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Latin American Economics Research
Ernest W. (Chip) Brown, Head
September 15, 2006
THE IMF AND THE WANING DAYS OF THE GOLDILOCKS ERA
REELECTION AND ROBUST GROWTH SUPPORTED BY MISALIGNING PRICES
BENIGN SCENARIO IN 2007, BUT COMPLACENCY AHEAD
2007 FISCAL BUDGET: HOW MUCH IS TOO MUCH?
STRONG EXTERNAL ACCOUNTS CONFIRM ECONOMIC STABILITY
REVISING OUR 2006-2007 FORECAST
THE IMF AND THE WANING DAYS OF THE GOLDILOCKS ERA.............................2
REELECTION AND ROBUST GROWTH
SUPPORTED BY MISALIGNING PRICES ..................................................................4
BENIGN SCENARIO IN 2007, BUT COMPLACENCY AHEAD ..................................7
2007 FISCAL BUDGET: HOW MUCH IS TOO MUCH?.............................................12
STRONG EXTERNAL ACCOUNTS CONFIRM ECONOMIC STABILITY .................16
REVISING OUR 2006-2007 FORECAST...................................................................21
Strictly Macro – September 15, 2006
OVERVIEW: THE IMF AND THE WANING DAYS OF THE GOLDILOCKS ERA
For a very long time we have been forecasting a Goldilocks global scenario for Latin America: buoyant global
demand, low interest rates internationally, and sufficient political good will at home to keep monetary policy in
check and preserve fiscal balances, strengthening external balances. The result for the region hasn’t been
porridge of just the right temperature, but a tepid meal of regional economic growth that at a projected 4.4%
for 2007 is far short of the best growth to be found in the emerging world.
There is now a sense that change of a more lasting nature is in the air, and that we may be in the waning days
of the Goldilocks era. This has been perhaps best exemplified by a warning last week by the International
Monetary Fund research team that commodity price declines in coming years could be significant. This was
followed by additional warnings from the Fund that the U.S. twin deficits and housing markets were untenable
in the long term.
We’re not as convinced as the IMF that the world, at least as far as it extends to Latin America, is changing
that quickly. The IMF itself is talking about modest reduction of global growth, not recession, and certainly not
collapse of the Asian growth story, which is crucial to the Latin American growth outlook. Supply problems
among copper producers (including Chile) may keep copper prices high in 2007, perhaps beyond. The IMF’s
view of Latin America, as reported by the press, is more pessimistic about growth in Mexico and more
optimistic about growth in Brazil than we are for 2007-08.
We are gradually unveiling our view of 2008 beginning with our team from Argentina, looking beyond the
election year of 2007. The rest of our team will present their initial forecasts for 2008 in the October issue of
Inside Latin America.
Our view of Latin America in this Strictly Macro reflects our skepticism about major changes being afoot, and
focuses more on how local changes can affect the local story over the next year or so. On the most aggregated
level, we still see 4.4% growth in 2007, slightly down from 4.5% this year and substantially higher than the
3.9% we were forecasting for the year this past January. Similarly, inflation remains around 5%, the regional
current surplus has grown to 1.3% of GDP for next year from 0.3% early this year, and fiscal balance is
maintained. There’s no pride of place in the current account surplus; all it really means is that the rest of the
world is accelerating its growth and consumption of exportable products from Latin America at a faster clip,
another sign of the regional growth numbers, which are decent but disappointing.
The highest growth in the region in recent years has been found in countries in Latin America that willfully
fracture all the neoclassical rules of sound economic management, specifically Argentina and Venezuela. It is
our view that this heterodoxy is unlikely to spread to the major economies of the region. We don’t think that
Kirchnesian economic policy (as our Juan Arranz in Buenos Aires refers to it) is easily transferable elsewhere
because there are few leaders in the region who have been as popular as Mr. Nestor Kirchner has been, and his
personal credibility is the mainstay of the price acuerdos in Argentina. By the same token, none of the Latin
leaders has the wherewithal from high petroleum prices that Venezuelan President Hugo Chávez enjoys, and
none is as willing to commandeer petrodollars for political advantage as is Mr. Chávez.
Chile enjoys a similar export revenue windfall from state-owned Codelco and reports growth that is at near-
Argentine levels, but Chile has been focusing on restocking a contingency fund and is far more cognizant of
the need to keep monetary aggregates under control in a market economy.
In Argentina, our Juan Arranz focuses on economic growth in an environment of misaligned, distorted prices.
Presidential elections are over a year away, but President Kirchner’s chances of being reelected are very high
indeed. Our team does see economic growth slowing in Argentina, but expansion at 6% next year is sufficient
to do the job of seeing the president reelected. We are worried about the energy sector in Argentina, as frozen
public utility rates have led to deferral of maintenance and cancellation of new investment in the sector. (Of
course, we are also concerned about the possible impact on neighboring Chile of shortages of imported gas
from Argentina.) We see the ad hoc system of price controls in Argentina gradually becoming less workable
and leading eventually to higher inflation, but not before Mr. Kirchner is easily installed for a second term in
2007. Meanwhile, by artificially raising real purchasing power, the price acuerdos are contributing to strong
domestic consumption spending and spending on real estate.
Our Brazil team focuses on the juxtaposition of a benign growth and re-election scenario for President Lula
and the tough economic policy decisions ahead, a theme that should be familiar to regular readers of our
research. Once again, we point out that the inflation battle has been all but won and the next challenge will be
to persevere with legislative changes needed to preserve fiscal balance. Brazilian government spending
continues to support wages and pensions at the expense of investment, sacrificing future growth for current
growth. Weighed in the balance, at least for 2007, the good inflation news trumps misgivings about the future
course of fiscal policy.
Our Chilean team points out a fiscal dynamic that will seem familiar to others: how much of a fiscal windfall
should be squirreled away for future need, how much spent today for urgently needed social programs? Our
Pablo Correa notes that 70% of spending is in the form of social transfers, which affect private consumption
spending and prices of goods such as housing and services. Accordingly, the decision to spend more of a
windfall has repercussions for fiscal policy, inflation, and economic growth. In Chile there are competing calls
for tax relief and for more spending on infrastructure and social programs. The Bachelet government, new this
year, prepares its first budget for fiscal 2007, within which we expect a “controlled expansionary” spending
policy with one eye firmly on the long-term level of copper income, not the near-term trend. Our ideal: no
more than an 8% expansion in government spending, adjusted for inflation.
Our Mexico City-based team focuses on the long-term trend of falling deficits in the current account and the
trade account in the balance of payments. Oil is, of course, a major part of this picture (exports up 44% in
1H06), but so is strong growth of manufacturing exports, up 18% over 2005 in the first half of this year, both
well outstripping growth in imports. Remittances by Mexicans working abroad will likely total US$24 billion,
the equivalent of 60% of oil revenues. Strong inflows in the balance of payments have encouraged the Ministry
of Finance to issue local bonds, using the proceeds to pay external debt, which will likely equal no more than
US$50 billion at the end of the year after a reduction of nearly US$27 billion during the Fox administration.
Finally, our Caracas-based team of economists has realigned its macro numbers to try to fully factor in the
positive effects from this year’s higher-than-expected oil prices. The highlight: Economic growth in 2006 will
now likely be up 9.6%, compared with our prior estimate of 7.5%. Growth next year will likely be 7.2%, an
upward revision of roughly the same magnitude as in 2006. Despite sharp increases in spending this year,
likely continuing through next year, this year’s finances will probably result in a slight surplus (0.7% of GDP)
instead of the deficit (0.6%) we’d previously forecasted, and the surplus in Venezuela’s public balance is likely
to grow next year to 1.5% of GDP compared with a 0.8% surplus we forecast six months ago. The country’s
capital account in the balance of payments is in deficit in part due to external debt buybacks and transfers of
reserves from the central bank to FONDEN, the government’s devel