Outlook Improves In North America; Slower Growth in Latin America
The clear divergence in economic growth trends between the developed economies in North America and Latin America widened during the third quarter. The U.S. is now the fastest growing developed country in the world, and has lifted the outlook for Canada and Mexico, two of its major trading partners in the region. Consumer sentiment remains buoyant in the U.S. on lower fuel prices, and as the labor market continues to strengthen. Though the U.S. Federal Reserve has ended its bond purchases, borrowing costs are expected to remain affordable in the short to medium term. Canada’s labor market also remains healthy, though low oil prices could limit the economic activity in select regions such as Alberta that depend heavily on energy production.
Most Latin American countries, except Mexico and Colombia to some extent, are facing slower growth on lower energy and commodity prices. Mining output continues to decline in most of these countries while new projects are being delayed as investors have become less enthusiastic. Domestic demand growth has also slowed in recent months, dragging manufacturing output lower in most countries. Low expectations from President Rousseff, who has been reelected for another term, have weakened investor sentiment in Brazil. Chile and Peru, the two countries that are in sound fiscal health, have initiated additional stimulus measures to revive growth.
At a Glance
United States: Economic growth remains healthy, and the fastest among developed countries, as further labor market gains and lower fuel prices have lifted consumer sentiment. The Federal Reserve has ended its bond purchases, but borrowing costs are likely to remain low as the Fed has pledged to maintain the current size of its bond portfolio.
Canada: Though lower oil prices are likely to restrict further gains, the outlook for Canada’s exports remains relatively healthy on strong U.S. demand. The labor market in Canada rebounded in September after the previous month’s decline. The central bank continues to hold interest rates steady.
Brazil: While the newly reelected President Rousseff has promised bold reforms to revive economic growth, investors remain skeptical. The economy is likely to see only a marginal expansion this year, as the central bank continues to hold its benchmark rate unchanged on inflation risks.
Mexico: Vigorous U.S. demand is expected to lift the Mexican economy in the coming quarters. However, lower oil prices could reduce government revenues and the flexibility to expand public spending.
Chile: Weak international copper prices have reduced the country’s exports this year, and the growth rate slowed significantly during the second quarter. The government has announced fiscal stimulus measures while the central bank has lowered interest rates in recent months.
Peru: Growth forecasts for the current year and 2015 have been lowered as the economy expanded less than expected during the second quarter. To prevent further decline, the government has expanded its stimulus program while interest rates have also been lowered.
Colombia: Though the pace of expansion has moderated, Colombia remains the fastest growing economy in the region. Domestic demand remains healthy and the central bank is expected to keep interest rates unchanged in the short term.
Argentina: The country has technically defaulted on some of its debt obligations after refusing to comply with a U.S. court order to repay residual holders of bonds defaulted earlier. Its economic outlook remains weak, though the country has recovered from recession.
UNITED STATES: ROBUST CONSUMER SENTIMENT HELPS SUSTAIN GROWTH MOMENTUM
The U.S. economy continues to see healthy growth trends and has become the primary driver of global growth, even as most other developed economies struggle. The pace of growth for the second quarter has been revised higher and most indicators suggest that the expansion was likely sustained during the third quarter as well. The potential for further gains in consumer spending should help the U.S. economy in the coming quarters. In addition to the strengthening labor market that is expected to push up wages, the steep fall in fuel prices has resulted in a meaningful reduction in household budgets. This has clearly started reflecting in consumer confidence, which has improved more than expected in recent surveys.
After the robust recovery in recent years, the housing market gains have moderated in recent months. Average housing price gains have shifted lower in most cities and have even seen modest declines in select cities where the market had recovered faster. Inventory levels of new homes, at about five months of sales, remain low and builders are more optimistic about demand outlook, according to recent surveys. Existing home sales trends have been less uneven when compared to new home sales, but have recovered in September after a decline during the previous month. Mortgage rates remain highly affordable when compared to historic levels, though tougher credit standards have discouraged some potential buyers in the recent past. That may be about to change as some of the mortgage refinance companies have agreed to lighter credit standards for borrowers, including lower down payment requirements.
The labor market saw further improvement during the third quarter and the unemployment rate has now slipped to the lowest level since the financial crisis. Job additions have been fairly healthy, and are likely to be sustained as the robust domestic demand is expected to encourage businesses to step up hiring. Average wages have also seen modest gains recently, and have helped lift consumer sentiment.
The Federal Reserve has formally ended its bond purchases, but has indicated that it will maintain the current size of its bond portfolio until economic conditions improve further. Proceeds from maturing securities in the Fed’s portfolio are also being reinvested, thereby delaying the potential rise in borrowing costs. The Fed has noted the recent labor market gains but believes the lower than expected inflation demands that the current record low interest rates be maintained. However, the subdued consumer price gains are partly due to cheaper fuel and the Fed is likely to review its policy based on evolving inflation and labor market trends.
CANADA: EXPORT OUTLOOK REMAINS POSITIVE, THOUGH OIL REVENUES ARE SET TO DECLINE
While the robust U.S. demand continues to help Canada’s economic outlook, the substantial fall in oil prices could limit further gains. Canada is one of the major exporters of crude oil to the U.S. and much of the country’s production is from oil sands, an expensive source of oil. Some of the production from Canadian oil sands could turn unprofitable if prices remain weak. In addition, U.S. import demand has been on the decline as domestic production continues to rise. These trends have started reflecting in Canada’s trade data as the country’s trade account slipped into a deficit in August, after three months of surpluses, as oil exports declined. Exports of automobiles were also lower in August, but this was likely due to seasonal shifts that could correct in subsequent months.
Weaker oil prices and the fall in equity markets have dented consumer confidence in Canada recently, though businesses remain positive according to a Bank of Canada survey. The labor market remains fairly healthy, adding 74,000 new jobs in September after a moderate decline in the previous month. The unemployment rate has slipped to a five-year low and average wages continue to rise. The Bank of Canada has maintained its benchmark rate unchanged at 1 percent for the last four years. The central bank expects the Canadian economy to expand by 2.2 percent this year and 2.4 percent in 2015.
Canada’s housing market remains robust as easier credit availability and low mortgage rates have helped sustain demand. The International Monetary Fund has warned that the Canadian housing market remains overvalued and household debt levels are elevated. The IMF has suggested further regulatory measures to restrict housing demand and prevent another price bubble.
BRAZIL: INVESTORS REMAIN SKEPTICAL OF PRESIDENT ROUSSEFF’S NEW REFORM PLEDGE
Dilma Rousseff, reelected recently for another term as Brazil’s president, has promised significant policy changes to address the weak economic growth that has beset the country in recent years. The decline in commodity prices after the global financial crisis has led to slower growth in exports from Brazil and a fall in industrial investments. Public demonstrations against high living costs worsened the environment as lower revenues restricted the government’s ability to sustain public spending. The government forced the utility companies to lower prices to diffuse the political crisis, but the intervention alarmed investors. Markets remain skeptical of the new reform pledge, as indicated by the fall in equity prices after the election result announcement.
After weakening during the first half of this year, the Brazilian economy has shown signs of a modest revival during the third quarter. Manufacturing growth was marginally above expectations in August while retail sales also expanded at a faster pace. The unemployment rate continues to fall, and is helping domestic consumption. Foreign direct investment flows were also above expectations during the months of July and August. The government has increased fiscal support measures to exporters and manufacturers since the beginning of this year, including a tax credit to exporters that is expected to cost over $2.5 billion in 2015. Exports declined nearly 2 percent during the first eight months of this year when compared to the same period last year. Nevertheless, the cheaper currency is expected to help exporters in the coming months.
Brazil’s central bank has left its benchmark rate unchanged in recent months, despite the weak growth rate, and at 11 percent is one of the highest among major economies. Inflation moved above the upper end of the central bank’s target range in September, but the central bank anticipates price levels to moderate next year. The bank expects the economy to expand by 0.7 percent this year while the International Monetary Fund has forecast a slower pace of 0.3 percent for this year, before recovering to 1.4 percent in 2014.
MEXICO: EXPORT DEMAND AND CONSUMER SPENDING LIFT CURRENT PACE, BUT LOW OIL PRICES CAUSE CONCERNS
The Mexican economy is seeing a moderate uptrend in growth rate on stronger U.S. demand, but cheaper oil prices could dampen the pace in the coming quarters. The manufacturing sector is expanding at a healthy rate, and continues to lift the labor markets. Job additions in recent months have been above expectations and the unemployment rate slipped closer to 5 percent in September. Accordingly, consumer sentiment has turned more positive and retail sales growth has accelerated. Low interest rates are encouraging borrowers to refinance their mortgages and other debt, and helping them to increase consumption.
However, lower oil prices could reduce government revenues and limit the ability to increase public spending. Following the recent steep fall in oil prices, the Mexican government has reduced its crude oil export price estimate for 2015 to $79 a barrel. The government had estimated an average export price of $94 per barrel for this year’s budget. A third of the government’s budget is financed by oil revenues, and a fall in oil export revenues could widen the budget deficit. The government had earlier announced plans to reduce its budget deficit to 1 percent of GDP for 2015, from an estimated 1.5 percent of GDP this year.
The Bank of Mexico has left its policy rate unchanged in recent months as the economy appears to be benefiting from earlier rate cuts. Though inflation has increased in October, the central bank is confident that price levels would decline next year. Economists surveyed by the bank expect rate increases by the third quarter of 2015, if the current growth projections hold. The economy is likely to expand between 2 percent and 2.8 percent this year, and 3.2 percent and 4.2 percent in 2015, according to central bank estimates.
CHILE: GOVERNMENT TO STEP UP SPENDING IN 2015 TO REVIVE THE ECONOMY
The Chilean economy has decelerated appreciably this year, as lower commodity prices have restricted export gains and the manufacturing sector has also weakened. International prices of copper, Chile’s major export, remain subdued and are nearly 35 percent below the high set in 2011. After a short recovery during the second quarter, copper prices have corrected again as concerns about Chinese demand rose. Exports of copper from Chile declined more than expected in August, restricting the volume growth in copper shipments since the beginning of this year to 4.5 percent.
Lower mining output and weak manufacturing restricted Chile’s economic growth to 1.9 percent annualized during the second quarter, compared to 4.1 percent for the whole of 2013. The sluggish trends continued during the third quarter as manufacturing contracted further. The unemployment rate has increased when compared to last year and, as a result, domestic consumer spending has also moderated. Chile’s central bank expects the economy to expand between 1.75 percent and 2.25 percent this year, before accelerating in 2015.
To prevent further economic deceleration, the Chilean government is stepping up public spending. The government is increasing spending by nearly 10 percent in 2015, to be financed by the tax increases recently approved by the president. The country’s central bank has also continued its interest rate cuts in recent months, allowing the Chilean peso to depreciate against the U.S. dollar this year. Economists surveyed by the central bank expect the benchmark rate to remain at the current level for most of next year.
PERU: GOVERNMENT EXPANDS FISCAL STIMULUS TO COUNTER EXPORT WEAKNESS
Peru has been one of the fastest growing economies in Latin America over the last decade, helped by the commodity price boom and cautious government policies to manage the export revenues. However, the ongoing decline in commodity prices has slowed economic growth as the country is now expected to post a trade deficit for the third year in a row. Lower export realizations have led to a fall in new mining projects and investments. This is expected to continue in 2015 as well, as Peru’s central bank expects both mining production and investments to fall further. The bank has lowered its growth forecasts for the current year to 4.0 percent, from 5.5 percent earlier, and to 6 percent for 2015.
Economic growth slipped appreciably to 1.7 percent annualized during the second quarter, when compared to the same period a year ago. Aggregate output was nearly unchanged during the April-June period, relative to the first quarter of this year. Capital investments declined during the quarter while exports were also lower. In response, the government has expanded its fiscal stimulus measures to boost domestic demand. This is expected to help the economy expand at a faster pace during the second half of this year.
To help revive investments and credit demand, the central bank cut its benchmark rate and lowered reserve requirements for banks during the third quarter. Inflation has slowed in recent months and is forecast to fall further to 2 percent, the mid-point of the central bank’s target range, next year. The Peruvian sol has also weakened this year on a weaker economic outlook and the reduction in interest rates. To stabilize the currency, the central bank started selling U.S. dollars during the last week of September.
COLOMBIA: DESPITE SLOWER EXPORT GROWTH, ECONOMY REMAINS FASTEST IN THE REGION
After outpacing most of its neighbors since last year, the Colombian economy is expected to see growth moderation as oil prices have declined appreciably. Most of Colombia’s oil exports were earlier destined for the U.S., where a surge in domestic production has reduced the reliance on imports. As a result, Colombia has more recently started seeking out Asian buyers such as India for its crude oil. Nevertheless, the U.S. remains Colombia’s largest trade partner by far and the positive U.S. demand trends should help Colombia’s exports in the coming quarters. Apart from crude oil, coal, and select farm produce, Colombia supplies nearly two-thirds of all cut flowers imported into the U.S.
Colombia’s second quarter economic growth at 4.3 percent annualized was below expectations, and appreciably lower than the 6.4 percent mark achieved during the first quarter. The pace of expansion was restricted by lower production in the oil and mining sectors, as renewed violence by militants disrupted operations. However, further gains in construction activity helped the economy as the government sustained its spending on public works as part of a stimulus program announced last year. The government expects the economy to expand by 4.7 percent this year, and is likely to remain the fastest growing economy in the region.
After hiking its benchmark rate for each of the five previous months, Colombia’s central bank left the rate unchanged in September. Though domestic demand continues to expand at a quick pace, the central bank expects lower export growth in the coming months. Inflation has moved past 3 percent, the mid-point of the central bank’s target range. The currency has also seen a moderate correction recently, allowing the central bank to scale back its dollar purchases to $1 billion during the third quarter. The bank had initiated the currency market interventions last year to prevent currency appreciation and had purchased nearly $2 billion during the second quarter of this year.
ARGENTINA: DEBT DEFAULT WORSENS THE ECONOMIC OUTLOOK
Argentina defaulted on some of its debt payments in July, after a U.S. court prevented the country from paying interest on its borrowings before settling the claims from the holders of bonds defaulted in 2002. The government initially rejected the court ruling, arguing that paying the residual holders of defaulted bonds would attract more claims that would be difficult for the country to honor. To bypass the court ruling, the Argentinean government initially proposed to pay foreign bondholders locally or swap their current holdings for new bonds that are outside international jurisdiction. Lack of interest for these proposals is likely to encourage the government to negotiate a settlement with the holdout investors.
After contracting for two successive quarters, the Argentinean economy expanded marginally during the second quarter when compared to the first three months of this year. Though the economy recovered from a technical recession, aggregate output was mostly unchanged from the same period of last year. Better than expected farm output helped offset the decline in domestic industrial activity and investments due to import restrictions. The Argentinean government had earlier introduced import controls to tide over a severe shortage of U.S. dollars and other currencies. The economy is expected to contract during the second half of the year as the economic environment has become even more uncertain after the debt default and a nation-wide workers’ strike in August. Declining foreign currency reserves have forced the government to introduce additional restrictions on currency transactions.
Nevertheless, the government is hopeful that the growth will rebound to 2.8 percent next year as exports revive. In its most recent budget forecasts, the government is also optimistic of slower inflation in 2015. However, any improvement in export volumes would depend on a rebound in international farm commodity prices. In addition, the recent currency devaluation would likely push up import costs and keep inflation elevated.
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