As regular readers are no doubt aware, we’ve devoted quite a bit of time to covering Brazil’s unfolding economic meltdown. The latest data [17] out this week showed GDP in “free fall mode” (to quote Barclays), inflation hitting double digits for the first time in over a decade, and unemployment soaring to 7.9% in August, up sharply from just 4.3% a year earlier.
In many ways, Brazil is representative of the problems facing EM as a whole. Slumping commodity prices, currency carnage, FX pass through inflation, sensitivity to decelerating Chinese demand and to Beijing’s yuan deval, Brazil has it all - they even have a seemingly intractable political crisis, and as we never tire of pointing out, idiosyncratic political risk factors have become an important part of the EM calculus (see Turkey and Malaysia for instance).
Because Brazil tends to dominate the discussion when we talk about Latin America, it’s sometimes easy to forget that the outlook for Brazil’s neighbors matters as well. Latin America is a net commodities exporter and we can learn a lot from observing the interplay between slumping prices for commodities, rising inflation, lackluster economic growth, and central banks forced by the prospect of rising prices to adopt procyclical, rather than counter-cyclical policies despite their weakening economies.
When last we checked in on Latin America as a whole, we said the following [18]:
“...a plunging currency, FX pass through inflation, and a soft outlook for growth is a pretty terrible place to be in if you’re a central bank, but that’s exactly where things stand for the “LA-5” (believe it or not, that’s not a reference to the Lakers, it’s short for Brazil, Chile, Colombia, Mexico, and Peru), who very shortly will be forced to decide whether the risks associated with further FX weakness outweigh those of hiking rates into a poor economic environment.”
We went on to highlight comments from Goldman regarding the likely path for Latin American monetary policy given the factors outlined above.
Now, Goldman is out with its latest take on the macro outlook for Latin America and unsurprisingly, the forecast is "uninspiring."
"Latin America’s growth performance has been eroding since 2010, and has unreservedly disappointed in recent years. Aggregate regional growth peaked in 2010 at above 6%, moderated steadily throughout 2011-13, and downshifted sharply to a significantly below-trend pace during 2014-15," Goldman begins, adding that "unfortunately, the near future may not be more endearing as we do not envisage a major pickup in growth buoyancy and expect inflation to remain relatively high."
Here's a more comprehensive assessment:
Given the shifting external backdrop, the region is unlikely to count on strong balance of payments dynamics to leverage and support a visible economic recovery. The expectation of low-for-longer commodity prices, weak non-commodity export demand, moderating FDI and portfolio inflows, and likely more expensive and selective access to external funding, may well demand additional current account adjustment. This would require further currency depreciation, higher domestic savings and contained investment (i.e., weak domestic absorption). Furthermore, we see virtually no room for additional countercyclical fiscal or monetary stimulus to support a more vigorous recovery.
[19]
And here's a big picture look at the growth/inflation outlook across the region:
[20]
As you can see, the inflation/growth mix doesn't look particularly favorable. As Goldman goes on to note, "Latin America is forecasted to grow an uninspiring +0.8% in 2016; a very shallow recovery from the -0.3% growth rate forecasted for 2015." Consider the following graphic, which underscores the extent to which the region is performing well below trend:
[21]
Subpar, disappointing growth that's disastrously below trend and will remain marginally so through 2020. Got it.
Of course what you don't want if you've got lackluster growth, is rising inflation because that sets the stage for the "S" word. Unfortunately, that's where Latin America looks to be headed. Here's Goldman on the inflation outlook:
Despite the weak growth dynamics, inflation is expected to remain high across LatAm. Average inflation ex-Venezuela is expected to reach 8.1% in 2016, down slightly from the forecasted 8.7% average for 2015.
[22]
In Brazil, headline inflation is expected to end 2015 in double digits and to moderate gradually throughout 2016, albeit to a still very high 6.5% due to weak policy fiscal and monetary policy credibility, renewed deterioration of inflations expectations, additional BRL depreciation, lingering upward pressure on administered and regulated prices, strong inertial forces, and widespread formal and informal indexation mechanisms which introduce significant downward rigidity (stickiness) in price formation.
Overall, inflationary pressures across the Andean economies are expected to remain relatively high throughout 1H2016 given the expected lagged pass-through from currency depreciation and the impact from what is expected to be an intense El Niño weather phenomenon.
And finally, coming full circle to our original discussion of how high inflation and weak currencies have put regional CBs in a position of having to, at the least, remain on hold and more likely adopt procyclical policies despite the tepid outlook for growth, Goldman suggests that "the scope for monetary accommodation in the region in 2016" is limited at best. "In Brazil, sticky above-target inflation should limit the capacity of the central bank to ease monetary policy in 2016 [and] the central banks across the Andean region have been normalizing monetary policy during 2H2015 given persistent and generalized above-target inflationary pressures," Alberto Ramos (the Goldman analyst who has a talent for making lists of Brazil's myriad problems that are so long as to induce riotous laughter) adds.
Last, but certainly not least, here's how the FX situation will likely develop in 2016:
Regional currencies have weakened significantly in 2014-15 and we expect further weakness in 2016. We expect most currencies to depreciate moderately in 2016 given the evolving global backdrop (low commodity prices with additional declines forecasted for copper prices, rising dollar yields, and strengthening USD), the unhappy domestic combination of low growth and high inflation, and a number of idiosyncratic factors.
So while it's probably too strong to equate the overall regional outlook with the stagflationary nightmare gripping Brazil, all of the above does indeed suggest that Latin America is stuck with a decidedly unfavorable growth-inflation outcome which is likely to worsen materially going forward. On that note, we'll close with one last passage from Goldman:
Despite the undistinguished growth outlook, in our assessment, the spectrum of risks is still tilted to the downside. In fact, the vector of risks is to a large extent not materially different from the risks the region was facing at the beginning of 2015, namely: (1) sharperthan-expected growth deceleration in China; (2) another leg down in commodity prices; (3) potential quasi-sovereign and private corporate sector forced deleveraging or balance sheet distress given heavy borrowing over the last few years and diminished profitability, and, last but not the least, (4) sharper-than-expected deceleration of capital inflows triggered by a strengthening USD, rising Dollar yields, and/or renewed bouts of volatility in international financial markets that could dampen sentiment towards emerging markets.
