetary contribution from regional governments suggest that the fiscal surplus will likely remain low and on a downward trend ahead.

Our calculations indicate that the recurring primary surplus (which excludes atypical or temporary revenue and expenditures from the conventional result) fell to 1.5% of GDP, the lowest reading since April 2011. In March, the public sector posted the second lowest fiscal result for the period since the beginning of the historical series (2002), reflecting tax cuts and administrative costs (“gastos de custeio”). The primary surplus in March stood at 3.5 billion dollars, or 0.9% of GDP. The 12-month rolling conventional primary surplus fell from 2.2% of GDP in February to 2.0% in March.

The National Treasury will no longer need to compensate for lower-than-expected fiscal results from regional governments. This change in rule proposed in the 2014 budget guidelines bill (PLDO) will be in force this year as well (following congressional approval of this amendment to the 2013 budget law). This change signals an attempt at greater flexibility for fiscal stimulus, and it creates new incentives to reduce the fiscal effort on regional and central governments.

 We lowered our forecast for the consolidated primary surplus in 2013 to 1.5% of GDP from 1.9%. We also reduced our primary surplus forecast for the central government, to 1.15% of GDP from 1.40%, with higher tax cuts and administrative costs (“gastos de custeio”). We still expect a sharper drop in the primary result of states and municipalities, which will likely reach 0.3% of GDP in 2013 (previous forecast: 0.4%), compared with 0.5% in 2012.

For 2014, we maintain our forecast for the consolidated primary balance at 0.9% of GDP, with a 0.9% result for the central government (exactly the target provided in the budget guidelines law) and a primary surplus for regional governments standing at practically zero. We believe that in the next year the central government will produce new tax cuts, which will likely amount to around R$90 billion (1.7% of GDP), against expectations of R$60 billion (1.2% of GDP) in 2013. Our estimate also assumes real-expenditure growth at a pace of 5% in 2014 (similar to our 2013 expectations). These fiscal actions will probably be part of an economic policy strategy designed to stimulate the resumption of activity growth.

Slightly lower GDP growth

We reduced our forecast for GDP growth in 1Q13 to 1.0% from 1.2% qoq/sa. Industrial production grew 0.7% mom/sa in March, below our 1.3% forecast. During 1Q13, industrial activity advanced 0.8% qoq/sa. The highlight was the weakness of the Mining sector, due to the decline in oil and iron ore production. While Mining fell 7.3% in the first quarter, Manufacturing grew by 1.5%. However, the first signs for April suggest a cool-down. The data point to a moderate growth of economic activity in the coming quarters. The expansion trend is still gradual and volatile. Furthermore, economic growth remains not very widespread. Exports are weak, and retail sales have slowed.

Strong investment in the first quarter, but weak ahead. On the demand side, the highlight in the 1Q13 GDP was probably investment. However, the decline in the confidence indices for the Industrial and Service sectors suggest a slowdown in gross fixed-capital formation ahead. This supports the scenario of moderate economic recovery throughout the year.

Credit market shows signs of recovery. Credit concessions, in real terms, grew 12.8% in March yoy. This pace exceeds the growth registered in the second half of last year. Delinquency in consumer loans more than 90 days past due fell slightly, to 5.35% in March from 5.42% in February, marking the sixth consecutive month of retreats. Delinquency in corporate loans dropped to 2.20% from 2.24%. Interest rates and spreads declined again.

The labor market conditions remain positive despite the slower pace of hirings and a slowdown in wages. The unemployment rate stood at 5.3% in March, and we expect it to hover around this level throughout the year. Both formal and informal hirings decelerated somewhat, but not enough to alter the unemployment rate. Furthermore, real wages slowed. Lower nominal increases and higher inflation reduced real gains. Despite the lower growth outlook for income, the labor market will still support consumption in 2013, along with the signs of credit expansion.

We reduced our forecast for GDP growth to 2.8% from 3.0% in 2013, and to 3.3% from 3.5% in 2014. The outlook of lower growth in the first quarter reduces the carry-over for the year. Moreover, recent data reinforce the slowdown scenario in the second quarter, which may be more intense than anticipated. For 2014, fiscal and quasi-fiscal incentives will probably be higher. Therefore, we expect stronger growth compared with this year. However, lower GDP growth in 2013 will likely lead to lower growth in investment in 2014.

Temporary relief in inflation, fundamentals unchanged

Inflation suffered continuous upward pressure early this year, ending the first quarter with a 1.9% gain, compared with 1.2% in the same period of 2012. This result drove the 12-month consumer price index (IPCA) to 6.6%, above the upper limit of the target range. The relief resulting from the 18% discount on electricity tariffs (-0.60 pp impact on IPCA) was not sufficient to compensate for the strong pressure of food prices, which rose 4.6% in 1Q13 (impact of 1.1 pp on IPCA).

The inflation outlook remains unfavorable; diffusion index and core measures remain high, despite some cool-down at the margin. Services inflation also remains under pressure, although increasing slightly less in the first quarter than in the same period of 2012 (2.5% versus 2.8%). Several changes in relative prices have affected the current inflation. On the one hand, there is the lift in food inflation due to supply shocks. On the other hand, there are the tax cuts, which likely reduced inflation by about 1 percentage point in the last 12 months. The smoothed trimmed means core is a measure of inflation that isolates an important part of such effects. This measure accumulated a gain of 6.2% in the 12 months through March, indicating that an upward trend is in fact occurring.

Despite the pickup early in the year, we expect inflation to retreat in the coming months, mainly due to the food group. Food prices will likely begin to reverse part of the increase posted in prior periods, due to remaining effects of the tax cut over the "cesta básica" and mainly due to the pass-through of falling agricultural prices. The recent sharp decline in grain prices already passed through to pork and chicken prices. Also, the normalization of the perishable food supply after the price hikes early in the year will probably bring major relief to inflation in the coming months. Between May and October, we expect inflation to range between 0.27% and 0.38% on a monthly basis.

The fundamentals, driven by the heated labor market and the persisting increase in inflation expectations, indicate an unfavorable balance of risk for inflation over longer periods. Thus, we don’t see a reversal of this outlook, given the fiscal and monetary stimulus in place. Our forecasts for the IPCA remain unchanged, at 5.6% for 2013 and 6% for 2014. Core inflation measures indicate that underlying inflation is slightly above 6%.

Divided Copom

Brazil’s central bank initiated a cautious adjustment in the monetary policy rate. The higher and more widespread inflation led the Copom to raise interest rates in April. Going forward, the Copom indicated that "internal and especially external uncertainties" warranted that monetary tightening be carried out with caution. In our view, the signal is consistent with our scenario of a 1.0 percentage point hike cycle in the Selic rate, at a pace of 0.25 percentage point hikes per meeting.

The global outlook in the short term reinforces the Copom’s cautious stance represented by a 0.25 percentage point rate increases per meeting. The latest figures show weaker growth in major world economic blocs. Commodity prices are stabilizing at a lower level compared with the end of last year. Internally, the recovery remains uncertain. There are signs of growth below expectation, and temporary relief to inflation in the coming months.

Persistent inflation, however, may lead to a split decision in the next Copom meeting. Although not the majority, some members of the Copom may argue that there is no alternative than more monetary policy tightening in order to keep inflation under control and bring it back to the target path.

We continue to forecast a hiking cycle of 1 percentage point in the Selic rate this year.

Oil negatively impacts trade balance and raises current account deficit

We reduced our forecast for the trade surplus this year to 6 billion dollars from 10 billion dollars. The trade balance in April was negative by 994 million dollars. On the positive side, the highlight was exports of 7.2 million tons of soybeans. On the other hand, delayed imports of refined fuels continue to negatively affect the trade balance. Moreover, the crude oil trade balance is negative by 1.5 billion dollars for the year. The significant drop in production of this commodity, along with the increase in refining, led us to estimate that crude oil will contribute about 3 billion dollars to the trade balance in 2013, down from a previous estimate of 7 billion dollars (equal to last year's contribution).

The trade balance revision increased our forecast for the current account deficit to 3.0% from 2.9% of GDP by the end of 2013. This deficit exceeds foreign direct investment (FDI). In March, the 12-month rolling current account deficit reached 67 billion dollars, while FDI reached 64 billion dollars. This is happening for the first time since 2010, reinforcing our expectation of deterioration in the balance of payments in 2013. With the current account deficit above the FDI, other sources of funding are needed. Otherwise, the exchange rate will depreciate or international reserves will fall.

We continue to expect the exchange rate at 2.00 reais to the dollar by the end of 2013 and 2014. Fiscal policy easing and the deterioration of the external accounts have contributed to an increase in the risk premium. This reflects fundamentals which are compatible with a more depreciated exchange rate than previously. Moreover, economic policy signs suggest that the desired exchange rate stands at around 2.00 reais per dollar.

 

Please open the attached pdf to read the full report and forecasts.



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