Itaú BBA - Challenging Decade, Better Latin America

Macro Latam 2020

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Challenging Decade, Better Latin America

March 20, 2012

It is not an easy task: to combine a subjective judgment of economic and political trends with the rigor of a general equilibrium model.

Long-Term Scenario

Once a year we try our hand at drawing a long-term scenario. It is not an easy task: to combine a subjective judgment of economic and political trends with the rigor of a general equilibrium model.

This year’s report has new features. Going beyond Brazil, we bring scenarios for the U.S., the euro zone and China, as well as Argentina, Chile, Colombia, Mexico and Peru. There’s also a separate section on commodities.

Economists think of potential growth in terms of a combination of capital and labor, and touch of “productivity”. How will those three evolve around the world in the remainder of the decade, and how much growth should we expect?

Productivity growth is harder to estimate and a frequent source of surprise, both positive and negative. Labor trends, on the other hand, arise more neatly from demographics, while macroeconomic conditions indicate capital availability.

It will be through these lenses that we analyze the growth potential of these many countries — adapting when needed to the particularities of each economy. In China, for instance, we analyze the impact of migrations on productivity. In Europe, any long-term discussion must start from a vision for the configuration of the monetary zone.

Through these lenses, the global outlook for the next years looks challenging, but emerging economies will probably continue to do better, Latin America among them.

Best regards,
Ilan Goldfajn and Economic team


Introduction
Challenging Decade, Better Latin America

The next ten years will be challenging. Emerging economies – Latin America among them – will continue to do better than advanced economies.

U.S.
Persistently Low Growth

We see potential growth at 2.1% until the end of the decade, due to a smaller demographic expansion, low savings rates and slower productivity gains.

Eurozone
Challenges to the Monetary Union

Greece will not attain fiscal and external balance without sharpening its competitiveness; in order to adjust it, the country could eventually leave the monetary union. Portugal would have the challenge of dealing with the contagion. The euro would probably survive, within a union of greater fiscal integration.

China
Necessary Rebalancing

We expect potential growth to slip to 6.5%-7.0% by the end of the decade, with a rising share of consumption and services in the economy.

Commodities
Still on the Rise

Growth in emerging markets and rising costs should push real prices up 10% by 2020.

Brazil
Growth Limited by Savings

We forecast a growth rate of around 4.0% until 2020. The country needs to deal with the lack of workers and savings in order to expand more quickly. Faster growth would probably pressure the external accounts, the exchange rate and/or inflation.

Latin America
Potential Growth Will Slow Down but Remain High

Investment and productivity gains will likely support strong economic growth, despite less-favorable demographic trends.


Introduction
Challenging Decade, Better Latin America

The next ten years will be challenging. Emerging economies – Latin America among them – will continue to do better than advanced economies.

The U.S. and Europe: too many drags on growth

In the U.S. and Europe, an ageing and indebted population will continue to weigh on the growth, although that is not exactly news. The difference now is that investment won’t help either.

In the U.S., high debt – private and public – will continue to cause balance sheets to shrink as the country deals with the excesses that led to the current crisis. That means a few more years of limited investment and consumption. We estimate potential GDP growth of 2.1% through the end of the decade.

In Europe, the reality of low growth is even more stark. We estimate potential GDP growth at 1.1%. Aging and migration will likely cause a decline in the working-age population (15 to 64 years old). In most countries, and particularly in the periphery, fiscal reform is badly needed to restore public-sector solvency and competitiveness. A tragic circularity may set in: reforms initially hurt growth, raising more doubts about solvency. Those doubts keep interest rates high, reducing growth, and demanding even more fiscal tightening.

The adjustment will take time, discipline and political resources that perhaps not all euro-zone countries can muster. Greece could eventually need to leave the euro zone. Portugal would face the challenge of fighting contagion.

China: seeking a soft landing

Deng Xiaoping famously thought it didn’t matter if a cat was black or white, “so long as it catches mice.” Deng was preparing China for fast growth, the imbalances of which were, to a large extent, ignored. Now, other priorities arise: sustainable energy usage, a wider consumer base, deeper and safer banking, less dependence on export markets. In addition, demographics will help growth in China less than in the last ten or twenty years.

The country is obviously not a small, open economy, and it cannot, as in the past, take the world as a given. China shapes the world just as the world shapes China, and growth will have to respect that. Taken together, these factors suggest growth will, from now on, be more balanced, less risky, but perhaps more modest. We expect potential GDP to decline to 6.5%-7.0% by the end of the decade, with a greater share of consumption and services in the economy.

Emerging economies and LatAm

Emerging economies are the world’s reserve of raw material, workers, consumers, and investment projects. Many have become politically more stable. Most now boast macroeconomic stability, better economic rules, and a more business-friendly environment. Capital has lived up to the improvement: it is flowing; and will likely continue to do so as growth falters in advanced economies. The share of emerging markets in global GDP will continue to rise.

In Latin America, even with weaker demographic tail wind, investment is likely to sustain growth. Potential GDP will probably decelerate, but stay high.

We expect Peru to remain the fastest-growing economy, with a potential growth estimate of 6.3%. Colombia comes second (5.1%). Mexico has the lowest potential growth estimate in our Latin American sample (2.7%), a fact that reinforces the need for productivity-boosting reform. Chile’s potential GDP growth (4.2%) is falling as a result of slower expansion of working-age population. In Argentina (3.0%), a worse demographic trend will be compounded by a greater drop in productivity due to distortions caused by economic policy.

Brazil: many opportunities, little savings

Brazil has a rich consumer base, well-developed financial markets and a wealth of natural resources. The country is also a stable, open democracy with about a quarter-century’s worth of investment backlog to catch up with.

That means a wide range of investment opportunities in commodities, infrastructure, consumer and service markets. But where will the money come from?

Brazil saves too little. This picture will improve, but slowly. The public sector will likely go back to saving, but will not save enough to offset the gap with investment. It is hard to see household savings rising in a society that’s incorporating millions of new consumers.

Over the next years (or for as long as the investment boom lasts), that gap will have to be bridged by foreign savings. That means running a permanent current account deficit, financed by strong capital inflows (such as foreign direct investment), which will keep the currency appreciated.

We expect GDP growth of 3.5% in 2012 and 5.1% in 2013. From 2014 on, we estimate growth at potential, around 4.0%. Trying to grow faster would probably pressure the external accounts, the exchange rate, and/or inflation.

Commodities: prices to increase due to higher income and rising costs

Rising income in emerging markets will keep demand strong forfood — both protein and industrialized— and energy, with oil and natural gasincreasingly taking over from sources such as coal and biofuel. Production, however, will happen at higher marginal costs: crops from worse land, metals from deeper mines, oil and gas from less-friendly places such as shale – not to mention greater operational and political risk. In this context, prices are likely to continue to rise in coming years. We forecast a 10% increase in real terms by 2020.

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



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