S&P Global has revised up its 2021 growth forecast for the six major Latin American economies to 4.9%, from 4.1% previously, following a 6.8% contraction in 2020 (see table 1).

The first reason for the upward revision is the improvement in our global growth projections. We now forecast global GDP growth of 5.5% this year, up 50 basis points from our previous projection. The rollout of COVID-19 vaccines, especially in the U.S.; stronger growth in China; and additional stimulus measures in the U.S., with positive spillover effects on Latin America, are the main factors behind our higher global growth projections.

The second reason is stronger-than-expected fourth-quarter 2020 GDP growth--the region grew 17.5% in quarterly annualized terms. The improvement happened because of continued resilience in commodities and manufacturing plus better-than-expected results in the services sectors in countries where stimulus was strong or lockdowns were eased, or both. The fourth-quarter growth, compared with roughly a 12% median expansion across major emerging markets, results in a strong statistical carryover for GDP in 2021.

Despite this, by the end of last year the median GDP in Latin America was still 4% below its pre-pandemic level (see chart 1). We expect the average Latin American economy to return to its pre-pandemic level around mid-2022.

Table 1

Table 2

Chart 1

GDP Will Pick Up In The Second Quarter

The resurgence of new daily COVID-19 cases at the beginning of 2021 led to every major Latin American economy reimposing lockdown measures. We think this will result in GDP softening or contracting in the first quarter compared with the previous quarter. We then expect GDP growth to firm up in the second quarter as lockdowns are relaxed and headwinds from strengthening global growth translate into continued strong demand for the region's manufacturing and commodities exports.

Where new daily infections have not subsided, we could see additional lockdown measures into the second quarter, which could delay the recovery. This is especially true in Brazil, where new daily cases are at new highs, daily COVID-19 related deaths continue to rise, and hospitals in several regions of the country are at or near capacity (see chart 3). Chile also recently announced new lockdown measures.

Chart 2

Chart 3

Services Will Be An Increasingly Important Part Of The Recovery

In the second half of 2021 and into 2022, we expect the services sector's performance will increasingly lead the regional GDP recovery. Recovery of the region's main trading partners, the U.S. and China, will include relatively lower demand for manufacturing and commodities and higher demand for services as lockdown restrictions continue to loosen.

Two things will determine how quickly activity in the services sectors in Latin America returns to more normal levels--the degree of damage inflicted on the companies in those sectors and the government support available to help repair that damage.

Many of the services sectors can't just turn on and off. Because of the financial pain many companies endured, especially smaller ones, they'll look for a high degree of confidence on growth prospects before restarting operations, and reemploying and reinvesting could take some time. As a result, resuming business might prove more difficult and may take longer in countries where the services sectors had a harder time during the pandemic and not much government support, such as in Mexico (see table 3).

Table 3

Second, the vaccine rollouts will determine both how quickly lockdown measures are phased out in the services sectors and the degree of confidence companies have in restarting operations, especially in businesses where social distancing is difficult to maintain, such as at restaurants, hotels, and other tourism-related sectors.

Vaccine progress in the region varies widely, but Chile is clearly leading the way, with nearly 50 vaccines administered per 100 population, among the highest rates globally (see chart 4).

Chart 4

The Impact Of Higher U.S. Yields: No Reason To Raise The Alarm Yet, But Local Rates Will Go Up

The adjustment by the major Latin American economies to this year's rise in U.S. Treasury yields has generally been orderly. The main reason for this, in our view, is that behind the increase in U.S. yields is reflation driven by greater confidence in the recovery of the U.S. economy--a good thing for the region. Naturally, markets will adjust as risk premiums are reassessed, as seen in higher government credit spreads. We expect this will be more pronounced in countries with higher external or fiscal imbalances.

As long as confidence in a strong U.S. economic recovery remains, which is our baseline scenario, we don't expect the rise in U.S. Treasury yields alone to lead to abrupt and disorderly market adjustments in the region, especially in higher-quality credits. Looking at implied foreign exchange (FX) volatility, which tends to jump rapidly when disorderly market adjustments do happen, the change in response to this year's rise in U.S. yields is only about one-fifth the change that occurred during the taper tantrum in 2013, when the Fed announced it would be reducing its purchases of Treasury bonds (see chart 5).

In fact, when looking at more recent periods in which long-term U.S. Treasury yields increased, especially when U.S. growth expectations also improved, there were times when implied FX volatility in Latin America actually declined. Cases where it increased were due to unrelated idiosyncratic factors.

For instance, around the time Donald Trump won the election in 2016, the U.S. 10-year Treasury yield increased by about 100 basis points (bps) over three months as expected tax cuts drove both inflation and growth expectations higher. The only country among the major Latin American economies that saw a significant jump in implied FX volatility over that period was Mexico--and it was over the threat of the repeal of NAFTA by then President Trump, not because of the movement in U.S. Treasury yields.

More telling, during the period of global synchronized growth between fall 2017 and 2018, U.S. 10-year Treasury yields rose about 120 bps, and implied FX volatility fell in every major Latin American economy.

That said, the most immediate and noticeable market reaction to this year's rise in U.S. yields is arguably happening in local rates. Importantly, in places were rates are moving the most, idiosyncratic factors are at play.

Chart 5

The clearest case is Brazil, where short-term rates have moved the most this year (see chart 6). The central bank reacted by increasing its policy rate by 75 bps this month, which started a monetary tightening cycle. Brazil faces a tough post-pandemic fiscal situation, with a high amount of short-term domestic government debt due over the next 12 months (about one-quarter of all debt outstanding) and rising inflation expectations--which is what led the more abrupt repricing of local rates than in peers.

Chart 6

That said, we expect most other major Latin American central banks to start increasing interest rates from their current record lows, either by the end of this year or early in 2022. This is because inflation expectations are likely to pick up in the coming months as the recent rise in energy prices filters through the economy. The upward impact that a rise in U.S. yields has on local rate curves means that central banks are more likely to act sooner, rather than later, to prevent disorderly adjustments in exchange rates, which would push inflation expectations even higher.

In most cases, however, real interest rates will likely remain low by historical standards over the next couple of years.

Chart 7

The Post-Pandemic Long-Term Growth Outlook Is Challenging

As sectors continue to reopen and output gaps close, we expect GDP growth to remain above trend in Latin America in 2022. We forecast average growth to be close to 3% that year, above its roughly 2.5% trend. Beyond that, we expect the region to converge to its traditional, structurally low growth rates, which is why we project growth around 2.5% at the end of our forecast horizon (2023-2024).

The region has a structural problem of low productivity, which has averaged just 0.5% in the previous decade, much lower than the 4.5% average across major emerging markets. At this point, it is hard to envision a major improvement in productivity in the region after conditions normalize from the pandemic downturn.

One reason productivity growth is so dismal in the region is that investment growth is low and inefficient. Real fixed investment in the region has averaged less than 0.5% since the global financial crisis (not including 2020), much lower than 5% in emerging markets. Plus, each unit of investment produces 50% less of GDP growth on average in Latin America than the average across major emerging markets.

The investment picture deteriorated sharply throughout the pandemic in most countries in the region, with the average investment-to-GDP ratio 1.5 percentage points below its pre-pandemic level. While investment will recover as economies normalize, returning to pre-pandemic levels of investment will be a slow process and highly vulnerable to setbacks amid persistently low expectations for long-term growth. Furthermore, higher debt ratios and challenging fiscal dynamics in most countries in the region mean that public investment will face more constraints after the pandemic than before it.

Chart 8

Employment also has a long path to recovery. This is likely to keep consumption growth low for some time. On average, in Latin America's major economies, the employment-to-working age population ratio is 8 percentage points lower than before the pandemic (see chart 9). This statistic excludes underemployment and a shift to lower-quality jobs. We will certainly see job generation pick up as services sectors open. But unless growth expectations improve, there is no guarantee that jobs will return rapidly.

Chart 9

Finally, another risk to the region's long-term growth outlook involves social and political dynamics. The pandemic hit the lower-income brackets the hardest and increased poverty and inequality in most countries in the region. With high unemployment and a busy electoral agenda over the next couple of years, policy direction could be more volatile than usual with potentially negative implications for long-term growth.

Our GDP Forecasts

Argentina

We increased our 2021 GDP forecast to 6.1% from 4.0% mainly because performance in 2020 improved more than we expected, resulting in a statistical 5% carryover for this year. The economy continues to face severe constraints, including persistently high inflation, a heavy foreign-currency debt burden, and low foreign-exchange reserves, which leads to a scarcity of U.S. dollars in the economy. In light of these dynamics, economic growth will remain susceptible to large swings, keeping investment weak and recovery slow. This is reflected in our relatively low projected 2.1% average GDP growth for 2022-2024 (the end of our forecast horizon).

Brazil

We have made only small changes to our projections for Brazil. We now forecast 2021 GDP growth of 3.4%, from 3.2% previously, after the economy contracted 4.4% in 2020 (40 bps better than we expected). We expect quarterly growth to contract in the first quarter, mainly because of a slowdown in consumption as stimulus was phased out at the beginning of the year. New lockdown measures amid a record-high number of new daily COVID-19 cases will also lower mobility in the first quarter and potentially into the second.

A new, but modest, stimulus package will help consumption improve in the second quarter, when we also expect services to resume their recovery as lockdown measures ease. We expect the Brazilian central bank to continue increasing interest rates throughout this year. A challenging post-pandemic fiscal picture and a significant amount of short-term maturities due over the next 12 months (north of 15% of GDP) will increase market expectations for higher interest rates to compensate for the rise in fiscal-related risk premia. We see growth normalizing around 2.5% starting in 2022, as fiscal and monetary tightening become economic headwinds.

Chile

We increased our 2021 GDP projections to 5.9%, from 5.2% previously. The country had one of the strongest fourth-quarter GDP performances in emerging markets, growing 30% in quarterly annualized terms, which leaves a high carryover for 2021 GDP growth. The economy in the fourth quarter benefited from the removal of lockdowns that were in place during the previous quarter and from a law that allowed pension withdrawals, which was reflected in a pickup in consumption.

While the first quarter and early second quarter are likely to be soft because of additional lockdown measures implemented, a successful vaccine rollout in Chile will likely help the services sector return to normal activity levels later this year. And, another round of stimulus of about 2% of GDP announced this month will also help the economy regain momentum. Key risks to Chile's growth outlook are associated with political events, including a process to rewrite its constitution and a general election scheduled for November. Both could keep social tensions high and policy predictability low.

Colombia

We forecast 6% GDP growth this year, up from 5.1% in our previous projection. The economy's 6.8% contraction in 2020 was nearly one percentage point better than we expected, which explains part of our upward adjustment. Colombia's exports had one of the worst performances in Latin America in 2020, falling 17%, as demand for oil, the country's key export, collapsed throughout the pandemic downturn. However, we expect oil exports to recover this year and into 2022, as services sectors that rely heavily on energy, such as travel, should normalize with the progress in the global vaccine rollout.

Mexico

Our 2021 GDP growth estimate for Mexico improved to 4.9% from 3.9% previously. This is mostly explained by our revision to U.S. GDP growth for this year to 6.5% from 4.2% previously. New stimulus measures in the U.S. are likely to keep demand for Mexico's manufactured goods relatively strong this year and remittances relatively high.

However, several factors will return Mexico to its traditionally low GDP growth rate of roughly 2% in the coming years. First, the investment picture, outside of manufacturing, remains relatively weak, partly because of government policies that have reduced investment incentives in key sectors, such as energy. Second, declining public investment over several years has contributed to the country's large infrastructure gap and low levels of productivity. Finally, because economic stimulus measures to offset harm from the pandemic have been lacking, amounting to only about 1% of GDP in 2020, the damage to small and medium enterprises during the pandemic has been relatively large. This means recovery in many sectors dominated by small and medium enterprises could take longer than in peer countries.

Peru

We forecast 10.2% GDP growth in 2021 GDP, a marginal adjustment to our previous 10% projection. However, most of the growth in 2021 is explained by a very high carryover of more than 14% after the 11.1% GDP decline in 2020. We expect a contraction in the first quarter of this year, driven by new lockdown measures and a worsening of the pandemic. Political uncertainty ahead of Peru's general election, which starts on April 11 and is likely to go into a second round in June given how divided the electorate is, will probably keep investment subdued throughout the first half of this year. After the election, we expect economic activity to pick up more noticeably and post growth of close to 5% in 2022.

Appendix

Table 4

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Table 6

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Table 8

Table 9