latin america and caribbean outlook - jan 2011

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


2/76

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


3/76

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

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4

5

6

7

8

9

1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11

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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

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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

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7/76

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

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8/76

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


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

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Agenda





9

Country overview 32


10/76

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


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


10INFLA

TION

ACCELERATION

TO

TRIGGER

POLICY

TIGH


11/76

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


Mexico Peru

Latin America: Food inflation

Index level, Jan 2008 = 100 %oya

ENIN

G

IN

2011

60

70

80

90

100


-5

0

5

10


11INFLA

TION

ACCELERATION

TO

TRIGGER

POLICY

TIGH


12/76

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


13/76

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


14/76

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


15/76

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


16/76

Agenda

Risks to monitor: China growth, Europe contagion, and FX intervention 16




16

Country overview 32


17/76

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


18/76

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


19/76

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


20/76

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

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CHINA

GRO

W

TH,EUROPE

CONTA


21/76

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


22/76

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


23/76

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


24/76

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


25/76

Agenda





25

Country overview 32


26/76

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


27/76

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

&


TH


28/76

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

&


TH


29/76

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

&


TH


30/76

External public debt ratios will remain stable in 2011 as higher growth offsets

increased borrowing

E

RE

COVERY

30CENT

RAL

AMERICA

&


TH


31/76

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

&


TH

31CENT

RAL

AMERICA

&


TH


32/76

Agenda





32

Country overview 32


33/76

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


34/76

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


35/76

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.

35COUNTRY

OVERVIEW


36/76

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.

36COUNTRY

OVERVIEW


37/76

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.

37COUNTRY

OVERVIEW


38/76

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


-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


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


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 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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latin america and caribbean outlook - jan 2011

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