latin america and caribbean outlook - jan 2011
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8/7/2019 Latin America and Caribbean Outlook - Jan 2011
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Latin America and Caribbean Outlook 2011
Emerging Markets Research
January 2011
See end pages for analyst certification and important disclosures, including investment banking relationships. J.P. Morgan does and seeks
to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest thatcould affect the objectivity of this report. Investors should consider this report as a single factor in making their investment decision.
Latin America Research Team
1 Fabio Akira, Neeraj Arora, Iker Cabiedes, Julio Callegari, Carlos Carranza, Gabriel Casillas, Laura Karpuska, Luis OganesAC, Felipe Pianetti, BenjaminRamsey, Tejal Ray, Franco Uccelli, and Vladimir Werning
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Agenda
Output gaps close as growth remains above potential 2
Inflation acceleration to trigger policy tightening in 2011 9
Risks to monitor: C hina growth, Europe contagion, and FX intervention 16
Central America & Caribbean: Consolidating the recovery 25
2
Country overview 32
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While G-3 growth will pick up in 2011, unemployment rates will still remain elevated
and justify the maintenance of policy stimulus
10
Real GDP (%q/q, saar) 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Developed market economies 3.3 3.0 2.4 1.7 2.6 2.7 2.7 2.6
United States 3.7 1.7 2.6 2.9 4.0 4.0 3.5 3.0
Japan 6.8 3.0 4.5 -1.5 1.0 2.0 2.5 2.0
Euro area 1.5 4.1 1.4 1.5 1.5 1.5 1.8 2.0
TENT
IAL
4
5
6
7
8
9
1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11
3OUTPUT
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EM growth will average a still high 5.9% in 2011, with Emerging Asia (7.4%) once
again leading the pack, followed by Latin America (4.5%)
1.82.8 2.3 2.6 2.2
-0.1
-3.8
2.8 2.6 2.5
5.7
7.5 7.18.1 8.4
5.5
1.3
7.05.9 6.0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
G-7 Emerging Economies
TENT
IAL
-10.9
2.3
7.4 8.1
4.9
8.7
2.6 3.64.5 5.7 4.2 4.2
2.9
11.9 11.09.4
10.9
6.9 6.3 6.27.9 7.8 8.5 7.4
-13.6
-3.1
4.05.1
3.3 3.1
-0.8
6.44.1 4.4 4.5 4.6
1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Latin America Emerging Asia Emerging Europe
4OUTPUT
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Latin Americas growth will slow in 2011 relative to 2010s high 6%, but will remain
above potential at 4.5%; Argentina, Chile and Peru will display growth of 5-7%
2012 Potential GDP
1Q 2Q 3Q 4Q %oya 1Q 2Q 3Q 4Q %oya %oya %oya
Argentina 13.4 11.2 1.6 2.0 8.5 6.0 8.0 8.0 6.0 5.5 5.0 3.5
Brazil 9.4 7.2 2.1 4.2 7.7 5.4 4.4 4.0 5.2 4.5 4.5 4.0
Chile -5.2 19.5 8.1 4.0 5.3 5.0 5.0 5.0 4.5 6.0 4.5 4.2
Colombia 5.5 3.5 0.9 5.0 4.0 6.0 5.0 4.5 4.7 4.5 4.0 4.5
Ecuador 2.0 7.7 6.5 3.0 3.0 3.0 2.5 2.5 2.0 3.5 3.0 3.0
Mexico -0.2 9.5 3.0 4.1 5.4 3.0 8.0 2.8 3.1 4.5 3.5 2.5
Peru 8.2 13.0 6.7 8.0 8.8 5.5 5.0 5.5 5.0 6.5 6.0 6.0
Venezuela -3.4 6.7 0.1 1.0 -1.5 1.0 1.5 1.5 1.5 1.5 3.0 3.0
Latin America 4.9 8.7 2.6 3.9 6.0 4.4 5.6 3.9 4.3 4.5 4.1 3.6Central America and Caribbean - - - - 4.0 - - - - 4.4 4.9 -
2010 2011
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Latin Americas growth will continue to be driven by domestic consumption and
investment in 2011, with net exports remaining a drag factor amid rising imports
TENT
IAL
6OUTPUT
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On the supply side, IP has been moderating across Latin America since mid-2010
along with global manufacturing, but signs of reacceleration emerged in November
Brazil Chile Colombia Mexico Peru*
Jan -17.5 -9.0 -9.9 -10.5 -0.5
Feb -16.8 -11.5 -12.4 -12.1 -6.7
Mar -9.7 -7.1 0.4 -5.4 -5.5
Apr -14.8 -11.1 -14.7 -12.1 -13.6
May -11.2 -10.5 -6.9 -11.1 -8.0
Jun -10.9 -8.3 -7.1 -9.4 -13.1
Jul -9.9 -7.4 -6.6 -6.2 -12.2
Aug -7.1 -3.8 -3.9 -7.9 -10.4
Sep -7.6 -5.2 -4.0 -5.6 -8.30
5
10
15
TENT
IAL
Oct -3.1 -6.6 -3.6 -6.0 -5.9
Nov 5.3 1.0 1.8 -2.1 -2.6
Dec 19.0 -0.3 2.1 0.9 1.6
2010
Jan 16.1 -1.1 1.6 3.4 0.7
Feb 18.2 0.5 3.5 4.5 7.0
Mar 20.2-17.4 6.7 7.6 15.6
Apr 17.4 -1.3 7.5 6.7 16.0
May 14.8 4.2 7.9 8.5 14.2
June 11.1 2.9 8.6 8.4 22.1
July 8.7 3.3 0.6 4.8 17.8
Aug 8.6 6.9 4.7 7.6 19.5
Sep 6.6 3.0 2.8 6.6 16.7
Oct 1.8 1.7 2.7 3.5 14.7
Nov 5.3 2.5 4.5 5.3 14.4
-20
-15
-10
-5
Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10
7OUTP
UT
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On the demand side, retail sales continue to grow strongly in Brazil, Chile and Peru,
with Colombia catching up and Mexico still lagging
Latin America: Industrial production Latin America: Retail sales
110
120
130Brazil Chile Colombia
Mexico Peru*
125
130
135
140
145Brazil Chile Colombia
Mexico Peru
Index level, January 2007 = 100, sa Index level, January 2007 = 100, sa
TENT
IAL
*The manufacturing index from INEI serves as a proxy for Peru IP.Source: J.P. Morgan
70
80
90
100
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
95
100
105
110
115
120
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
8OUTP
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Agenda
Inflation acceleration to trigger policy tightening in 2011 9
Output gaps close as growth remains above potential 2
Risks to monitor: C hina growth, Europe contagion, and FX intervention 16
Central America & Caribbean: Consolidating the recovery 25
9
Country overview 32
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4
6
8
10
12 Brazil Chile Colombia
Mexico Peru
Latin America: Headline CPI (%oya)
Core inflation is joining the ride up across Latin America, as headline inflation has
risen to or above the mid-points of target
6
8
10Brazil Chile Colombia
Mexico Peru Latin America
Latin America: Core CPI (%oya)
ENIN
G
IN
2011
-6
-4
-2
0
2
Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10
-2
0
2
Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10
10INFLA
TION
ACCELERATION
TO
TRIGGER
POLICY
TIGH
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110
120
130
140
150
Agriculture Energy
Latin America: Agriculture & energy prices in LACI terms
The global commodity price rally is no longer being offset by currency appreciation,
so higher agricultural prices measured in local currency is pushing food prices up
15
20
25Brazil Chile Colombia
Mexico Peru
Latin America: Food inflation
Index level, Jan 2008 = 100 %oya
ENIN
G
IN
2011
60
70
80
90
100
Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10
-5
0
5
10
Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10
11INFLA
TION
ACCELERATION
TO
TRIGGER
POLICY
TIGH
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Although inflation targeters are expected to meet targets in 2011, inflation will stay
close to the upper bound of target ranges in most countries, with risks to the upside
2010 2011
Inflation Target (%)Dec (%m/m) %Dec/Dec 4Q 1Q 2Q 3Q 4Q %Dec/Dec
Argentina1 0.84 10.5 10.5 10.5 11.0 11.5 12.0 12.0
Brazil 0.63 5.9 5.6 5.8 5.9 6.4 5.6 5.4 4.5 (2)
Chile 0.12 3.0 3.2 3.4 4.0 4.9 5.5 5.5 3.0 (1)
Colombia 0.65 3.2 2.7 3.4 3.1 3.4 3.6 3.2 3.0 (+1)
Ecuador 0.51 3.1 3.3 3.0 3.5 3.6 3.8 3.7
Mexico 0.5 4.4 4.2 3.6 3.6 3.7 3.7 3.7 3.0 (1)
Peru 0.18 2.1 2.1 2.4 2.5 2.0 2.4 2.5 2.0 (1)
Venezuela 1.67 27.5 27.3 30.4 29.0 30.6 33.8 35.0
Latin America 0.65 6.9 6.7 6.9 6.9 7.3 7.3 7.3Inflation targeters2 0.54 4.9 4.6 4.6 4.6 5.0 4.7 4.5E
NIN
G
IN
2011
1. Forecast is for official inflation measure.
2. Inflation targeters include Brazil, Chile, Colombia, Mexico and Peru
12INFLA
TION
ACCELERATION
TO
TRIGGER
POLICY
TIGH
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Tightening in Latin America of 125bp during 2011 will be highest among EM regions,
but cumulative hikes in 2010-2011 will only reverse 50% of cuts since Lehman
ENIN
G
IN
2011
13INFLA
TION
ACCELERATION
TO
TRIGGER
POLICY
TIGH
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Latin America is reversing the fiscal stimulus adopted in response to the crisis only
gradually, so the task of containing inflation will rest mostly on monetary policy
ENIN
G
IN
2011
14INFLA
TION
ACCELERATION
TO
TRIGGER
POLICY
TIGH
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Although fiscal policy will not be tightened aggressively in Latin America during 2011,
external borrowing needs will be lower than in 2010; net issuance will be negative
ENIN
G
IN
2011
15INFLA
TION
ACCELERATION
TO
TRIGGER
POLICY
TIGH
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Agenda
Risks to monitor: China growth, Europe contagion, and FX intervention 16
Output gaps close as growth remains above potential 2
Inflation acceleration to trigger policy tightening in 2011 9
Central America & Caribbean: Consolidating the recovery 25
16
Country overview 32
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Risk to monitor #1: China growth: Latin Americas terms of trade and exports are
heavily driven by commodity prices, which in turn are driven by Chinas growth cycle
China growth cycle closely related to commodity demandLatin America: Export growth and commodity prices
15
20
25
20
40
60China IPJ.P. Morgan commodity price index (rhs)
%oya, 3mma %oya
20
30
40
50
60
Export growth Commodity prices
%oya
GION
,AND
FX
INTERVENTION
Source: J.P. Morgan Source: CEIC and J.P. Morgan estimates
0
5
10
1994 1996 1998 2000 2002 2004 2006 2008 2010
-60
-40
-20
0
-40
-30
-20
-10
0
10
1999 2000 2002 2004 2006 2008 2010
17RISKS
TO
MONITOR:
CHINA
GRO
W
TH,EUROPE
CONTA
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Indeed, China is among the top destinations for exports from Brazil, Chile and Peru,
with trade links between China and other Latin American countries also growing fast
GION
,AND
FX
INTERVENTION
0.1 0.51.1
7.9
2.2
5.8
10.9 11.4
0.9 1.0
2.9
7.1 7.5
13.2
15.8
23.1
Ecuador Mexico Colombia Argentina Venezuela Brazil Peru Chile
2005 2009
18RISKS
TO
MONITOR:
CHINA
GRO
W
TH,EUROPE
CONTA
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200
250
300
Latin America
Emerging Asia
Central and Eastern Europe
Latin America export volume behind other EM regions Latin America (ex Mex): current account is back in deficit
Resilient terms of trade are particularly important for Latin America because export
volume growth is relatively low and current account deficits will widen further in 2011
-1
0
1
2
% of GDP2000=100; export volume
GION
,AND
FX
INTERVENTION
50
100
150
2000 2003 2006 2009
Source:
-6
-5
-4
-3
-2
1998 2000 2002 2004 2006 2008 2010 2012
Source: J.P. Morgan Source: J.P. Morgan
19RISKS
TO
MONITOR:
CHINA
GRO
W
TH,EUROPE
CONTA
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The good news is that FDI will continue to finance current account deficits in 2011,
with the notable exception of Brazil where reliance on portfolio flows is increasing
2010 2011 2012 2010 2011 2012
Latin America -51.1 -88.3 -126.2 80.5 99.0 105.0
Argentina 3.1 0.1 -8.9 3.0 2.0 4.0
Brazil -48.9 -69.1 -91.2 32.0 40.0 45.0
Chile -2.1 -9.2 -15.7 11.0 15.0 15.0
Colombia -5.7 -7.5 -8.6 9.0 11.0 11.0
Ecuador -0.4 0.6 1.3 0.5 0.5 0.5
Mexico -10.1 -18.0 -23.3 20.0 23.0 18.0Peru -2.1 -4.9 -6.5 7.0 6.0 7.5
CA balance FDI
(US$ billion) (US$ billion)
GION
,AND
FX
INTERVENTION
Venezuela1 15.2 19.6 26.6 -2.0 1.5 4.0
20RISKS
TO
MONITOR:
CHINA
GRO
W
TH,EUROPE
CONTA
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Latin America: exports to the EU and Spain
Risk to monitor #2: Contagion from Europe: Latin Americas trade links with peripheral
Europe are highest with Spain but small overall; Spanish FDI is no longer as dominant
Latin America trade balance with Spain
GION
,AND
FX
INTERVENTION
Stock of Spanish FDI in Latin America (% of total stock) Spanish FDI flows to Latin America (% of total flows)
0
20
40
60
80
100120
140
160
1993 1996 1999 2002 2005 2008
0
5
10
15
20
25Level Share (rhs)
0
5
10
15
20
25
30
1992 1995 1998 2001 2004
0
10
20
30
40
50
60
70Level Share (rhs)
21RISKS
TO
MONITOR:
CHINA
GRO
W
TH,EUROPE
CONTA
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Claims of foreign banks in Latin America
Large claims of Spanish banks in Latin America do not mean big outflow risks if bank
conditions in Europe deteriorate; Latin bank loans are mostly funded by local deposits
Latin America: credit profile (% of GDP)
GION
,AND
FX
INTERVENTION
Source: J.P. MorganSource: J.P. Morgan
22RISKS
TO
MONITOR:
CHINA
GROW
TH,EUROPE
CONTA
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Risk to monitor #3: FX intervention: Growth, commodity prices and rate differentials
still support Latin FX and put pressure on policymakers to contain more appreciation
REER: Current versus 30-year average (except CEE3 12-year average and Peru since Jan 91)
34.0 33.631.7
24.221.0
17.815.2 14.0 13.3 13.2
10.27.0
4.3 3.5 3.2 3.11.6
-1.2 -3.1 -3.9
-5.9 -9.1 -9.8-12.8
GION
,AND
FX
INTERVENTION
Source: Bloomberg, J.P. Morgan
Latin America FX forecasts
Source: J.P. Morgan
-21.4-24.9
AUD BRL NOK NZD IDR CZK CHF INR COP ZAR CLP THB PLN HUF TRY PEN EUR JPY MXN PHP CAD MYR SEK GBP TWD KRW
End of Period 1Q11 2Q11 3Q11 4Q11
USD/ARS 4.10 4.10 4.15 4.35
USD/BRL 1.72 1.75 1.77 1.80
USD/CLP 480 470 455 455
USD/COP 1,850 1,850 1,850 1,850
USD/MXN 12.50 12.25 12.25 12.25
USD/PEN 2.82 2.82 2.79 2.75
USD/VEF 4.30 4.30 4.30 4.30
23RISKS
TO
MONITOR:
CHINA
GROW
TH,EUROPE
CONTA
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Policymakers are trying to contain FX appreciation through aggressive intervention;
after Chiles recent measures, the next country of market focus is Mexico
State of current FX regime, capital controls, and possible future intervention measures
FX Regime Recent Measures Possible Future Measures
Reserve Accumulation2010*
(US$ billion)2010 % Change
in ReservesArgentina Non Convertible and capital outflow
controls remain in place with a minimumholding period of 1year and US$2mmoutflow per month
None None 3.2 7%
Brazil Non Convertible. Tax of 6% on foreignfixed-income investment and 2% onequity investment. Increase margin forderivative transactions
Increase IOF Tax on fixedincome investment to 4% onOct 4th, to 6% on Oct 18,increased reserve
requirements to 60% on bankshort USD position on Jan 6and resumed reverse swap
Risks remain high for furtherinterventions and possiblenew tax measures
50 21%
GION
,AND
FX
INTERVENTION
intervention on January 13
Chi le Non Convert ible. No capital controls US$12 bill ion reserveaccumulation program for 2011announced Jan 3, US$50million per day intervention.
None 2.5 10%
Colombia Non Convertible. 34% tax on income andcapital gains and 6% WHT on couponpayments for bonds with maturities up to5 years and 4% for longer bonds.
USD purchases of $20mm dayand complementary actions(such as postponing the USDinflows from the official sector)
Risks remain high for furtherinterventions both in spot fxand potentially increases inReserve Requirements forforeign investors.
3.0 12%
Mexico Free floating and deliverable. No FXcontrols. Banxico sells $600mm ofUSDMXN puts per month.
None Increase in the size ofUSD/MXN put optionauctions per month oroutright spot USD purchasespossible if MXN rallies below11.9
22.8 25%
Peru Non Convertible. Reserve Requirementson foreign deposits (120%), 30% tax oninterest paid to non-residents. Limits onpension fund short USD positions
USD purchases in the spotmarket, increase in reserverequirements on inflows fromabroad and sells PEN-linkedUSD CDs
FX intervention shouldremain high. Although taxmeasures are unlikely, thispossibility is still in the cards
11 33%
24RISKS
TO
MONITOR:
CHINA
GROW
TH,EUROPE
CONTA
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Agenda
Central America & Caribbean: Consolidating the recovery 25
Output gaps close as growth remains above potential 2
Inflation acceleration to trigger policy tightening in 2011 9
Risks to monitor: C hina growth, Europe contagion, and FX intervention 16
25
Country overview 32
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Growth in the Central America and Caribbean (CAC) region fared better than the
Latin American average during the 2009 recession
E
RE
COVERY
26CENT
RAL
AMERICA
&
CARIBBEAN:CONSOLIDATING
TH
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But the CAC region has underperformed during the recovery phase in 2010 and
will likely perform in line with the Latin American average in 2011
ERE
COVERY
27CENT
RAL
AMERICA
&
CARIBBEAN:CONSOLIDATING
TH
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Regional inflation should remain broadly stable in the Caribbean and increase
moderately in Central America, but surging global food prices suggests upside risks
E
RE
COVERY
28CENT
RAL
AMERICA
&
CARIBBEAN:CONSOLIDATING
TH
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Fiscal deficits in the CAC region should narrow in 2011 as countercyclical policies
are phased out and growth accelerates
E
RE
COVERY
29CENT
RAL
AMERICA
&
CARIBBEAN:CONSOLIDATING
TH
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External public debt ratios will remain stable in 2011 as higher growth offsets
increased borrowing
E
RE
COVERY
30CENT
RAL
AMERICA
&
CARIBBEAN:CONSOLIDATING
TH
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Increased external borrowing and FDI inflows should cover the CAC regions
current account deficits, which will widen in 2011
E
RE
COVERY
E
RE
COVERY
CENT
RAL
AMERICA
&
CARIBBEAN:CONSOLIDATING
TH
31CENT
RAL
AMERICA
&
CARIBBEAN:CONSOLIDATING
TH
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Agenda
Output gaps close as growth remains above potential 2
Inflation acceleration to trigger policy tightening in 2011 9
Risks to monitor: C hina growth, Europe contagion, and FX intervention 16
Central America & Caribbean: Consolidating the recovery 25
32
Country overview 32
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Brazil: Full 2010 GDP growth revised up to 7.7% (from 7.5%)
After suffering its sharpest recession in recent history,
Brazils growth began a remarkable rebound, and theeconomy has been expanding at a pace much faster
than potential since 2Q09. Currently, we believe there
is little, if any, economic slack remaining in the
economy.
The economy slowed in 2Q10 and 3Q10, despite
strong domestic demand, on the back of an inventory
adjustment process and, mainly, external drag.
However, 4Q indicators point to robust economicactivity at the end of last year, meaning full 2010 GDP
growth should approach 7.7% - higher than our last
forecast of 7.5%.
The stronger than expected 4Q10 activity performance
along with support from the inventory cycle and a
favorable global growth outlook put some upside risks
to our 4.5% GDP forecast for 2011 growth. At this point
we still think that the drag from net exports and somefiscal and monetary tightening will prevent higher GDP
growth.
Therefore, while we are still factoring in some fiscal
tightening in our forecasts for 2011 we reckon that this
is up in the air, and if this tightening fails to materialize
we should see a combination of stronger
growth/inflation and more monetary tightening than
currently envisioned (175bp by year-end).
33COUNTRY
OVERVIEW
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Brazil: Central Bank to start a new tightening cycle
Brazils Central Bank has begun the tightening cycle with
liquidity and credit measures, following with an adjustmentin the policy interest rate. The reserve requirement ratios
on demand and time deposits have been increased, and
the capital requirements on household loans with
maturities above two years have also been lifted. It is hard
to evaluate exactly the final impact of the measures, but
they should contribute to the impact of the traditional
tightening cycle via reference rate increase.
After remaining on hold for six months, the COPOM
resumed its tightening cycle this week with a 50bp hike inthe Selic rate to 11.25%, as expected. The accompanying
statement stressed that this hike was designed to
contribute to the convergence of inflation to the targeted
trajectory, in tandem with the effects of macroprudential
measures (credit tightening measures). We understand
that the mention of the effects of macroprudential
measures in the statement sends a signal that further
credit tightening, rather than an acceleration in the pace of
rate hikes, may be announced if inflation dynamics
continue to deteriorate..
On the inflation front, the already high inflation level and
the combination of underlying pressures from above-trend
growth along with supply shocks derived from rising
commodity prices raise some upsides risks to our already
above-target inflation forecasts. While IPCA closed 2010
at 5.9%, we expect some accommodation to take place
during 2011, taking the IPCA back to the 5.4% level.
However, mounting evidences of still strong domestic
demand makes Brazil CPI too vulnerable to any new spike
in international prices.
34COUNTRY
OVERVIEW
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Brazil: Debt dynamics not an issue, but fiscal trends are concerning
With the sovereign now long USD in net terms, lower
real interest rates, and robust growth, there are nosolvency risks on the radar.
Public debt has increased both in net terms (due to
BRL strengthening) and in gross terms (due to the
sterilization of USD purchases and debt issuance to
capitalize BNDES). Although net debt at 40% of GDP
does not raise solvency concerns, gross debt close to
a 60% level is very high by international standards,
creating downward rigidity in debt services.
The u sur e in tax collection with above-trend rowth
has been offset by the strong pace of fiscal
expenditures. Even considering the strong
performance of the economy in the recent months,
expenditures have still been growing firmly, indicating
that the 3.1% target for the primary surplus will be
reached in 2010 only with the accounting of one-off
revenues and subtracting up to 0.9% of GDP of
expenditures related to infrastructure projects which
is allowed by the budget.
The public sector primary surplus has been running at
2.5%of GDP in a 12-month sum since the Petrobras
oil rights revenues have been accounted in the public
sector balance.
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Brazil: BRL should be quite sensitive to portfolio flows and risk assets ebbs and flows
The large market BoP surplus (which excludes
official FX transactions) registered in previous yearsrested on either a CA surplus, or a modest deficit
neither of which will be repeated in coming years (at
least not until a BRL correction takes place). Indeed,
even assuming relatively optimistic views on terms of
trade (flat at high levels) and FDI and portfolio inflows
(about US$80 billion p.a.), and a cautiously upbeat
assumption for corporate external debt issuance
(150% of amortizations), the final result for net FX
inflows for this year will depend critically on short-term
abroad.
We think that strong capital inflows in the pipeline
should keep USD/BRL toward 1.70, but FX
intervention (amid existing concerns about BRL
overvaluation) should prevent significant appreciation
beyond that level. That said, we do not see the
government intervening in a way to push the spot tolevels close to or above 1.90.
The J.P. Morgan commodities group sees most
commodity prices roughly flat or slightly higher in
2011, and the BRL should continue to move in line
with the trend for commodity currencies, powered by
its high-yield characteristics.
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Brazil: A popular president elects his successor; eyes on the cabinet formation
The government supported candidate, Dilma Rousseff, got
56% of the vote versus 44% for Jose Serra. The focus now
is on the transition and cabinet formation. The new
government's intention is to create a positive environment
within opinion makers after Lula's aggressive fiscal
expansion of late, but the signals are not so consistent at
this point.
The President-elect Dilma Rousseff officially announced
her economic team, in line with what the media had been
reporting. Current Finance Minister Guido Mantega will
remain at that post, while Alexandre Tombini, who iscurrently the BCB director for Norms and Organization, will
, .
press note, Rousseff announced these appointments and
reiterated that the new economic team would ensure the
continuity of macroeconomic policies based on the
inflation-targeting regime, a floating exchange rate, and
fiscal responsibility.
The reappointed Finance Minister highlighted that the new
government will continue to target higher growth, but isalso focused on controlling inflation. He noted that the
government will make an effort to reduce current
expenditures and will provide fewer resources to BNDES
in 2011 (compared to 2010). We continue to believe that
implementation risks on the fiscal side remain very high,
given signs that the minimum wage will be raised to a level
higher than budgeted, and the recent reduction in the
primary surplus target.
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Brazil: Economic projections
After a sharp and short recession, Brazils GDP will
grow at an above-trend pace of 7.5% in 2010. Thisremarkable recovery is already resulting in inflationary
pressures, and we reckon that the initial monetary
tightening implemented in 2010 will be extended this
year.
The reduction in sovereign vulnerabilities opened room
for aggressive fiscal and monetary policy actions that
soothed last years liquidity squeeze, and provided an
important boost to final demand.
n response o oca grow an e g o a recovery,
inflation accelerated in 2010, triggering tightening
policies, mainly on the monetary front.
In the long term, a more stable macro scenario and
lower rates should boost private sector investments
(with the development of capital markets) and
household consumption (with the expansion of credit to
consumers)
The lack of structural reforms reducing fiscal constraints
and enhancing private sector competitiveness remains
the main obstacle to faster growth.
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Mexico and US manufacturing production
Source: INEGI and US Federal Reserve
Mexico: A more promising scenario in the US has prompted us to rise our 2011
GDP growth forecast to 4.5%
-20
-15
-10
-5
0
5
10
1520
Jan-05 May-06 Oct-07 Feb-09 Jul-10
Mexico US
%oya The recent approval of the Bush era tax cuts
prompted our US economist to revise his GDP growthforecast for 2011 to 3.3%
The adjustments included a significant revision to the
US manufacturing production forecast to 4.6%, from
3.3% previously
Manufacturing is Mexicos major economic link with
the US
This adds to stronger domestic demand, a
,
banking credit, and the imminent beginning of
construction on a number of infrastructure projects
As a result, we now believe Mexicos GDP will expand
4.5% in 2011, instead of 3.5% as projected previously
Furthermore, we expect the Mexican economy to grow
3.5% in 2012
Source: J.P. Morgan.
Mexicos economic activity forecasts
%oya 2010 1Q11 2Q11 3Q11 4Q11 2011
Aggregate D/S 9.4 6.5 5.8 6.0 5.4 5.9
GDP AS 5.4 4.7 4.5 4.4 4.2 4.5
Agriculture 4.8 6.2 3.3 3.3 4.9 4.4
Industrial 5.6 4.3 4.0 4.1 4.7 4.3
Manufacturing 9.0 3.7 3.7 3.5 5.1 4.0
Other 1.3 5.1 4.4 4.8 4.3 4.6
Services 5.1 4.9 4.9 4.8 4.1 4.7
Imports 23.4 12.2 9.5 10.3 8.5 10.1
GDP AD 5.4 4.7 4.5 4.5 4.2 4.5
Consumption 5.3 4.8 4.7 4.4 4.0 4.5
GFI 2.7 2.2 4.8 5.3 5.1 4.4
Exports 20.5 8.7 8.8 8.4 8.6 8.6
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Auto and manufacturing production, and auto exports
Mexico: A reinvigorated auto industry will continue to be the main driver of
manufacturing activity
-80
-40
0
40
80
120
160
Jan-07 Aug-07 Apr-08 Dec-08 Jul-09 Mar-10 Nov-10
-20
-10
0
10
20
30Auto exports
Auto production
Manufacturing output (RHS)
%oya, both axis
Auto production has averaged a strong year-to-date
expansion of 61%oya in 2010, with exports being the
primary driver, averaging a rebound of 66%oya
We believe that the auto industry has been, and will
continue to be, key to Mexicos manufacturing activity
Several automakers across the world have reallocated
part of their production to Mexico to benefit from a
weaker peso, skilled Mexican labor, still-high transport
costs, and the countrys strategic geographic location
Moreover, this has also permeated into other
Source: INEGI and AMIA,
aeronautics
Source: AMIA
Auto sales
-40
-30
-20
-10
0
10
20
30
Jan-05 Mar-06 May-07 Jul-08 Sep-09 Nov-10
%oya
Source: J.P.Morgan
Announced date US$, mn State
Total - - 4,950 - -
Chrysler 1Q09 300 Coahuila
GM 3Q09 300 San Luis Potosi
Ford 4Q09 600 Chihuahua
Ford 4Q09 1,000 Cuatitln
Chrysler 1Q10 550 Toluca
Volkswagen 1Q10 1,000 Puebla
Mazda 4Q10 500 - -
Volkswagen 4Q10 550 Guanajuato
Toyota 4Q10 150 Coahuila
Recent investments in Mexico's auto sector
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Mexico: The credit system could be a key driver for domestic consumption
Total commercial bank credit to the private sector
represents less than 15% of GDP
Mexican banks are well capitalized
Following a credit boom in 2003-2006, non-performing
loans increased significantly, forcing banks to rethink
their credit extension policies
Nevertheless, commercial banks have now 'cleaned
up' their credit balances and employment conditions
have improved significantly over the past 12 months
22.520.4
17.4 17.3 16.4 16.4 15.2 15.1 15.1 14.7
0
5
10
15
20
25
Banamex
Inbu
rsa
Scotiabank
IXE
Santander
Banorte
HSB
C
BBVA
Bancomer
Azte
ca
Afirm
e
Index
Regulatory minimum 8%
Capitalization indices of major commercial banks
-30
-20
-10
0
10
20
30
40
Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Nov-10
Total
Consumer credit
Housing credit
Credit to firms
%oya
Source: J.P.Morgan with data from Banxico
Source: National banking Commission (CNVB), Oct. 2010
Commercial bank credit Banking credit to the private sector
will probably lead to an ascending trend in the
country's domestic credit cycle
Source: J.P.Morgan with data from Banxico
-60
-40
-20
0
20
40
60
80
Jan-00 Jun-10 Nov-10 Apr-10 Sep-10 Feb-10 Ju l-10 Dec-10
0
5
10
15
20Credit card Del inquency rate (RHS)
%oya in real terms % of total credit
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Elections in 2011
Mexico: We highlight three risks to our optimistic growth outlook
Governor Local Congress Date
Guerrero X - - 30-Jan
Baja California Sur X X 6-Feb
Coahuila X X 3-Jul
Estado de Mxico X - - 3-Jul
Nayarit X X 3-Jul
Michoacn X X 13-Nov
In our view, there are three important risks to our
positive appraisal of Mexicos growth in 2011:
1. A potential escalation of drug-related violence
2. More potentially negative issues emerging from the
Euro area periphery countries
3. The possibility of less vigorous growth in the US
In our view, the government has been consistently
cracking down on the major drug cartels, an
important step in the governments efforts to combat
organ ze cr me. owever, ere are s r s s,
particularly with the gubernatorial elections that will
take place this year in six states
On the other hand, we have downplayed the direct
effects of a major sovereign crisis in the Euro area,
we believe that the escalation of drug-related
violence is indeed curbing Mexicos growth potential There is no doubt that Mexico needs several
structural reforms, particularly meaningful fiscal and
labor-market reforms as well as new guidelines to
empower antitrust officials to dilute monopolies and
foster competitiveness. We strongly believe that the
lack of these structural reforms is restraining
domestic demand, and Mexicos potential GDP
Unfortunately, the large GDP growth rates that the
country has observed in 2010 and will probably
observe in 2011 appear to be providing a false sense
of security to government officials, particularly
legislators, who have now downplayed the need for
reforms in Mexico
Furthermore, with gubernatorial elections due in six
states this year, particularly in the highly-populated
and politically-sensitive State of Mexico (Estado de
Mxico), we believe it is going to be difficult to secure
congressional approval for these key reforms that the
country truly needs
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Headline inflation
Source: J.P.Morgan with data from Banxico
1.0
2.0
3.0
4.0
5.0
6.0
7.0
Jan-07 Jul-08 Jan-10 Jul-11
Banxico's inlfation target
Forecasts
%oya
All the indications are that global grain prices will remain
high throughout 2011. This is an important risk to our
inflation call for end-2011 of 3.7%oya
Nevertheless, well-anchored medium-term inflation
expectations (around 3.6%), and moderate wage increases
clearly support our 'low-for-long' monetary policy call, in
which we anticipate that the first hike will not take place
until 2Q12 (Consensus: 1Q12)
On the inflation front, we have observed an importantstructural chan e comin from two sources: the Wal-Mart
Mexico: The US Feds long pause, moderate inflation, and well-anchored inflation
expectations will keep Banxico on hold until 2Q12
effect, and the Viva Aerobus effect
Wal-Mart has been consistently opening stores in Mexico in
the past few years. We believe this has been an important
reason why we have observed a higher degree of
competition among retailers in Mexico
In the past few months we have observed that even though
Mexicana, once a leading airline in Mexico, shut its doors
about six months ago, air fares have not only not increased,
but have actually declined. We attribute this 'new' dynamic
to Viva Aerobus, a somewhat newly created 'low-cost'
airline that, in our view, has taken Mexicanas bankruptcy
as a strategic opportunity to gain market share
Source: Banxico, Ministry of Labor, CONASAMI, and J.P.Morgan.*The series was moved 1-year forward
Inflation expectations and wages in Mexico
3.0
3.5
4.0
4.55.0
5.5
6.0
6.5
7.0
2002 2003 2004 2006 2007 2008 2010 2011
1-year ahead inflation expectations*
Minimum wage
Wage negotiations
%oya
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CPI goods and services components
Source: J.P.Morgan with data from Banxico
1.0
2.0
3.0
4.0
5.0
6.0
7.0
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
Contribution to 12-month headline inflation
Banxico has announced important modifications to the
methodology for calculating the CPI
We highlight that the central bank will publish the new
component weights for the new CPI on January 24
These methodological modifications respond mainly to
changes in consumption patterns fostered by technological
and structural changes
The new way to calculate housing prices could reduce the
influence of commodity price swings in the new CPI
Mexico: CPI calculation improvements could partially isolate inflation from
commodity price swings
In this new framework, Banxico will calculate the use of
housing price inflation using rental prices, instead of input
prices (e.g. cement, copper, iron, etc.)
On the other hand, we note that rental prices have a very
low variance compared to commodity prices. In Mexico, for
example, rental prices are usually modified once a year by
landlords. As a result, this change could help inflation to be
less responsive to the recent rise in global commodity
prices, and provides support to our current 3.7% inflation
forecast for year-end 2011
INEGI will take over the calculation of consumer price
inflation in July 2011, instead of Banxico
Most important modifications to the CPI calculation
1 Change of CPI base year to 2H-Dec 2010, from 2H-Jun 2002
2 Use of INEGIsincome-expenditure survey (ENIGH) of 2008,instead of the one conducted back in year 2000. This could haveimportant changes in the CPI weights as the income sharesassigned to different goods and services have changed in time
3 Some specific items will be grouped as generic items in order to
reduce any potential bias emerging from regional differences4 Some generic items will be ungrouped with specific items
5 Some items will be moved to other groups
6 Some groups will be renamed to become more transparent,modern, and to continue incorporating best practices worldwide
7 The services component will have a larger weight in the newCPI, relative to the current methodology
Source: Banxico
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Mexico: Still positive on the peso, we expect USD/MXN at 12.25 by year-end.
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p p , p y y
However, we believe it could trade at lower levels in the short-term
Major emerging currencies index
40
50
60
70
80
90
100
110
120
130
140
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Mexican peso South Korean wonPeruvian sol Brazilian realColom bian pes o Southafrican rand
Index Jan (2000 = 100)
Market participants should continue to look to countries with
relatively positive growth potential and no fiscal problems
Healthy public finances, low rates for an extended period of
time worldwide, and the inclusion of Mbonos into the Citigroups
World Government Bond Index (WGBI), suggest that Mexico
should continue to benefit from foreign flows in 2011
In this context we expect USD/MXN at 12.25 by year, but we
believe it will trade stronger in the short-term
In our view, while the uncertainty on the US economy
punished the peso since the crisis started back in 2008, a
more constructive growth scenario for the US with Mexico'source: oom erg an . . organ
1. Calculated using CME non-commercial positionsSource: J.P. Morgan with data from Bloomberg
MXN net long positioning vis--vis the US dollar1
-3
-2
-1
0
1
2
3
4
5
6
Jan-00 Feb-02 Mar-04 Apr-06 May-08 Jun-10
US$, billion
prudent fiscal stance and healthy external accounts may
support the pesos strength
Going forward, the fact that other EM currencies have
strengthened more than the peso vis--vis the US dollar, as
well as the US Feds QE2 and the market-friendlier FX stance
of the Mexican authorities, could continue to allow the Mexican
peso to gain ground
In this context, we believe USD/MXN could reach 11.50 by end-
2012
However, we acknowledge that the main risk to our call would
be a significant escalation in drug-related violence, as the
USD/MXN market has proved very sensitive
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Mexico: Economic projections
We believe there are five reasons to be positive on
Mexicos growth in 2011:
1.The recent approval of the Bush era tax cuts
2.Stronger domestic demand
3.A reinvigorated auto sector
4.A positive outlook for banking credit; and
5.Major infrastructure projects to begin construction
As a result, we recently revised our GDP forecast to 4.5%
in 2011, instead of 3.5% that we had projected before
We identify three risks to our optimistic growth call:
6.Potential escalation of drug-related violence
7.Further negative news from European periphery countries
8.The Possibility of less vigorous growth in the US
The US Feds long pause, moderate inflation, and well-
anchored inflation expectations will keep Banxico on hold
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Argentina: After having peaked, growth remains strong and inflation is accelerating
again but the Presidents positive image is recovered
Energy rationing and labor disputes genuinely hurt industrial
performance in 3Q, while import growth continues to advance.But the economy is expected to have rebounded in 4Q and
averaged 8.5% real GDP in 2010.
Neighboring economies like Brazil are booming, low global
rates have helped to mitigate capital flight (even as domestic
policy volatility has persisted), terms of trade are favorable, the
agricultural sector is enjoying a strong rebound in the harvest
industrial inventories have come down sharply (as demand
recovers), and import barriers have increased (allowing local
producers a temporary advantage)
Growth will decelerate in 2011 to 5.5% as dry weather is
.
The post-2009 legislative election environment has
consolidated a muddle-through scenario on macro policy and
intensifying of regulation on specific business sectors in micro-
policy. The opposition has gained a majority in the legislature
but remains fragmented and coordination is thus difficult.
The 1Q inflation acceleration owed to food prices and
particularly beef but inflation moderated in 2Q. After averaging
1.5% m/m in 3Q(measured by private sources) , inflation isrunning at 1.8% m/m average October-November.
Cristina Kirchners image, which benefited strongly from the
recovery (while not suffering from high inflation) has been
boosted to 56% from 36% following the death of her husband
and ex-president Nestor Kirchner. At the end of 2009 her
positive image was 21%. The evolution of this trend will be
critical in defining the peronist party candidate for the 2011
presidential elections (primaries: August, election: October).
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Argentina: Trade surplus is still providing a solid cushion for the balance of payments;
ARS is the nominal anchor ahead of elections
Private sector capital flight halted in 4Q. While a recovery in
capital flows seemed likely for 2010, political conflicts dampenedthe outlook and capital outflows resumed in early 2010. But by
mid year the outflows had again receded. This not only facilitates
reserve accumulation but is also a plus for the economy.
The 1Q inflation acceleration owed to food prices and particularly
beef but inflation moderated in 2Q. After averaging 1.5% m/m in
3Q(measured by private sources) , inflation is running at 1.8%
m/m average October-November. The peso has been
appreciating in real terms due to high inflation and is a concern
for the future.
In 2010, strong external demand and a larger soy harvest
%oya Private , 3mma (ar)
Official, oya
Private, oya
restrictions) boomed The trade surplus is $13.8 billion, down only
moderately from $16. 2 billion at year end 2009. In 2011 export
volumes will be hurt by smaller harvest but increases in
international prices of agricultural commodities will compensate,
allowing Argentina to rely on a high trade surplus again.
Reserves have been growing at a steady, yet moderate, pace
despite use of CB reserves by the Treasury to pay down debt.
The central bank has been buying dollars in the spot market and
futures market.
FX policy is geared to tightly managing spot ARS as an anchor
for inflation expectations and to maintain central bank reserves
high given the reliance of fiscal authorities on BCRA as a lender
of last resort (LOLR).
Authorities are unlikely to allow a sharp adjustment in ARS
ahead of October 2011 presidential elections. ARS is likely to
end 2011 at 4.20
12-mo sum, US$ billion
12-mo. sum
3mma, saar Farmers strike
Commodity price boom
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Argentina: Fiscal accounts get cyclical uplift; Treasury relies on BCRA; liability
management may lag due to politics
The primary fiscal surplus will narrow to 1.1% in 2010 after
reaching 1.5% in 2009. Fiscal revenues are rising strongly but
spending has remained elevated until recent months. Theprimary surplus is running at 1.6%.
High growth and higher inflation suggest upside risk to the
primary fiscal surplus forecast of 1.1% of GDP. But central bank
profits and Anses interest earnings exaggerate the reported
primary balance.
The one-off revenues that boosted the 2009 result make it
difficult to foresee an improvement in 2010 despite the rebound
in growth. Note that while the primary surplus is currently above
the year end forecast, the extraordinary 0.7% point improvementof the fiscal surplus in December 2009 will fall out of the 12-
Primary spending
Reported revenues
%oya, 3mma
month sum in December 2010.
The public sectors lack of voluntary market access remains a
liabilitybut at current yields Argentina could issue debt in
voluntary markets if it decided to. For now, the Treasury
continues prefering to rely on BCRA reserves as lender of last
resort (LoLR) for financing needs.
Following the debt swap for untendered bonds Argentinas
Treasury was looking to reaccess markets with an international
bond issue ($1 bn); to swap local short-term USD bonds for
longer foreign law USD bonds for cashflow and NPV gains, swap
EUR paper for USD paper for NPV gains. However, political
events have led Argentina to (informally) postpone these
objectives. In contrast, Paris Club talks have been restarted and
April is the governments target for striking a deal.
Adjusted
Reported
% of GDP
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Chile: The economy is growing strong and the administration has the benefit of the
doubt from the business community
Activity
Real retail sales
%change
GDP growth should average 5.2% in 2010 and 6.0% in 2011.
Yet it is the high double-digit domestic demand boom that is themost eye-catching. Activity will accelerate sharply to an 8-9%
pace on an over-year-ago basis in 1Q due to base effects from
the earthquake earlier this year.
The backbone of the recovery is domestic: a substantial
monetary and fiscal stimulus. The earthquake reconstruction
effort will further boost domestic demand for non-tradable goods.
Mood among businesses picked up visibly as president Pieras
pro-growth agenda raises expectations. In fact, the positive mood
persisted despite the earthquake.
Mood among consumers has been affected negatively by the
earthquake but is now fully recovered, although some slippage
ocurred a the end of 2010. Tightening labor markets and benign
inflation have helped support a recovery in household confidence
yet inflation could pick up more visibly ahead.
Pieras original plans were to provide macroeconomic
incentives for investment (accelerated amortization) and
reinvestment (shifting of income tax to distributed, rather than
accrued, profits) as well as microeconomic incentives for raising
efficiency in the public (reorganizing state companies) andprivate sector (environmental and labor reforms). The
administration, however, does not have a majority in Congress.
Fiscal policy will make room for reconstruction spending but will
shift to a tightening bias earlier than expected as the government
redefines the fiscal rule and targets narrowing the structural
deficit
Business confidenceConsumer confidence
Earthquake
level
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Chile: Inflation remains within the target band but in 2011, but in the aftermath of FX
intervention, inflation risks are rising and BCCh may not meet its target
BCCh expects the output gap to close in 1H11 and continues to
reaffirm its tightening bias. Unemployment continues to decline ata rapid pace and wage pressures, quite benign until mid-year, are
now starting to build. Moreover, global agricultural prices are likely
to lift domestic food prices visibly in coming quarters. We expect
inflation of 5.5%Dec/Dec (above target) in 2011 and
3.8%Dec/Dec (within the +/-1% tolerance range of the 3% target)
in 2012.
For the time being inflation has remained benign. The pesos
appreciation has played a large part in anchoring inflation. As
tradable goods were up only 0.5% while non-tradable goods were
up 5.6%.
.
Septembers reading of 2.0%oya. The acceleration in core CPI
has been gradual and lagging that of the headline while relevant
inflation expectations remain well behaved. BCChs preferred
measure of core CPI is at -0.5%oya. In the next months CPI
should continue to print low readings.
Due to CLP appreciation, excess demand pressures will partly
manifest themselves through stronger imports and a deterioration
of Chiles external balance rather than just a higher CPI inflation.
BCChs announcement of FX intervention in early January involves
a $12 billion full-year reserve accumulation program (50% larger
than the announced intervention in 2008). The daily USD
purchases of $50 million can bee fine-tuned by BCCh according to
developments.
We expect that BCCh will continue tightening The forecast sees a
3.75% policy rate by 1Q11, 4.5% by 2Q11, 6.0% by 3Q11 and
6.5% by 4Q11.
August 21, 2008 = 100
%
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Chile: Economic projections
GDP growth should average 5.2% in 2010 (with downside risk
given weak October) and 6.0% in 2011. Yet it is the high double-digit domestic demand boom that is the most eye-catching. The
acceleration of activity can be partly attributed to the temporary
boost from post-earthquake spending but business and
household confidence is strong and notwithstanding a
deceleration, demand should remain strong.
Fiscal policy will make room for reconstruction spending but will
shift to a tightening bias earlier than expected as the government
redefines the fiscal rule and targets narrowing the structural
deficit
Inflation has remained benign but in 2011 domestic and external
. .
BCChs intervention in the FX market and the tactical rate
pause in the january policy meeting highlight the challenge that
multiple objectives could present for BCCh if inflation does
accelerate as forecasted. BCCh can calibrate FX intervention
through adjustments to daily purchases even as the annual
target is fixed at $12 billion reserve accumulation.
Given the updated CPI inflation forecast, we expect that BCCh
will continue tightening to 6.5% by end 2010 and the peso toappreciate to 455. This scenario prompted a revision to 2012
growth to 4.5%
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Colombia: Mixed messages from activity readings, but growth should regain
traction in 2011
GDP growth came in at an underwhelming 3.6%oya pace in 3Q10,
with the drag coming largely from a -10.5%oya performance in
construction due to a fall in public works.
Supply-side data suggest that manufacturing remains subdued,
while domestic demand gains momentum. The gradual recovery in
employment, credit expansion and improving consumer confidence
have been supporting a strong expansion in retail sales. In the
opposite direction, industrial production growth continues to fade
(first chart).. Our assessment is that the increasing perception of
high inventories along with the strong COP in 3Q and the start of
4Q have hurt the manufacturing sector, despite relatively high
business confidence.
The weak 3Q10 result prompted us to change the full-year 2010growth forecast to 4.0% (from 4.3%). Public investment should not
improve much in 4Q, even though it will likely be less of a drag
compared to 3Q. At the same time we should continue to see the
retail sector flourishing and IP underperforming.
We maintain our 4.5% growth forecast for 2011. Recent floods
should drive higher public investments in 1Q11, while the inventory
cycle and some modest recovery of exports to Venezuela could
help boost the manufacturing sector in 1H11. Finally, we expect
private consumption to remain supported by a gradual
improvement in the labor market and credit expansion(underpinned by loose monetary policy). Therefore it remains
reasonable to expect some reacceleration in activity next year.
Employment continues to expand in the retail sector, but remains
subdued in the manufacturing sector. Employment in the retail
sector has been showing a vigorous expansion, with real wages
improving considerably. However, employment in the
manufacturing sector continues to shrink, at the same time that real
wages also lose momentum after the surge recorded in 1H10.
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Colombia: BanRep on hold during 1Q11, but will likely hike rates in 2Q11
Colombian domestic demand has been rebounding in recentquarters, while both inflation and inflation expectations haduntil
Decemberbeen subdued. Despite end-year food price
pressure, core inflation remains contained and economic activity
is showing some mixed signals (namely, lagging manufacturing
activity). This should lead BanRep to keep the policy rate at its
current (admittedly stimulative) level over the near term.
Recent headline inflation numbers have been accelerating on the
back of higher food prices, while core figures remain benign.
This acceleration was a result of some pass-through from the
recent spike in international commodity prices, which hascoincided with extreme weather conditions in Colombia (harsh
rains and flooding) that have added pressure on fresh food
items. Inflation is poised to accelerate even further in the coming
quarters as food prices should reflect the pressure in external
markets, while domestic demand is expected to remain on a
strong footing.
BanRep has been highlighting that its technical team projects
with a high degree of confidence that inflation will remain inside
the target range in 2011. BanReps official forecast was looking
for 2011 inflation only slightly above 2.0%, but this seems overlyoptimistic, especially after the recent spike in local food inflation.
Market expectations are for inflation to finish 2011 well above
3%, and the downward trend in these forecasts has reversed
sharply in January following Decembers upward surprise
(second chart).
We continue to see BanRep beginning to remove monetary
stimulus with an initial 25bp hike in April amid higher inflation and
activity data. We see the policy rate finishing 2011 at 5.5%.
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Colombia: Should get the Investment Grade stamp this year
Reforms point to a better fiscal outlook, but Congress may still
water down key projects. The Santos administration has
presented a full plate of inter-related fiscal reforms to Congress,
including constitutional reforms to the royalties system and to
elevate fiscal stability to a constitutional right (on par with health
care); a fiscal rule proposal; and a so-called mini-fiscal reform
to reduce tax exemptions and eliminate loopholes. The originally
stated goal of the fiscal rule would be to reduce Colombias
central government debt from 39.4% of GDP in 2010 to 28.4% in
2015 via a very gradual move toward a primary surplus by the
end of Santos term.
The reform of laws governing energy/mining sector royaltiesintends to better channel and manage the expected boom in the
coming years, including the creation of a centrally managed
counter-cyclical stabilization fund. The constitutional reforms
passed both houses of Congress in the 2H10 legislative session,
and now, as required under Colombian law, must be taken up
again in the 1H11 session. Royalties reform has good
momentum but could face further watering down, as local
interests push back against centralized control of the windfall.
The constitutional reform on fiscal stability is more controversial
and could face stepped up opposition. Overall, many crucial
details are set to be defined this year.
All three major rating agencies have Colombias rating one notch
below Investment Grade, with a positive outlook. The approval
and implementation of fiscal reforms may be a catalyst of rating
agency action. But at this point even a less-than-ideal final
reform package could earn Colombia an Investment Grade
rating, given the agencies overall positive assessment of
Colombias macroeconomic resilience and positive policy
agenda.
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Peru: Elections dominates the political landscape, but risks seem subdued
The first round of presidential elections will take place on April
10, 2011, with a likely second round taking place on June 5
The early frontrunners in electoral polls (Keiko Fujimori, Luis
Castaeda and ex-President Toledo) are unlikely to make
meaningful changes to Perus market-oriented
macroeconomic policy. Moreover, even if nationalist candidate
Humala (currently with 10-12% in the polls) does make it to a
second round, he has been trying to distance himself from
Chavez-style policies, highlighting instead that he would
respect private property, preserve the independence of the
BCRP, not pursue expropriations, not seek reelection, etc.
Other candidates to watch include former finance minister
,
political leaders of northern Peru, as well as a candidate from
the center-left Fuerza Social party of the newly elected mayor
of Lima Susana Villaran. At this point, however, they seem
unlikely to make it to a second round.
We recognize that polling trends can still change dramatically
in the months ahead, but at this point we see a relatively low
risk of exaggerated political noise around the 2011 vote.
There could be some modest political noise surrounding aproposal in Congress to lift mining royaltiespotentially
including companies with stability contractswhich could
become a factor in the electoral debate
51 55
38
31
51
32
Scenario 1 Scenario 2 Scenario 3
Castaneda
Toledo
K. Fujimori
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Peru: BCRP took a preventive 25bp hike; policy rate to reach 4.5% by year-end
The BCRP hiked the policy rate by 25bp to 3.25% at the
first meeting of 2011. The move was described as
preventive in the face of the strong tone of domesticdemand as well as rising international food/energy prices.
2010 inflation ended at 2.1%, and we see the CPI reaching
2.5% in 2011. The BCRP has mentioned the recent spike
in international food and energy prices, stating that the
preventive rate hike aims to avoid any impact on
inflationary expectations.
We see GDP growing 8.8% in 2010, while the strong tone
of private investment should sustain growth at about 6.0%in 2011. The BCRP u dated the official 2010 GDP forecast
to 8.8% in the December Inflation Report from the 8.0%
forecast in the September Report. The Board has
mentioned that recent economic activity indicators have
been pointing to a strong expansion.
The recent measures that were taken by the BCRP
increase in reserve requirements and the preventive rate
hike in Januaryshould allow the Board to pause again
and take stock before starting a hiking cycle in earnest.
Given the latest move was preventive and that inflation
should remain relatively tame in the short-term, we keep
our call for the next rate hike to take place in April, with the
policy rate eventually rising to 4.5% by year-end. However,
if inflation or inflation expectations start to deteriorate,
BCRP has shown that it could react by adjusting monetary
policy again sooner than our base-case scenario
especially as the output gap is poised to turn positive.
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Peru: PEN should strengthen amid low volatility; further rating upgrades likely
The continued increase in commodity prices has been
limiting the deterioration in external accounts despite thestrong growth of domestic demand, and the current
account deficit should remain below 3% of GDP in 2011.
Constructive external accounts, limited evidence of
overvaluation of the PEN on a REER basis, a strong
growth outlook, additional monetary tightening and mild
and temporary election noise all augur well for further PEN
appreciation this year. We expect the strong measures
enacted by the authorities to keep PEN appreciation
gradualbut we see USD/PEN gradually appreciating to2.75 by end-2011.
Fiscal expenditures surged in 2009 and in 1H10 on the
back of the fiscal stimulus program announced in 2008, but
started to moderate in 3Q10. In 2010 as a whole, the fiscal
stimulus should still add 1.2%-pts to 2010 GDP growth, but
the recent moderation in public expenditures will result in
fiscal tightening in 2011. Perus government is now aiming
to reduce public spending further, which could bring the
overall fiscal deficit to about 0.5% of GDP in 2011.
Rating agencies could well upgrade Peru in 2011. S&P
and Fitch both revised Perus rating outlook to positive in
2010, reflecting strong growth and fiscal and external
accounts that compare well against ratings peers
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Venezuela: Politics have become more competitive and thus will be even
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Venezuela: Politics have become more competitiveand thus will be even
noisier than usual heading toward 2012 presidential elections
President Chavez faced myriad challenges in 2010: sharp
stagflation, electricity rationing that exposed underinvestment
and mismanagement in the sector, a mini-banking crisis and
related scandals, and fallout from an unwieldy fx policy, including
a long-resisted formal devaluation and USD scarcity for the
private sector after closure of the parallel fx market
The business climate continues to be tense, marked by a new
wave of nationalizationsmany in the food distribution sectors
following 2009s takeover of some oil service providers
The on-again, off again confrontation with Colombia has
surprisingly eased with the election of Santos, but bilateral trade
remains depressed and the current dtente may be fleeting
2010s political challenges were in contrast to 2009, when
7.31
4.38
6.315.44
4.29 4.55.19
5.78
Presidential
election - 2006
Constitutional
referendum -2007
Term-limits
referendum -2009
National
Assem bly - 2010
Chavez Oppos ition*
Chavez was flying high after a February 2009 referendum victory
left him free to run in 2012 presidential elections
Polls now show Chavezs popularity below 50%, and most
pollsters show the public remains skeptical of radicalization.
Chavezs PSUV still managed to maintain the simple majority in
the September 2010 National Assembly election, but the
opposition broke the qualified 2/3 majority and relegated the
PSUV to a minority in the popular vote
Lest one be tempted to believe the relatively strong opposition
showing would restore some semblance of checks and balances,
the lame-duck Assembly handicapped the incoming body by
granting Chavez decree power for 18 months
Chavez also asserted his power post-election with a new wave of
nationalizations. This suggests a double-down radicalization
strategy, though Chavez must balance this with better economic
performance if he hopes to recover popularity
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Latin America economic forecasts
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Latin America economic forecasts (cont.)
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