Latin America – The Week Ahead: July 27 – 31


In Brazil, the smooth recovery should guarantee the end of the easing cycle.  The latest COPOM decision to cut the Selic by 50bps to 8.75% came in line with consensus and our view. We now expect the easing cycle to be over, even though the monetary authority made sure the wording of the statement left the doors open to an additional cut – “the level of the nominal base rate is at this moment consistent with a benign inflationary scenario in which inflation rates will converge to the targeted path within the relevant horizon as it is consistent with a non-inflationary recovery of the level of economic activity”.

Since the end of May, when the BRL broke the BRL2.000/USD barrier, the currency remained relatively stable within the range of 2.00 to 1.91/USD until the latest COPOM decision and is now below BRL1.900/USD. We maintain our year-end forecast at 1.85-1.92/USD range and thus expect further appreciation on the coming quarters. This scenario combined with a benign inflation path should also hold inflation expectations on a comfortable trajectory throughout 2009-2010 – another key variable monitored by the BCB. But on the downside, fiscal accounts continue to deteriorate and the BCB is certainly accounting for this aspect as well as incorporating the already implemented fiscal stimuli and its future lagged effects over the level of economic activity, in addition to the lagged effects that the 500bps cut in the base rate itself will have on future level of economic activity. Therefore, the most likely outcome is an extended pause, probably beyond H1 2010 but at this moment we still don’t see significant triggers for rate hikes anytime before the end of 2010.

On the labor market, the 8.1% reading on June’s unemployment rate was unexpected on the face of the 8.9% consensual estimate compiled by Bloomberg. The main reason for the sharp drop was the contraction of the labor force which is probably responding to the extended period of labor contraction in the industry. The labor force does respond to the performance of the industry on an accumulated manner – the YTD performance of the industry is certainly grey (-12% y/y YTD) and is definitely contributing to the dropout of the labor force. We refrain from revising our year-end unemployment rate estimate waiting to see a more consistent pattern of improvement – even though the phenomenon of labor force dropout does not really represent an improvement of the conditions in the economy, it is in truth a caveat of the unemployment rate measure.

Another positive sign on the Brazilian economy is the latest FGV’s consumer confidence reading, now printing a positive advance on a y/y basis: 6.4%. The increase comes after a drop of 0.7% y/y in June and is a near recovery to the levels before crisis. We stand now at 108.4, whereas the reading back in September 2008 was 112.7. Improved confidence will be a supporting force sustaining consumption amidst the losses on the labor market still to be seen throughout the year.

In Mexico, headline and core CPI for mid-July came in at 0.20% 2w/2w (0.38% 2w/2w mid-July 2008) and 0.21% 2w/2w (0.24% 2w/2w mid-July 2008), respectively, indicating that inflationary pressures continue subsiding. The headline number was in tandem with expectations (Bloomberg: 0.2% 2w/2w; RGE: 0.21% 2w/2w) while the core print was above forecasts (Bloomberg: 0.15% 2w/2w; RGE: 0.13% 2w/2w).  On a year-over-year basis, headline inflation dropped to 5.54% y/y from 5.74% y/y in June and core CPI eased to 5.33% y/y from 5.39% y/y.  Overall, the sharp decline in domestic demand, administrative measures, and stable/strong currency favored the downward inflation trend.  In fact, non-core inflation continued trending down (6.15% y/y vs. 6.72% y/y in June) on the back of lower inflation in agriculture as well as in the administered and concerted categories.  Core prices also moved lower though showing some stickiness due to seasonal pressures stemming from other services (airfares and tourist services), despite lower prices in processed food and housing.  We maintain our view that inflation pressures will continue subsiding in the coming months, bringing headline and core inflation to around 4% y/y and 4.25% y/y by the end of 2009.  Our inflation outlook for 2010 considers headline and core CPI reaching 3.5% y/y and 3.8% y/y in 2010.  Against this backdrop, and foreseeing a poor economic outlook for 2009 and 2010, we do not discard the possibility that further easing might be needed in the upcoming months.

The trade balance for June posted a deficit of USD 206mn as exports declined by 27% y/y and imports went down by 25% y/y.  The result was worse than expectations (Bloomberg and RGE: surplus of USD 356mn). A sharp decline in crude prices (-44% y/y) and export volume (-13% y/y) brought oil exports lower by 50% y/y.  Meanwhile, poor automobile exports (-43% y/y) kept manufacturing sells abroad deep in the red (-21% y/y).  Imports fared somewhat better with consumer (-32% y/y vs. 38% y/y 3MMA), intermediate (-24% y/y vs. -32% y/y 3MMA) and capital imports (-25% y/y vs. -24% y/y 3MMA) showing slight signs of stabilization.  Total trade (exports plus imports) deteriorated though at a lesser pace (-26% y/y vs. -32% y/y 3MMA), indicating that strong contraction forces are somewhat abating.

Finally, June’s unemployment rate came in better than expected at 5.17% (Bloomberg:  5.65%; RGE 5.7%); however, we anticipate that the unemployment rate will climb above 6% n the upcoming months.  Retail sales plunged 8.4% y/y (-3.4% m/m SA), driven by poor demand for semi-durable and durable goods.  The result was well-below estimates (Bloomberg: -6.1% y/y; RGE: -6.2% y/y).

Overall, the aforementioned results, together with poor industrial production in May (-11.6% y/y), disappointing results in Mexico’s automobile industry (production: -42% y/y; sales: -36% y/y), and weak US industrial output in June (-15.8% y/y NSA) is consistent with our view that Mexico’s GDP declined by around 10% y/y in Q2 2009.  However, we should point out that some data is already showing signs of stabilization.  We maintain our view that Mexico will post a severe contraction in 2009 (down 7.3% y/y) and that the recovery in 2010 is likely to be slow (up 2.5% y/y).

In Argentina, the Finance Ministry informed that June’s primary fiscal balance posted a surplus of ARS 910bn, which is 66% lower than the surplus reached in June 2008.  This result brings the primary surplus to around 2.1% of GDP on a 12-month rolling basis.  In June, fiscal spending surged (38% y/y vs. 23.5% YTD to May) because of the mid-term congressional elections.  In fact, wages (37% y/y) and transfers to the public sector (61% y/y) kept growing at a rapid pace.  Concurrently, although revenues went up significantly (27% y/y), it was only because of a sizable one time transfer from the central bank (ARS 3bn).  Excluding the CB transfers, revenues would have gone up only by 11% y/y and the primary fiscal result would have printed a deficit of ARS 2bn, thus bringing the primary surplus to 1.7% on a 12-month rolling basis.  RGE was expecting a primary surplus of ARS 850mn excluding the transfer from the central bank.

Given the sharp deterioration in the fiscal standing, we are revising down our primary fiscal surplus for 2009 to 1.2% of GDP from 1.9% of GDP (3.1% of GDP in 2008).  In H2 2009, we see revenue dynamics being limited by the economic deceleration and low trade-related tax income, despite strong social security transfers and a weaker currency.  On the spending side, the lack of solid government impetus to moderate spending significantly will likely maintain outlays growing rapidly in H2 2009, though less than in H1 2009 when on average the spending increased by 26% y/y.

Finally, INDEC informed that industrial production (EMI) in June went up 0.6% y/y (+1.6% y/y in June 08; -1.3% y/y 3MMA).  The result was above forecasts (Bloomberg: + 0.4% y/y; RGE 0% y
/y).  The official print for June suggests that industrial output declined by 1.5% in H1 2009 (+6.1% in H1 2008).  Adjusted for seasonality, INDEC indicted that EMI expanded by 1% m/m.

Among the components with the heaviest weights, strong growth in the food (+21.5% y/y) and chemicals industries (+15% y/y) supported the index.  This is despite contractions in basic metals (-29% y/y), metal-mechanic (-2.8% y/y) and automobiles (-12% y/y).  Food output benefited from the fact that in June 2008 food production fell sharply as a result of the conflict between the farmers and the government.

Since the positive effect in food production will wear out in July and domestic and external demand remains weak, we see industrial output returning to negative territory in July.

In Colombia, the board of the central bank (CB) decided to keep the monetary policy rate at 4.5%, which is in tandem with the Bloomberg consensus and our expectation.  Since the decision was not unanimous, it suggests that some board members most likely wanted to lower rates.  In the communiqué, the CB pointed out that inflation and inflation expectations continued falling in June driven by weak domestic and external demand, improved inflation outlook and lower commodity prices (compared to the record highs reached last year).  Moreover, the central bank showed some concern regarding the strengthening of the local currency, given the unfavorable external context.  Finally, the CB stated that forthcoming monetary policy decisions will be based on upcoming economic data.

In our view, the central bank statement has raised the possibility that the central bank might lower rates again in the near term as inflation and inflation expectations have declined rapidly and the economic growth outlook is still challenging.


MEXICO:  Economic Activity likely Plunged Again in May

The two most important pieces of information this week will be the release of INEGI’s Global Economic Activity Indicator (IGAE) for May and the central bank’s Quarterly Inflation Report.  On the latter, markets will pay close attention to Banxico’s revisions to economic activity for 2009 (currently at a range of -3.8% y/y to -4.8% y/y), the inflation outlook, and any comments on the monetary policy path.

On Tuesday July 28th, INEGI will report on May’s economic activity and we expect a contraction of around 10.4% y/y (-9.4% y/y 3MMA).  If we are correct, economic activity should have declined by 9.5% YTD (+3.1% YTD to May 2008).  Overall, the H1N1 flu outbreak, together with poor US and internal demand dynamics, should have accelerated the output contraction.   Indeed, industrial production declined sharply (-11.6% y/y vs. -10.8% y/y 3MMA) and leading indicators for the service sector, which we expect to drop by 10.9% y/y (9.3% y/y 3MMA), are not encouraging.  For instance, total trade (-34.1% y/y vs. -30.6% y/y 3MMA) and retail sales continued falling (-8.4% y/y vs. -5% y/y 3MMA).  Consumer and business confidence have showed signs of improvement though very mild. The Bloomberg consensus expects economic activity to plunge by 10.4% y/y in May.

CHILE:  Weak Industrial Production and High Unemployment in June

On Thursday July 30th, INE will report on industrial production for June and the unemployment rate for the April-June moving period.  We anticipate industrial production to print a contraction of 10.6% y/y (9.5% y/y 3MMA) as domestic and external demand remained weak.  However, a positive calendar effect (June 2009 had one more business day than June 2008) should have worked in favor.   The unemployment rate will likely come in at 10.65% in response to a weak economy and seasonal factors.  The Bloomberg consensus anticipates industrial production to fall by 9.4% y/y and the unemployment rate to inch up to 10.7%.