Most of the major Latin American economies have performed better than expected so far this year, showing some resilience to external headwinds--high global food and energy prices, rising U.S. interest rates, and COVID-19-related lockdowns in China. For the six major Latin American economies (LatAm 6), real GDP in the first quarter (the latest available data) expanded, on average, 0.9% quarter over quarter, up slightly from 0.7% in the last quarter of 2021 (see chart 1). The reasons for better-than-expected growth vary by country. In some cases, it was robust export performance (Brazil and Mexico), and in others, ongoing strength in domestic demand (Colombia and Chile).

However, the recent tightening in global financial conditions, rise in inflation owing to supply chain issues and high food and energy prices, and an increase in uncertainty about global growth are likely to weaken activity in the region in the rest of 2022 and into 2023.

We raised our 2022 GDP growth forecast for LatAm 6 to 2.0%, from 1.7% previously, but decreased our forecast for 2023 to 1.8% from 2.1%. Our assumption for average long-term growth to average roughly 2.5% in the region remains unchanged.

Chart 1

Table 1

Table 2

Higher Inflation, Higher Interest Rates, Softer Demand

In line with other regions, inflation in Latin America has been higher-than-expected in recent months because of rising food prices and persistently high energy prices (see chart 2). Several governments in the region have introduced measures that attempt to curb inflation, such as subsidies, reductions in taxes on fuels, and trade restrictions on food. Despite those measures, we expect inflation to remain above the central bank targets of the major economies throughout the rest of 2022, and in most cases throughout 2023 as well. S&P Global Ratings now assumes that Brent will average $100 per barrel (bbl) the rest of 2022 and $85 per bbl in 2023 (see more in "S&P Global Ratings Raises Oil And Natural Gas Price Assumptions On Further Market Price Step-Ups," published June 8, 2022), $15 higher than our March assumptions. Energy prices appear likely to remain elevated for longer as the Russia-Ukraine conflict and sanctions continue. Food prices are following a similar trend due to the fallout of the conflict (see more in "The Global Food Shock Will Last Years, Not Months," published June 1, 2022).

Chart 2

Several central banks in the region have stepped up their tightening cycles to anchor inflation expectations. As a result, domestic financial conditions have tightened, with interest rate curves now pricing in higher interest rates--both in the rest of 2022 and 2023--than previously expected. We believe Brazil and Chile are the closest to ending their rate hiking cycles and are likely to start unwinding some of the monetary tightening toward the end of 2023. Despite this, real interest rates are likely to remain high across the region in 2023.

Chart 3

Countries where domestic demand has been above trend are likely to experience a larger deterioration in demand--in response to tighter monetary policy--than countries that still have a lot of slack in the economy, where momentum from the pandemic recovery is stronger. For those reasons, we expect domestic demand in Chile and Colombia to weaken more than in their peers. In both of those economies, domestic demand is already over 10% above pre-pandemic levels (see chart 4), fueled by stimulus measures that have been phased out.

Chart 4

What A More Aggressive U.S. Federal Reserve Means For Latin America

Higher-than-expected inflation in the U.S. has raised our expectations for the Federal Reserve to hike the federal funds rate above 3.5% by mid-2023, a much swifter pace of normalization than just three months ago. This has pushed up our interest rate profile across the region, as central banks attempt to curb capital outflows to prevent abrupt exchange rate depreciations, which would increase inflation expectations. Countries with large current account deficits are likely to face higher pressure on interest rates in the absence of an improvement in external dynamics. Colombia and Chile stand out from this angle--both economies are running current account deficits of over 6% of GDP (see chart 5).

Chart 5

How Slower Growth And The Risk Of More Lockdowns In China Could Affect Latin America

The impact of COVID-19-related lockdowns in China has been more severe than we anticipated, prompting us to lower our 2022 GDP growth forecast for China from 4.9% to 4.2% in May, and now further to 3.3%. While China's economic trajectory can have a large impact on Latin America's growth prospects, it depends on the underlying factors. In this case, slower growth in China is more a result of weaker-than-expected consumption, rather than investment, since lockdowns lowered household spending due to strict mobility restrictions. Latin America's exposure to Chinese consumption is relatively low, especially compared with other emerging markets in Asia. Latin America sells mostly commodities to China, which are tied to the investment story, especially in infrastructure.

Table 3

However, if lockdowns do restrict manufacturing activity in China, Latin America could be affected through supply-chain disruptions. Latin America's largest supply-chain linkages with China tend to be in Mexico, mostly in four sectors: computer and electronics, electrical equipment, machinery and equipment, and autos. If we look at the performance of those sectors when the most recent lockdowns in China were the strictest, in April, we see that production continued to improve throughout that month. In other words, so far manufacturing production in Mexico is not showing a clear impact from lockdowns in China. This could be a sign of better inventory management, or that the impact will be felt in the months ahead.

Chart 6

Risks To Our Forecasts Are Squarely To The Downside

A weaker-than-expected U.S. economy is a key risk to the region and has increased in recent months. The economy most vulnerable to a deterioration in U.S. economic conditions is unsurprisingly Mexico, given its sizable trade and investment ties. However, the associated deterioration in confidence and financial conditions that would likely follow a weaker-than-expected U.S. economy would take a toll on Latin American assets as risk-off sentiment increases, and potentially also resulting in weaker investment. High levels of political uncertainty is also a key risk to growth in Latin America. The current high inflation, low employment, and subpar growth in most economies in the region could increase social unrest, reducing policy predictability and making investment decisions more difficult.

Our GDP Forecasts

Argentina:  First-quarter growth was stronger than expected, at 0.9%, driven by resilient domestic demand. This has pushed our 2022 GDP growth forecast up to 3.3%, from 2.8% projected in our March baseline. However, weaker external conditions have prompted us to lower our 2023 growth forecast to 1.8% from 2.0%. Our macro narrative for Argentina has not changed materially. Argentina's producers of grains will benefit from the increase in prices since the Russia-Ukraine conflict began. However, government policies, such as the recent increase in export taxes on soymeal, will limit those gains. The government reached a staff-level agreement to renegotiate its $45 billion deal with the IMF. However, implementation of the agreement will be challenging, requiring ambitious fiscal, monetary, and reserves targets.

We expect inflation to remain high throughout the year, which will conversely keep interest rates high as well. The exchange rate will remain under pressure, given the combination of lower foreign-exchange reserves and a heavy foreign-currency debt burden. The government continues to face large fiscal imbalances and has limited access to international capital markets following the restructuring of $65 billion worth of debt last year. This means that the government will continue to finance its large fiscal deficit through local debt issuance, which will weigh on the currency and add to inflation.

Brazil:  We have increased our projection for 2022 GDP growth for Brazil to 1.2%, from 0.4% in our March baseline. This is due to stronger-than-expected growth in the first quarter of 1%, compared with the fourth quarter of last year, driven by strong export growth. We still expect the Brazilian economy to weaken in the second half of 2022 and into 2023 as tight monetary conditions and high inflation weaken domestic demand. As a result, our 2023 growth projection is now lower at 1.4%, compared with 1.7% previously. We expect inflation to stay above the central bank's target through the rest of 2022 and in 2023 as well, which we believe will prompt the central bank to keep real interest rates relatively high throughout that period. Uncertainty regarding the general election in October--in which former President Luiz Inácio Lula da Silva is likely to run--could also result in delays to investment. We see the risks to growth outlook skewed to the downside.

Chile:  We kept our 2022 growth forecast unchanged at 2.1%. The economy contracted 0.8% in the first quarter, driven by a 5.9% decline in investment. We expect Chile to enter a technical recession in the second quarter, as domestic demand contracts, following very strong growth last year that was fueled by pension withdrawal allowances that are no longer in place. In our view, Chile is one of the economies in Latin America that will be the worst hit by the Russia-Ukraine conflict through a higher energy bill. This, combined with weaker external conditions, has led us to revise down our 2023 GDP growth forecast to 1.3%, from 2.4% previously. Uncertainty over the rewriting of Chile's constitution, which is suffering from delays at the moment, will also likely temper investment until there is more policy visibility.

Colombia:  We kept our 2022 growth forecast unchanged at 4.6%. Following strong growth of 1% in the strong quarter, we expect growth to moderate the rest of the year. While Colombia is one of the only countries in the region that benefits from higher oil prices on a net basis in nominal terms, export volumes have not benefited given stagnant oil production. Gustavo Petro was elected as the new president of Colombia on June 19 in a runoff against Rodolfo Hernandez. Key among his campaign promises was to reduce the Colombian economy's reliance on the hydrocarbon sector, which could result in lower investment in that sector, but also help diversify the economy in the long term. President-elect Petro will face a divided congress, which means it is likely he will have to moderate several of his campaign promises. We lowered our 2023 GDP growth forecast to 2.7%, from 3.0% previously, owing to the more challenging external scenario Colombia and other countries in the region will face.

Mexico:  We lowered our 2022 GDP growth forecast for Mexico to 1.7%, from 2.0% previously, as well as our 2023 projection to 1.9% from 2.3%. This mostly reflects a weaker-than-previously assumed U.S. economy, which will mean less demand for Mexico's manufactured goods exports. The Mexican economy's recovery from the pandemic remains one of the weakest in the region, with domestic demand returning to its pre-pandemic level in the first quarter of this year. (Most other Latin American economies reached that point around the middle of 2021.)

Furthermore, Mexico is a net energy importer, given a large amount of imports of gasoline and natural gas, which means that the recent increase in energy prices will hurt growth. The government has reacted to higher energy prices by lowering taxes on gasoline. As a result, the longer that oil prices stay elevated, the higher the fiscal cost for the Mexican government. Beyond 2023, we continue to expect Mexico to be close to its traditional structurally low growth rate of 2% because of low and inefficient levels of investment.

Peru:  We kept our 2022 growth forecast for Peru unchanged at 2.5%, but lowered our 2023 projection to 2.8%, from 3.1% previously, because of weaker external conditions. President Pedro Castillo has survived several impeachment proceedings against him, but has to navigate a fragmented congress, which will keep policy predictability low. Exports have been a main cause of growth in recent quarters, helped by high copper prices. However, investment is likely to weaken as a result of uncertainty about both global growth and domestic policies. Beyond 2023, we expect growth to stay near 3%.

Appendix

Table 4

Table 5

Table 6

Table 7

Table 8

Table 9