OUTLOOK ’22: Higher US interest rates, China slowdown weigh on LatAm GDP

Al Greenwood

28-Dec-2021

HOUSTON (ICIS)–Growth in the three largest economies in Latin America will slow markedly in the upcoming months – if they grow at all – as the countries struggle with high inflation and the prospects of a stronger dollar and slower growth in China.

Brazil is already in a technical recession after posting its second consecutive decline in GDP earlier in 2021. Argentina will likely default on its loan from the International Monetary Fund (IMF) if it cannot negotiate new terms.

In South America, slower growth could become a reinforcing trend. Brazil and Argentina are members of the Mercosur trading bloc, and they rank among each other’s largest export markets. Slower growth in Argentina could drag down GDP in Brazil, and the same in Brazil could slow the economy in Argentina.

Mexico should resume its years-long trend of growth below 3%, a rate slower than that of the US, with which it has close economic ties.

The following table shows the forecasts for economic growth and inflation based on surveys conducted by the countries’ central banks. The central banks published the forecasts before the 15 December meeting by the Federal Reserve, the central bank of the US.

Brazil Mexico Argentina
2021 GDP 4.65% 5.70% 9.7%
2022 GDP 0.50% 2.80% 2.5%
2023 GDP 1.90% 2.10% 2.1%
2021 Inflation 10.05% 7.22% 51.1%
2022 Inflation 5.02% 4.03% 52.1%
2023 Inflation 3.46% 3.60% 40.8%

Source: central banks

STRONGER DOLLAR
The US dollar is expected to strengthen further in 2022 because the Federal Reserve is tightening monetary policy to control inflation, which has consistently exceeded the central bank’s target of 2%.

The tightening campaign will take place in two stages. The central bank has already started the first phase, under which it is tapering its monthly purchases of Treasurys and mortgage-backed securities. On 15 December, it voted to speed up the pace of those reductions, advancing the timeline when it could start raising interest rates.

Federal Reserve board members and bank presidents expect the central bank will raise rates three times in 2022, raising it to nearly 1% from close to zero.

The federal-funds rate acts as a benchmark, so other interest rates will also rise.

The rise in rates will have a cascading effect on the global economy. Higher US interest rates will attract money into the country, increasing the value of the dollar against other currencies.

WEAKER CURRENCIES
The currencies of the Brazil real and Mexican peso and the Argentine peso have all weakened against the dollar during 2021, as shown in the following table. The Argentine figures represent the official exchange rate.

Exchange Rates Brazil reis (R) Mexico peso (Ps) Argentina peso (PS)
1-Jan-21 5.19 19.92 84.08
15-Dec-21 5.68 21.04 101.8
% Change 9.44% 5.62% 21.08%

Source: Xe

Economists expect exchange rates to continue weakening in 2022 with the exception of Brazil, as shown in the following table. The forecasts were made before the 15 December meeting by the US Federal Reserve.

Exchange Rates Brazil Mexico Argentina
2022 average R5.55 Ps21.30 Ps161.00

Source: central banks

Weaker exchange rates contribute to inflation. In Brazil, this exceeds 10%, well above the central bank’s target of 2.25-5.25%.

In response, the Brazilian central bank has started raising the nation’s benchmark Selic interest rate. The rate now stands at 9.25%, and the bank stressed the need to put monetary policy significantly into restrictive territory, acting as a brake to the economy.

The bank expects to increase the rate by another 1.50 points at its next meeting. Economists expect the rate will reach 11.50% in 2022. Inflation should reach the high end of the central bank’s target range.

As in Brazil, inflation is running ahead of Mexico’s target of 3%. Similarly, the central bank has been increasing interest rates. In November, it rose by a quarter point to 5.00%. Economists expect Mexico’s interest rate will end 2022 at 6.00%. Inflation will still remain above the central bank’s target of 3%.

For Argentina, one of the common measures of the country’s financial market is the BADLAR. This is the annual interest rate for fixed-term deposits that exceed peso (Ps) 1m for 30-35 days in private banks. As of 15 December, the rate stood at 34.13%.

Economists expect it will end 2022 at 35.00%.

A lot will depend on the course of inflation. The rise in interest rates and tightening of monetary policy could tame prices. More relief could come from higher production of oil and natural gas from OPEC and its allies (OPEC+) as well as countries outside of the cartel. Logistical constraints could work themselves out.

On the other hand, logistical constraints could take longer to sort out. A resurgence of the coronavirus could jam up ports and restrict output. Oil production could continue to lag demand.

These surprises would require interest rates to rise beyond the high levels predicted by the economists.

SLOWER GROWTH IN CHINA
Higher interest rates in themselves tend to slow down the economy.

For Brazil and Argentina, both countries will have to contend with slower growth in China, by far their largest export market and a big buyer of their commodities.

China’s two main manufacturing purchasing managers indices (PMIs) were close to 50 in November, the level that indicates neither growth nor expansion. One was 50.1 and the other was 49.9.

Slower industrial production and the problems in China’s real-estate sector point to a long-term structural slowdown, according to John Richardson, senior consultant, Asia.

Fitch Ratings, a credit-ratings agency, said that growth in China’s GDP could slow to 4.8% in 2022, down from 8% in 2021.

LATAM POLICY RESPONSE
In Brazil, the danger is that the administration could adopt policies to improve the prospects of re-election in the upcoming presidential election in 2022.

Already, Brazilian President Jair Bolsonaro is effectively increasing the size of the country’s spending cap so his administration can increase monthly economic-aid payments. Although the administration is nominally in compliance of the spending cap, the market interpreted the move as a breach. The nation’s stock market fell and the currency weakened.

Some trends are outside of the control of the Brazilian government.

A historic drought has caused output to decline in Brazil’s important agriculture sector, contributing to the country’s technical recession.

The drought also decreased hydroelectric production, causing Brazil to import much more expensive liquefied natural gas (LNG) to power its thermal plants.

In Mexico, economists surveyed by the central bank continue to express concerns about arbitrary policy-making and erosion of the rule of law.

Such worries could make companies more reluctant to invest in new plants and capacity.

In Argentina, the country’s chronic financial problems will likely prompt the government to maintain restrictions on foreign exchange and imports as well as keep caps on prices. This will make it more difficult for local companies to import needed feedstock and equipment or pass through higher prices.

Thumbnail shows Latin American currencies. Image by Al Greenwood

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