At the beginning of 2021, international organizations including the United Nations Economic Commission for Latin America and the Caribbean (“ECLAC”), the Economist Intelligence Unit (“EIU”) and the World Bank were generally pessimistic about the economic recovery in Latin America and the Caribbean (“LAC”). “However, the region has achieved growth beyond expectations. International organizations forecast economic growth in Latin America in the range of 6.2% to 6.7% in 2021, which exceeds the average for emerging markets and developing economies and is significantly higher than the level of developed economies.
Due to the increase in the comparative base in 2021 and the impact of internal and external factors, economic growth in Latin America will slow down significantly in 2022, and may even become the slowest growing region in the world again.
In 2021, growth exceeds expectations and policies are gradually tightened
Latin America’s economy in 2021 far exceeded expectations for its 1.9% to 3.7% growth rate at the beginning of the year, with a particularly strong recovery in the second quarter, but economic growth has been gradually slowing since the second half of the year. Overall, the economic environment in Latin America in 2021 will be characterized by the following key features.
Two-way supply and demand drive, economic recovery beyond expectations
The international economic and social adaptation to the new pneumonia epidemic (hereinafter referred to as “the epidemic”) is gradually increasing, and the rapid progress of vaccination in Latin America (60% of the region’s population has been fully vaccinated as of early January 2022), the economy of Latin America will recover more than expected in 2021, driven by both the demand and supply sides.
ECLAC estimates that the Latin American economy will grow by 6.2% in 2021, with South America growing at 6.4% and “Central America and Mexico” at 6%, while the Caribbean (except Guyana) will grow by only 1.2% due to a sluggish recovery in tourism. Among them, five countries had an economic growth rate of 10% or more, namely Guyana (18.5%), Peru (13.5%), Panama (12.4%), Chile (11.8%) and Dominica (10.4%).
From the demand side, both external and internal demand in Latin America were strongly supported. On the external demand side, the successive lifting of the epidemic embargo measures and the relaxed international policy environment have driven global demand growth, with commodity prices continuing to rise and the average price level rising by 42% year-on-year in 2021, with Latin America’s exports significantly increasing under the dual impetus of volume and price; on the internal demand side, the growth of private consumption is the main driver of economic recovery in Latin America, overlaid with The growth effect of gross fixed capital formation and exports once pushed up the region’s economic growth to 16.1% year-on-year in the second quarter of 2021.
On the supply side, the bottoming out of the construction, business and manufacturing sectors, which were most affected by the blockade measures in the earlier period, was an important reason for the region’s economic boost as the epidemic eased and adaptation to the epidemic improved. In addition, the job market is gradually picking up, with the labor force participation rate improving to 60.5% from 57.2% in 2020 and a slow recovery in jobs, with the unemployment rate falling slightly to 10%.
Fiscal balance and inflation under pressure as easing is gradually withdrawn
Fiscal sustainability has become a key concern for most countries in Latin America as the expansionary fiscal policies implemented in response to the epidemic put enormous pressure on the region’s fiscal balance. 2021 sees a gradual rollback of stimulative fiscal policies in Latin America, with reductions in subsidies and transfers easing the pressure on fiscal payments, while the expiration of tax incentives and economic recovery simultaneously boost tax revenue growth. As a result, the region’s fiscal deficit shrinks from 6.9% of its gross domestic product (GDP) in 2020 to 5% in 2021, and the primary deficit decreases from 4.2% to 2.4% of GDP. However, the fiscal balance improved less in Caribbean countries than in Latin American countries due to large expenditures for post-disaster reconstruction. Despite the turnaround in the fiscal position compared to 2020, the size of the primary deficit still exerts greater pressure on the region’s public debt, and debt levels remain high.
Despite the early start of the interest rate normalization process in Latin American countries, inflation in most countries in the region exceeded central bank targets and reached historical highs in 2021, and currencies continued to weaken, so most countries accelerated the tightening of monetary policy. In September 2021, inflation in Latin America reached 6.4%, the highest since October 2008, with inflation in South American countries being the most severe, reaching 7%, up 4.6 percentage points year-on-year. Inflation in Latin America is, on the one hand, driven by rising energy and food prices in international markets and global inflation spillover; on the other hand, it is driven by increased costs due to higher prices of intermediate goods and factors. Faced with the dual pressure of inflation and exchange rate depreciation, Latin American countries, where the policy rate is the main monetary policy tool, have raised interest rates one after another, with eight major countries raising rates by an average of 2 percentage points. Among them, Brazil has raised interest rates the most and adjusted them the most, experiencing seven rate hikes, raising the policy rate from 2% in March 2021 to 9.25% in December.
Resilient high trade growth, but deteriorating current account balance
In 2021, total trade in Latin America grows significantly and terms of trade generally improve. The value of goods exports increased by 25%, with export prices contributing 17% of the growth and another 8% stemming from an increase in export volumes. Imports grew even faster, up 32% year-on-year (12% increase in price and 20% increase in volume). Clearly, the growth of international market demand for Latin American products was lower than the growth of Latin American import demand, reflecting the structural problems of its production and exports that have accumulated over time. However, Latin America’s terms of trade generally improved, by an average of 5%, as export prices achieved more substantial growth. Among them, the terms of trade improved by 15% for energy exporters, 13% for metal and mineral exporters and agro-industrial exporters, while the terms of trade of non-energy exporters in the Caribbean declined by 5% due to difficulties in recovering tourism exports.
Latin America’s trade surplus narrowed in 2021, decreasing by 8% year-on-year, as goods imports grew at a faster rate than exports. At the same time, imports of services grew in tandem with imports of goods, further widening the services trade deficit. And profit remittances from foreign companies also increase significantly due to higher commodity prices. Ultimately, after a brief “passive” improvement in 2020, Latin America’s current account shifts back into deficit, but well below the pre-epidemic deficit level, at 0.6% of GDP.
2022, slowing growth and challenges
The UN expects global economic growth to fall to 4.9% in 2022 from 5.8% in 2021, while the World Bank forecasts a drop from 5.5% to 4.1%. International organizations have estimated economic growth in Latin America in the range of 2.1% to 2.6%. Clearly, the recovery in Latin America will slow down significantly more than the global average. ECLAC estimates that only 14 countries could recover to the pre-epidemic 2019 level of economic activity by the end of 2022, less than half the number of countries in the region. The reasons for this are mainly due to the recurring and lengthening duration of the epidemic, which has further exacerbated long-standing structural problems in Latin America, causing serious damage to the region’s economic growth in the short and medium term. Faced with the uncertainty of the external and internal environment, the economic recovery of Latin America in 2022 is facing a lot of challenges.
From the external environment, the successive withdrawal of global macro-stimulus policies will have an obvious negative spillover effect on the Latin American region. On the one hand, the U.S. monetary tightening, global liquidity reduction, Latin America’s attractiveness to international funds will weaken, financing costs rise; on the other hand, the global demand slowdown, especially China and the United States and other major trading partners of Latin America economic growth deceleration will significantly drag down the growth of external demand in the region. According to the World Trade Organization (WTO) estimates, the growth rate of global trade in goods in 2022 will drop from 11% in 2021 to 4.7%, and the growth of Latin American exports will certainly be seriously affected. In addition, the risk of a new variant of the virus leading to another outbreak cannot be ignored.
From the internal environment, the uncertainty in Latin America is also increasing. First, Brazil and Colombia will have general elections in 2022. Although it is too early to predict the election results, the possibility of a left-wing government coming to power will increase the uncertainty of policy adjustments in the region. Moreover, with the return of left-wing governments and the high prices of primary products, resource nationalist tendencies will rise in Latin America. Second, Latin American countries have been withdrawing from expansionary fiscal and monetary policies, resulting in weakened internal growth momentum. Third, rising inflation and high sovereign debt levels will worsen the business environment and undermine investor confidence. Fourth, sovereign credit risk may further deteriorate. 2021, 12 countries in Latin America’s sovereign debt rating decline; forecasts show that almost all Latin American countries will be further downgraded in 2022. Debt risks are likely to trigger significant volatility in financial markets. Fifth, structural factors such as low levels of investment and productivity, informal employment rates, high inequality and poverty rates remain persistent problems that have long plagued the development of the Latin American region. Sixth, the lagging medical infrastructure and the speed of vaccination in some countries have increased their vulnerability to new variants of the virus. In the face of limited policy space, how to balance economic recovery with prices, exchange rates and financial stability will be a serious test for countries in Latin America.
Cultivating opportunities in the crisis, opening a new game in the change
In 2022, there are still development opportunities for Latin American economies. First, commodity prices will continue to remain at relatively high levels. Favorable terms of trade will not only lay the foundation for growth in trade and investment, but will also provide space for economic adjustment and structural reform in Latin American countries.
Second, the epidemic has given rise to the development of new industries in Latin America, especially in the digital economy, which has a promising future. The financial technology sector in Latin America is becoming a new growth point for investment.
Third, enhancing international economic cooperation will help Latin America’s internal economic growth. Despite the divergent global recovery under the epidemic, economic and trade cooperation between China and Latin American countries is growing against the trend, showing great potential and strong vitality. Looking ahead to 2022, with structural reform as the backbone and high-quality development as the goal, China and Latin America can expand cooperation in areas such as intelligent manufacturing, new infrastructure, digital economy and sustainable development.
