Latin America looks set to grow steadily on the back of domestic demand and supportive commodities that maintain the investment pipeline. The external risks are significant, mainly due to the possibility of a deep correction in commodities, while potential complacency on the part of domestic authorities could limit economic performance. Overall, the region is likely to maintain its status as an investment magnet, but for varying reasons.
Mexico’s growth has outperformed in 2012. Dormant domestic demand has revived, pointing to a virtuous cycle of stability. This favours the financing of homes and businesses in an environment where inflation is low and stable. Meanwhile, the country’s underutilised, but solid, financial system is capable of meeting solvent credit demand. The Mexican outlook is not exempt from downside risks, including lacklustre activity and debt sustainability issues in the US, its main economic partner. But the country’s domestic stability and sound fiscal and external balance has also facilitated the entry of cash flows and established Mexico as a potential ‘safe haven’. On the flip side, the Mexican currency remains exposed to global developments and is likely to remain volatile, while investors view its liquidity and accessibility as a risk hedge.
Brazil remains the main economy in the region and the largest consumer market, having enjoyed a substantial boost from domestic demand in recent years. But signs of exhaustion in the Brazilian economy (slower credit, tight labour markets and overall lower Asian demand) and a gradual loss in competitiveness through lack of reform have started to shift the momentum in Mexico’s favour. Still, monetary and fiscal stimulus should help to lift the economy, along with the mega events of the next few years (the Football World Cup in 2014 and the Olympics in 2016). Overall, the country’s infrastructure needs and government plans are likely to stimulate the investment pipeline while checking currency appreciation.
Despite the global slowdown and obstacles faced by some large projects, Peru’s prospects continue to be bolstered by investment in mining, energy and infrastructure. Public works will probably help Peru to keep its position as Latin America’s fastest-growing economy, with export volumes partly offsetting lower prices. Additionally, the development of a fixed income market has proved an attractive alternative for foreign investors and the market may yet benefit from continued rating upgrades and overall policy flexibility. Meanwhile, the central bank has insisted on limiting the volatility of the Peruvian currency through continued intervention in FX markets.
Investment in Colombia continues to surprise and drive currency appreciation. After enjoying record levels of foreign direct investment in 2011, the country’s economy grew more than 25% in the first half of 2012, with oil and mining industries hoarding more than half the gain. The peak may be over as external demand slows, but domestic demand is resilient, favouring sectors such as retail or food products. The reduction in the public deficit, lower funding costs and higher savings continue to improve Colombia’s fiscal flexibility. And improving the rate of execution of public works will help to speed up growth into 2013. If Colombia’s domestic conflict ends, that could be a significant boost for investment.
Alejandro Cuadrado is head of Latin America FX strategy at BBVA.
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