Latin America is headed for another year of slow growth in 2020 as many economies experience some of their lowest growth rates since the global financial crisis. S&P Global sees the region growing less than 2% for a seventh consecutive year--with projected aggregate GDP growth of 1.5% for the six largest economies in the region, or LatAm 6, in 2020 (see chart 1).

Underwhelming levels of investment are the main factor dragging on growth. In most cases, weak investment is due to uncertain domestic political dynamics--the impact of which has been amplified by concerns over the trajectory of global trade and growth in the last couple of years.

However, our GDP growth forecast for next year is a moderate improvement from 0.5% in 2019--mainly because of looser monetary conditions abroad and domestically. Also, in some cases, the effects of political shocks, such as delays in public investment associated with the transition in government in Mexico, are subsiding.

The risks to growth remain concentrated on the downside--mostly related to the evolution of domestic policies that have taken a toll on investors' perception toward growth in the region.

Chart 1

What Has Changed Since Our Previous Quarterly Update?

Several important developments have taken place since our quarterly update at the end of September, but they were broadly as expected, so in most cases, they have not changed our 2020 GDP growth outlook. Specifically, the opposition won Argentina's October presidential election, as most expected, and we continue to expect the economy to contract about 1% in 2020 amid rigid financial conditions. In Brazil, long-awaited pension reform was approved. The final version of the bill was within the parameters that most observers anticipated, and it underpins our unchanged expectation for growth to improve to 2% in 2020 from 0.8% this year.

In contrast, recent unexpected social and political instability in Chile and Peru has prompted us to lower our 2020 growth outlook marginally. In our view, this instability is a reflection of the pent-up social and political tensions that are present in much of the region due to limited upward socioeconomic mobility. We also lowered our 2020 GDP growth projection for Mexico to 1.0% (from 1.3%) since the data has been weaker than expected, especially on the investment side, a trend we broadly expect to continue into next year.

Table 1

Table 2

Low Interest Rates Will Persist In 2020

Interest rates are likely to remain low in 2020, following monetary policy easing by most major Latin American economies in 2019:

• Brazil reduced its reference rate by 150 basis points (bps) to a record-low 5.00%,
• Chile by 100 bps to 1.75%,
• Mexico by 75 bps to 7.50%, and
• Peru by 50 bps to 2.25%.

In one-year real ex ante terms, interest rates are among the lowest they have been in over five years (with the exception of Mexico), and negative in the case of Chile (see chart 2). The U.S. Federal Reserve's interest rate cuts (by a total of 75 bps) this year were an important factor encouraging Latin American central banks to reduce their interest rates in that they relieved depreciatory pressure on the currencies.

While we currently do not anticipate additional easing by the Fed in 2020, we believe that the bias of central banks in the region will be toward additional cuts. This is especially the case in Mexico, where the interest rate is still above neutral (by about 200 bps), growth dynamics are weak, and inflation is within target (expected to run around 3% in 2020).

Chart 2

Amid challenging fiscal and public debt dynamics in most countries in Latin America, monetary policy will remain one of the main tools to stimulate growth. That said, the transmission mechanism of lower interest rates is mixed, given limited access to credit markets in several countries and rigid financial systems. However, in some cases, such as in Brazil, lower domestic interest rates are having a clear impact on credit, especially by boosting domestic bond issuance.

Social Unrest Could Keep Risk Perceptions High

The recent bouts of social unrest in several countries in Latin America, most notably in Chile, make it difficult to make assumptions about policy direction in the next few years, which could also continue to discourage, or at least postpone, investment in the region.

It is not entirely a surprise that social demands for deep political change are taking place, considering the evolution of key measures of economic progress over the last decade. For example, we looked at GDP per capita convergence with the U.S. In the average Latin American economy, GDP per capita in purchasing power parity terms is about 30% of that in the U.S., and in the last decade (2010s), it has either retreated or convergence has markedly slowed. In contrast, in most other emerging markets, GDP per capita convergence has improved (see chart 3). In addition, several measures of income distribution have lagged in Latin America versus most other emerging markets.

Chart 3

Our GDP Forecasts

Argentina

President-elect Alberto Fernandez's incoming administration faces a tough economic scenario, with elevated policy uncertainty, especially regarding the government's high and rising debt burden. We assume financial conditions will remain rigid throughout most of 2020 amid capital and price controls and a likely debt restructuring. We forecast the economy to contract 1% in 2020, following a 3% contraction in 2019, with the risks to our outlook firmly to the downside.

Brazil

The approval of pension reform is an important step in addressing the government's rapidly rising debt ratios, but more needs to be done to further progress on that issue, especially regarding rigidities on public spending. We continue to expect growth to improve to 2% in 2020 from 0.8% in 2019 as investment prospects strengthen and the slow cyclical recovery from the 2015-2016 recession continues. The reform drive by the current administration could lead to better GDP growth than we expect, but the polarized legislature poses significant risks to the approval of additional bills that require constitutional change.

Mexico

Data continues to reflect a significant weakening in growth in 2019, mainly because of a sizable decline in both private and public fixed investment. We see continued sluggish growth in 2020, expanding at one of its slowest rates since the global financial crisis--about 1.0% according to our forecast (revised from 1.3% in our previous update). This is an improvement from our estimate of 0.1% in 2019, mainly because of the subsiding effect that this year's transition of government had on public investment, less of a drag from the ongoing decline in oil production, and looser monetary policy abroad and domestically.

The risks to our growth outlook for Mexico are mostly to the downside, given a high degree of uncertainty stemming from several policies by President Andres Manuel López Obrador's government, especially toward the energy sector.

The Rest Of The Region

We've lowered our growth outlooks for Chile and Peru due to the recent social and political instability that has occurred over the last couple of months.

In Chile, the social unrest, which was initially triggered by an increase in metro fares and expanded to reflect dissatisfaction with social security and education, has been accompanied by disruptions to ports, transportation, and mining operations. We therefore lowered our 2020 GDP growth forecast by about 30 bps to 2.4% (as well as lowered our 2019 estimate by a similar amount).

In Peru, political paralysis following the president's dissolution of the legislature and call for a parliamentary election is disrupting public investment, and we have lowered our 2020 GDP growth outlook by 20 bps to 2.8%.

In Colombia, by contrast, we have kept our 2020 GDP growth forecast unchanged at 3.2%, underpinned by a recovery in oil production and stable growth in the services sector. However, recent social unrest in Bogota and other major Colombian cities, where protesters have taken to the streets to oppose labor and pension reform, among other government proposals, poses significant downside risk to our growth outlook for Colombia.

Key Assumptions

• We do not anticipate additional Fed rate cuts, but the effective Fed funds rate is likely to remain low throughout 2020, at 1.625%, and the bias in monetary policy in advanced economies generally looser, rather than tighter.
• We expect an orderly deceleration in GDP growth in most advanced economies in 2020. We see a 25%-30% probability of a U.S. economic recession over the next 12 months and growth remaining close to potential in 2020.
• We assume recent policy easing in China will stabilize the economy toward the government's target of 5.8% in 2020.
• Regarding Argentina, we assume a somewhat orderly debt restructuring process--if that's not the case, we'll revisit our GDP growth projections.
• Our baseline GDP forecast for Mexico includes continued uncertainty over President Andres Manuel López Obrador's policies that reduces private-sector investment in key sectors, such as energy. We also think public investment will improve in 2020, compared with 2019, after the typical delays in the first year of a new administration.

Key Risks

• A more pronounced deceleration in real GDP growth in the major advanced economies than what we currently assume could challenge the mild economic recovery in Latin American economies.
• The ongoing trade dispute between the U.S. and China, if it escalates again, potentially as the U.S. presidential election campaign picks up, could renew risk aversion and lower appetite for emerging markets assets, resulting in capital outflows from Latin America.
• While there has been an important push to ratify USMCA (the United States-Mexico-Canada Agreement) in recent months, its approval remains at risk of political infighting ahead of the U.S. presidential election. A significant delay in ratifying the treaty that would replace NAFTA could generate uncertainty toward trade and investment relations between the U.S. and Mexico.
• The political situation in Argentina is very challenging and still very fluid. Downward pressure on the currency and on the government's debt profile could trigger drastic policy measures that result in a more protracted downturn in domestic demand that we currently project.
• Brazil will likely see a very active 2020 political agenda, with several bills in the pipeline, many that involve constitutional amendments. Given the highly divided legislature and chronically low economic growth, the potential for disappointment and under-delivering on policy objectives is high.
• Failure to execute on delayed public investment plans in 2020 and additional polices by President Andres Manuel López Obrador that either restricts or discourages fixed investment further would make us revisit our assumptions for Mexico.

Appendix

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