IMF Warns: Commodities Bonanza for Brazil and LatAm Is Over

Vale do Rio Doce Latin American economies are facing an awkward combination of slowing activity, more difficult external conditions, and still-high inflation. After four years of strong output growth, the pace eased in most economies of the region during the first half of 2008, largely because of moderating exports, according to the IMF World Economic Outlook.

Domestic demand has remained quite robust so far this year, sustained by terms of trade gains for commodity exporters, but is expected to be dampened as the global economy slows and by the shift toward monetary policy tightening to contain inflation. Countries in the region have also been facing more difficult external conditions in recent months.

Latin America has been increasingly affected by turbulent conditions in mature financial markets, with equity prices falling sharply, spreads widening markedly, access to dollar funding tightening appreciably, and exchange rates coming under pressure, especially in commodity-exporting countries facing lower export prices.

Overall, GDP growth is projected to come down from 5½ percent in 2007 to 4½ percent in 2008 and 3¼ percent in 2009. The somewhat sharper deceleration in 2009 than envisaged in the July 2008 World Economic Outlook Update reflects the weaker global outlook, softer commodity prices, and more difficult external financial conditions.

Growth in Brazil would come down below trend, and activity would remain sluggish in Mexico as exports and remittances are dampened by the US slowdown. Growth in Central America and the Caribbean is also expected to ease, reflecting the impact of slow US growth on remittances, trade, and tourism, as well as high fuel costs.

Some numbers for country growth in the region, 2008 and 09, follow: Argentina, 6.5% and 3.6%; Brazil, 5.2% and 3.5%; Chile, 4.5% and 3.8%; Colombia, 4 and 3.5%; Ecuador, 3 and 3%; Mexico, 2.1% and 1.8%; Peru, 9.2% and 7%; Uruguay, 6.5% and 5.5% and Venezuela, 6% and 2%.

Headline inflation for the region as a whole rose to 8% in August, the highest rate in five years, although it is expected to moderate in the latter part of 2008 and 2009, helped by softening international commodity prices, tighter monetary policies, and slowing demand growth.

Still, inflation will remain at double-digit levels in a number of countries in the region, including Bolivia, Paraguay, the República Bolivariana de Venezuela, and several Central American countries, and analysts believe that actual inflation in Argentina is considerably higher than the official rate of 9% in August.

Although nominal wage growth has remained under control in most countries, high inflation expectations are feeding into wage negotiations in countries such as Argentina and the República Bolivariana de Venezuela, where capacity constraints are tight.

In countries with inflation-targeting central banks?Brazil, Chile, Colombia, Mexico, and Peru?inflation has also risen, in some cases above target ranges, but increases have generally been more contained than elsewhere in the region, and there are signs of stabilizing or even declining inflation expectations for some countries.

In response, central banks have raised policy interest rates, most actively in the inflation-targeting countries, where exchange rate appreciation has also helped contain inflation pressures. In Brazil, monetary policy tightening has been supported by an increase in the primary fiscal surplus target for 2008 by ½ percentage point of GDP.

However, fiscal policy has not in general been restrictive across the region, in part because of the budgetary impact of delayed pass-through of international oil price increases and increased explicit subsidies.

Although inflation should now gradually recede, monetary tightening is still warranted in some countries where real interest rates have become significantly negative and there is a sense that policy credibility is being eroded.

Central banks with inflation-targeting regimes have earned some limited scope to tolerate temporary deviations of headline inflation from objectives, but, depending on evolving risks to activity, some may still need to raise rates further.

At the same time, tighter control over the growth of government spending would help restrain domestic demand growth and reduce exposure to adverse shifts in market sentiment.

External positions are generally robust, although the turbulence in the global economy may erode the cushions that have been built up over the past few years. The region's current account balance is expected to move to deficit in 2008 and 2009, after being in surplus since 2003, but the deficit will remain quite low.

Moreover, reserve levels are high, and flexible exchange rates provide room to maneuver in a number of countries. Overall, public sector balance sheet vulnerabilities have been reduced and credit ratings raised. Brazil and Peru both achieved "investment grade" ratings in recent months.

However, conditions for US dollar funding have tightened in several countries over the past month, which together with a sustained drop in commodity prices could stretch macroeconomic policy frameworks.

Risks to this outlook are to the downside, largely related to external developments. A deeper downturn in global growth could trigger a sharp drop in commodity prices, while external financing conditions facing Latin America could continue to tighten.

Such a scenario would slow growth in the region even more, and although inflation would moderate considerably, external positions could come under serious stress. In this event, policymakers would need to stand ready to adapt policies as needed to preserve macroeconomic stability and the prospects for long-term growth.

Those few countries with very strong fiscal positions may have some scope for a countercyclical fiscal response. Flexible exchange rate management would provide resilience in the face of potentially volatile foreign exchange flows.



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