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outlook of Latin America
Economic development in Latin America, particularly in main Latin American economies (Argentina, Brazil, Colombia, Chile, Mexico and Peru) has been negatively affected by the Covid-19 Pandemic. Lately Latin America has been the global epicenter of the pandemic and, despite the delay in its effects on the continent, the pandemic has shown an all-too-family pattern of spread.
Woes of Latin American Economy
The pandemic struck Latin America at a time when the economic situation in the region was already precarious (to say the least) due to various idiosyncratic reasons. Some factors, such as high labour market informality and the poor quality of some institutions, could amplify the impact of the health crisis. However, in general, the pandemic is affecting the region through the key channels of trade, tourism, commodities, finance and domestic demand.
National containment measures, along with the global nature of the shock and the differential effects on the region, are seeing analysts revise their GDP forecasts for 2020 notably downwards, citing risk that is mostly tilted to the downside. According to Economic Commission for Latin America and the Caribbean (ECLAC), the Latin American economy is expected to shrink by 9.1% in 2020 due to Covid-19 pandemic; GDP is expected to drop 8.4% in Central America and Mexico and 9.4% in South America. S&P Global Economics has also dropped its GDP forecast for Latin America by over 2 percentage points to a reduction of roughly 7.5% in 2020. They expect the growth in 2021 will be just below 4%.
"National efforts must be supported by international cooperation to expand policy space through increased financing under favorable conditions and debt relief. Likewise, making progress on equality is crucial for effectively controlling the pandemic and for a sustainable economic recovery in Latin America and the Caribbean," Barcena (the United Nations Executive Secretary of ECLAC).
Impact of Covid-19 Pandemic
The economic downturn which began in early 2019 has clearly been exacerbated by the Covid-19 pandemic. Despite the late entry of the pandemic to Latin America compared to most of the other regions of the world, Latin America has been one of the hardest hit regions economically from the outset. This is due in large part to the fall in external demand, in particular from the U.S. and China, as well as from the abrupt tightening in financial conditions and the global decline in commodity prices.
Economies with high exposure to Chinese demand, such as Chile and Peru, experienced a severe hit to exports early in the first quarter of 2020; similarly, oil producers such as Colombia, were impacted long before Covid-19 cases started being reported in the region. Countries exposed to the U.S., such as Mexico, experienced a severe drop in their exports toward the end of the first quarter. Unemployment is consequently on the rise, with a current projected unemployment rate of 13.5% in the region. Such deteriorating conditions have also resulted in the rise of the rate of extreme poverty rate to a staggering 15.5%.
Inflation this year reached 5.9% in June, rising from 5.8% in May. Higher inflation is recorded in Mexico and Brazil, primarily owing to recovering energy prices, which drove the uptick. The majority of regional currencies lost ground against the US dollar and are projected to be substantially weaker this year than during the same period in 2019. Countercyclical monetary policy with a low-interest rates and more liquidity injections may help to stem the tide of imminent recession.
Growth and Betterment of Economy
Economic analysts, who observe the Latin American economy closely, have examined the extent to which GDP growth will be impacted, in combination with other macro-economic factors, and have predicted a widespread recovery in 2021. Growth should reach 1.4% in the current year and 2.1% in the next. The recovery will predicated upon the improvement of the global environment with some reduction in idiosyncratic uncertainty. With expansionary monetary policy in place, inflation should remain relatively low. Recovery will likely be widespread, with heterogeneous effects across Latin America. GDP for the next two years is expected exceed 3% in Colombia and Peru, and will be around 2% in Chile, Brazil, Uruguay, and Mexico. However, recession in Argentina will continue until the end of 2020 due to the shortage of US dollars and high inflation. Increasing growth, in the context of relatively low commodity prices and downside risk, will be quite challenging and the region may be vulnerable to factors such as high debt, poor quality of institutions and policy uncertainty with large current account deficits. However, it is expected that these challenges will be overcome by 2021.
Mexico and the New Trade Deal
Many of Latin America's largest economies are stuck in the so-called “middle-income trap,” with slowing productivity growth making it unlikely that they will catch up to the top global economies in the near future. Mexico stands out as a prime example of this trend, continuously attempting and yet struggling to escape the middle-income trap through economic integration-focused developmental strategies.
The Economies of Mexico and U.S. are closely linked due to strong trade, investment, and socioeconomic ties between the two countries. Trends in Mexican GDP growth generally follow US economic trends, but with higher fluctuations. The economy is highly dependent on manufacturing and US economic patterns, as approximately 80% of Mexican exports are destined for the United States.
The country’s economy will likely continue to remain closely tied to that of the United States, despite Mexico’s efforts to diversify its trading partners. Mexico has experienced relatively low economic growth with an average growth rate of only 2.6% over the past 30 years. An examination of Mexico’s GDP growth over the past three years shows that its GDP actually declined by 0.3% in 2019 and grew by only 2.1% in 2017 and 2.2% in 2018.
It is expected that the Covid-19 pandemic will severely impact Mexico’s economy for many of the reasons described above. Its GDP is forecasted to fall by 9.5% in 2020 largely due to sharp drop in domestic consumption and investment, combined with weak external demand. Mexico is expected to face continued challenges in improving investor confidence, restoring workers’ remittances, and restoring the tourism industry.
The country benefitted from important structural reforms initiated in the early 1990s, but events such as the U.S. recession of 2001 and the global economic downturn of 2009 adversely affected growth and offset the government’s efforts to improve macroeconomic management. Since then, numerous economists have given credit to the Mexican government for enacting structural reforms, which included improvements in fiscal performance, responsible and reliable monetary policy to curb inflation, and constitutional reforms in telecommunications, energy, labor, education, and other areas. According to the OECD, full implementation of Mexico’s structural reforms had the potential to add as much as 1% to the annual growth rate of the Mexican economy.
While these achievements were seen as positive, the OECD cited continuing challenges in regard to alleviating poverty, decreasing the informal economy, strengthening judicial institutions, addressing corruption and increasing labour productivity. The effects of the COVID19 pandemic are adding to ongoing challenges, as the pandemic has negatively affected trade, tourism, oil and remittances. Many economists predict a severe economic downturn for which President Lopez Obrador may not be preparing adequately.
These fundamental economic challenges must also be viewed in the context of the United States Mexico Canada Agreement (USMCA), an updated version of the nearly 25-year-old, trillion-dollar North American
Free Trade Agreement (NAFTA).
The revised agreement includes major changes to automotive production policy and new policies on labour and environmental standards, intellectual property protections and some digital trade provisions.
Country of origin rules: One of the biggest differences between NAFTA and USMCA is stricter rules on how North American automobiles and auto parts qualify for reduced tariffs. The new rules, which seek to increase car production within the region, specify that 75% of the components of automobiles should be manufactured in Canada, Mexico or US to avoid tariff (this percentage was 62.5% under NAFTA).
Labour provisions: 40-45% of automobiles parts should be made by workers earning at least $16 per hour by 2030. In this context, Mexico agreed that it will pass a new labour law to give more protection to the workers, women and immigrants. The labour reforms will give Mexican workers the right to vote in independent unions and cast secret ballots as well.
US farmers get more access to the Canadian dairy market: US made Canada open its dairy market to US farmers.
Intellectual property and digital trade: The deal extends the copyright terms to 70 years beyond author’s life (an increase from 50 years set previously). USMCA’s biggest strength is its "modernization" chapters, which, in part, take stock of how the internet has changed trade since NAFTA began in 1994. The revised deal, for example, prohibits the three countries from slapping duties on digital products like movies, books or other streaming material — a win for tech companies like Netflix and Amazon.
Sunset clause: The agreement includes a 16 year sunset clause, under which the agreement will expire. Moreover, the deal is to be reviewed every six years and can be extended upon the three countries’ mutual consensus.
A closer look at the economic conditions of Latin America and specifically Mexico show a clear deterioration over the past five years especially in terms of exports. In this context, as the twelfth largest exporter in the world and with its close economic ties to the U.S., Mexico has been particularly hard hit. The Covid-19 pandemic has significantly worsened these conditions. However, analysts are optimistic forecasting economic recovery as soon as 2021.
About the author(s)
Harold Alby is a managing director and chief operating officer at Inova Capital. Justin Inniss is a managing director at Inova Capital.For more details on our insights please get in touch with us at Inova Capital AG on +41 415616905. Inquire about our ideas and nowcasting capabilities.