Ten key questions – and answers – on Latin America’s economy this year.

BY ALBERTO M. RAMOS

“The secret of change is to focus all of your energy, not on fighting the old, but on building the new.”
Socrates (c. 470–399 BC); Greek philosopher credited as the founder of Western philosophy.

In the first LatAm Economics Analyst of the year we discuss what in our assessment are the most important questions and vectors of the region’s macro and asset market performance for 2024.

The LatAm macroeconomic rebalancing is set to continue in 2024. Stage I of the adjustment (2023) cleared without major setbacks and without any visible damage to either fiscal or monetary frameworks. LatAm’s short-term outlook remains complex but admittedly less challenging than in 2023 given significant progress on the inflation front, the ongoing shift to gradually less restrictive monetary stances, and strong current accounts and balances of payments (except in Argentina). However, political and policy risk and uncertainty are expected to remain high across the region, and Argentina’s macro adjustment remains extraordinary difficult.

Q1. Can LatAm growth remain resilient in 2024?

No, Not Likely. Real activity, after surprising to the upside in 2022 and exhibiting notable resilience in 1Q-3Q 2023, is forecasted to shift to a more moderate growth track given, among other things, lack of significant spare capacity in both the goods and labor markets.

Following the covid V-shaped 7.2% rebound in 2021, real activity in the LA7 region surprised to the upside in 2022 by expanding 3.9% despite much higher-than-expected inflation and tight domestic financial conditions. Growth is projected to settle at 2.1% in 2023 (amidst significant cross-country heterogeneity), of which 0.6% due to the statistical carry-over from 2022.

Real GDP growth is expected to downshift further in 2024: to a modest 1.4% for the LA7 (1.8% for the LA-IT5; i.e., ex-ARG and ECU) given still tight domestic and external financial conditions, exigent credit conditions, tighter labor markets, low levels of economic slack (in some economies the output gap turned positive), lingering political and policy uncertainty, and subdued consumer and business sentiment. The carryover from 2023 is projected at a minor 30bp.

On the positive side, growth in 2024 should benefit from moderating inflation, gradually less restrictive monetary stances, well bid commodity prices, and in places like Brazil and Mexico, fiscal stimulus. At a broader level, LatAm could also stand to benefit from near/friendly-shoring FDI inflows, the repositioning of EM capital flows away from China and other large EMs facing economic and political hurdles, and the fact that the region has significant endowments and recognized potential in agribusiness, green-energy, and key minerals for the transition to a net-zero carbon economy.

At the country level, after declining in 2023, real activity in Argentina is expected to retrench again in 2024, under the weight of triple digit inflation (projected to approach 300% yoy by Apr-May) and frontloaded macro-fiscal adjustment dynamics. In Brazil and Mexico, real activity is projected to decelerate in 2024 from the robust above-trend 3%-handle in 2023, and in Colombia remain in the low 1%-handle. In Chile and Peru, after a dismal 2023, real activity is forecasted to firm and move into positive but not exuberant territory. Real GDP growth is also forecasted to decelerate in Ecuador given the weak outlook for investment spending, rising violence, and overall deterioration of the public security situation.

Q2: Will inflation fully converge to the target(s) in 2024?

No, Unlikely. In our assessment it is unlikely that headline inflation will converge to the inflation target midpoints, but in several places, inflation will move either close to the upper-limit or within the upper-half of the inflation target bands.

The quest to bring regional inflation down to target is a work in progress, but there was undeniably very tangible and meaningful progress throughout 2023. After peaking at a multi-year high during 2H2022, headline inflation has been trending gradually down, driven chiefly by goods’ prices but more recently there has also been visible progress among more inertial components such as core and services. The inflationary pressures are also becoming less generalized. Except for Colombia, where headline and core inflation remain stubbornly high (with core still at 8.8% yoy), headline inflation across the other four inflation targetters is tracking between 3.2% (Peru) and 4.7% (Mexico), with core between 2.9% (Peru) and 5.4% (Chile). Wage pressures in places such as Chile and Mexico and tight labor markets (e.g., Brazil, Mexico) could slow the convergence of inflation to the targets. Argentina remains an outlier: inflation reached triple digits in Feb-23 and has been accelerating since then: with annual headline/core inflation surging to 211%/229% by Dec-23.

We expect further gains on the disinflation front in 2024 but broad headline inflation realignment with the inflation targets is expected only for at best late 2024, more likely some time in 2025. Core and in particular services inflation are expected to remain stickier given tight labor markets in several places and high real wage growth. For the LA7 economies (Argentina, Brazil, Chile, Colombia, Ecuador, Mexico and Peru) inflation accelerated to 29.5% in 2023, from 18.1% in 2022, driven chiefly by the very high triple-digit inflation environment in Argentina, and is expected to moderate to a still very high 26.2% in 2024. Excluding Argentina and dollarized Ecuador, inflation in the five inflation-targeting economies (LA-IT5) is expected to moderate but remain high and above the respective targets: headline inflation moderated from a decade-high 7.9% in 2022, to 5.0% by end 2023, and is forecasted to reach 4.2% in 2024. By end-2024, inflation is forecasted at a still high 6% in Colombia and to remain at or above 4% in Brazil and Mexico.

Q3: Can the LatAm IT5 central banks cut rates to neutral in 2024?

No, Unlikely. While we expect further progress on the disinflation front throughout 2024 to allow central banks to reduce the degree of monetary policy restrictiveness, we expect policy rates to remain above-neutral.

The LatAm central banks were among the early hikers. Rate hikes were aggressive and the normalization/tightening cycles long and deep. Except for Mexico, the other four LA-IT5 central banks have already started to cut the policy rate (Brazil, Chile, Colombia, and Peru).

A more comfortable inflation backdrop and moderate growth dynamics should allow the LA-IT5 central banks to continue to ease throughout 2024, with the pace and depth of cuts a function of progress on the disinflation front, the evolution of the overall balance of risks, and global monetary and financial conditions. We expect, however, the regional central banks to remain somewhat conservative given the expectation of still above-target inflation, in particular core and services, still (slightly) unmoored inflation expectations in some places, tight labor markets, high real wage growth, limited economic slack, above-neutral global core yields, and in several places inadequate fiscal policy support and high political, fiscal, and policy risk premia. The central bank of Mexico is expected to deliver the first rate cut in 1Q24.

Q4: Will we see major structural/fiscal reforms in Brazil in 2024?

No, No Major Reforms Expected.

Congress approved late in 2023 a streamlined dual-VAT tax reform. The VAT tax reform still embodies many exceptions and special regimes, has established a long transition period, and as designed requires significant federal public transfers to capitalize three funds to assist local governments. We expect the 1H2024 congressional agenda to be dedicated mostly to secondary legislation to enable and operationalize the VAT reform, including the definition of the ordinary statutory VAT rate, and likely another batch of bills submitted by the government to raise more revenue. Legislative work in 2024 will be conditioned and shortened by the October municipal elections.

Our macro baseline scenario assumes no tangible progress on the lagging structural reforms, including a long delayed administrative (civil service) reform. The government is expected to submit to congress in 2024 the blueprint for an income and payroll tax reform: most likely entailing changes to the personal and corporate income tax code to make the system more progressive but to also raise more revenue. We expect the reform to be deferred to 2025, and the overall likelihood of approval is, in our assessment, lower than even. Finally, we expect the continuation of a state-centered, interventionist, and heterodox micro policy mix, with no privatizations, limited public concessions, and weak SOE management.

Q5: Will the Brazilian government meet its primary fiscal balance targets?

No, Very Unlikely. The 2024 zero primary fiscal target is unlikely to be met given the administration’s revealed weak inclination to control spending growth.

The primary fiscal balance improved in 2022 by more than originally envisaged given the buoyancy of revenue, but the medium-term fiscal picture and debt dynamics remain a key source of macro vulnerability. Given expensive campaign promises the primary fiscal balance is set to return to deficit in 2023, projected at -2.3% of GDP vs a +1.3% of GDP surplus in 2022, and gross public debt as a share of GDP resumed its upward trend in the first year of the Lula administration. The overall consolidated public sector nominal deficit is projected to exceed a high 8% of GDP in 2023.

For 2024, we expect a primary fiscal deficit shy of 1% of GDP given that the government has been revealing only a soft commitment to contain spending to deliver the zero primary balance target. In our assessment, there is a high probability that the 2024 target will be reset during 1H2024 to a deficit of at least 0.5% of GDP. The +0.5% of GDP primary surplus target for 2025 is also unlikely to be met.

Ultimately the new fiscal framework is not perceived as credible: it has failed to anchor expectations around the announced path for primary fiscal balance. What is also troubling is that the government is still bent on aggressively raising fiscal revenue, validating an even higher tax burden, with little to no inclination to contain the growth of spending. In all, in 2024-25 we expect the continuation of the ongoing inefficient tax & spend fiscal strategy.

Q6: Will the new Argentine administration be able to deliver on its ambitious macro rebalancing and reform agenda?

Yes, But Only Partially. The macro and financial imbalances are very large. The new government has put forward an ambitious macro adjustment agenda, but weak governability conditions will likely limit the capacity of the Milei Administration to deliver on its bold policy agenda.

In our assessment, the Milei administration has the correct diagnosis of the issues that have been ailing Argentina and that have led to the notorious macro underperformance of recent years. The administration also seems energized and committed to delivering a bold front-loaded fiscal-led macro adjustment. In our assessment political, social, and legal constraints will likely allow the Milei administration to deliver only partially on its policy commitments. Given the very large macro-financial imbalances it is unclear whether just partial adjustment will be able to steer the economy towards a better equilibrium. Overall, macro risk remains high.

The official exchange rate was devalued by 54% on Dec 13, 2023, to 800 ARS per Dollar, a larger than expected move and the first (important) step on the new government macro rebalancing/adjustment agenda. A change in import levies made the effective exchange rate on imports even weaker. Following the large devaluation, the ARS/USD has followed a tight 2% monthly crawl. The IMF welcomed the policy announcements: the “new package provides a good foundation for further discussions to bring the existing Fund-supported program back on track.” A staff-level agreement to complete the delayed 7th EFF program review was announced Jan 10, 2024.

Soon after inauguration the Milei administration also unveiled a set of bold macro adjustment measures. Finance Minister Caputo presented a list of measures intended to eliminate the fiscal deficit in 2024. The fiscal package is large: 5.2% of GDP, of which 2.9% of GDP in spending measures involving cuts in discretionary transfers to the provinces, costly subsidies, and investment spending (public works). That was followed by a broad and ambitious omnibus bill, submitted to Congress under the fast-track legislative procedures, entailing a large number of reforms ranging from changes to the electoral system and tax code to modifications to several laws and regulations with a view to deregulate the economy and make it more market-centered and efficient. Additional pieces of legislation are expected to follow soon.

The Milei administration is seeking to fast track the approval of the omnibus bill by the end of January. Implementation risk is high. Many of the new measures put forward since inauguration require congressional approval but the Milei administration enjoys limited political support in Congress. Social pressure is also expected to be high, and court challenges and setbacks should be expected. In our assessment, rather than the proposed full elimination of the fiscal deficit, it will already be a notable achievement if the Milei administration manages to approve enough measures to eliminate the primary fiscal deficit in 2024 and bring monthly inflation to low single digits by end-2024. A possible but difficult endeavor.

Q7: Is Argentina running towards hyperinflation and dollarization?

No, Not Necessarily. But expect very high triple-digit annual inflation for a while. Risk of a wage-price-devaluation spiral is non-negligible.

Inflation is extraordinarily high, expectations are drifting, and inflation pressures intensified late in 2023 following the large ARS devaluation. Consumer prices rose a very high 25.5% in Dec, following the 12.8% Nov print and the Aug-Oct 11.1% monthly average. Annual headline inflation accelerated to 211.4%. Core inflation printed at an even higher 28.3% in Dec, with the annual rate surging to 229.4%. The very high Dec inflation print was driven by the large pass-through from the Dec-23 ARS devaluation and significant fuel price increases. Inflation should also remain high in 1Q24 driven by additional pass-through and the planned adjustment of below-market government set prices/tariffs. All in, headline inflation should climb further and reach close to 300% in Q2 (it took just 10 months for inflation to accelerate from the 100%-handle to 200%-handle).

Against the current highly fragile and unstable backdrop, the risk of a wage-price-FX devaluation spiral (feedback mechanism) is significant, and a concomitant loss of monetary and price control should not be minimized. Short-term monetary and FX management will be key for the success of the attempted macro stabilization plan and whether highly distressed and dysfunctional financial dynamics will eventually lead to even deeper endogenous dollarization of the economy (savings and financial transactions) and ultimately formal dollarization of the economy. In earlier work (Is Dollarization an Offer You Can’t Refuse?) we discussed the pros and cons and macro implications of formal dollarization in a country with the track-record and characteristics of Argentina.

Q8: Will Mexico outperform again in 2024?

Yes, to Some Extent. Mexico shows a more balanced macro and comparatively stable political profile than regional peers and therefore milder macro and asset price left-tail risks. But there are also policy idiosyncrasies that cap the upside and room for significant macro outperformance. Elections in Mexico in early June and in the US later in the year are potential sources of (likely moderate) financial volatility.

The inflation dynamics, monetary stance, capital flows, near-/friendly-shoring investment dynamics, US and Mexico elections and the post-election overall macro policy direction are the key known factors shaping the short- and medium-term performance of the economy and likely the main drivers of asset prices.

The economy’s performance during 1Q-3Q 2023 was admittedly strong (above-trend investment-led growth) leading to a positive output gap and tight labor market backdrop. The economy is forecasted to grow 3.4% in 2023, and to moderate to a still respectable 2.2% in 2024, possibly higher. The inflation backdrop improved steadily throughout 2023, and we anticipate further progress in 2024. We expect the MPC to start to gradually normalize the monetary stance in 1Q24. The current account has been improving, driven by both the oil and non-oil balances, and record high workers’ remittances. We expect the current account to remain well anchored (modest under 1% of GDP deficit).

We expect the fiscal stance to ease in 2024, and the proposed post-election fiscal consolidation in 2025 appears overly-optimistic. Fiscal pressures are expected to increase over the medium term. Claudia Sheinbaum, of the governing Morena-PT-PVEM coalition, will face PAN Senator Xóchitl Gálvez (representing the PAN-PRI-PRD coalition) and Jorge Álvarez Máynez (representing MC). Based on current public polling, Ms. Sheinbaum is seen as the favorite to win the June 2 election given President López Obrador’s high and enduring approval ratings.

In 2024, Mexico should also benefit from moderate near/friendly-shoring FDI inflows and diversion of capital flows away from China and a few other large EMs where the perception of economic and policy risk remains high. This could set the stage for another year of macro outperformance and well-supported asset prices, including the high-carry and high-Sharpe ratio MXN and back-end rates. Despite the recent rally, 5yr TIIE rates are still tracking above 9.7%, vs 5yr Treasuries at 4.36%, preserving the scope for further receiving opportunities. Against this backdrop, the high-carry friendly/near-shoring-favorite MXN can continue to trade well and remain in overvalued territory through 2024. Our strategists recommend long FX-unhedged 3-yr local Mbonos.

Q9: The last few years were ‘very exciting’, can investors now relax about the politics?

No, Not Yet. The 2024 election calendar is relatively light, but political polarization across the region remains high and policy uncertainty and risk remain elevated.

The political/policy sphere remains flustered in many places and the disapproval ratings of incumbents are high, adding uncertainty and risk to the LatAm macro-outlook. Furthermore, in recent years there has been a clear increase in the dissatisfaction with democratic regimes, the mainstream political establishments and the performance and representativeness of the traditional political parties. Overall, political and social polarization remains high, amidst heightened uncertainty and risk, with regards to policy direction and policy implementation capacity.

Following the action-packed 2022 season, the 2023 political calendar turned out more eventful than expected: a pivotal presidential election in Argentina that crystallized a political and policy regime shift, the rejection in Chile for a second time of a draft for a new constitution, and snap general elections in Ecuador, to name just a few of the major events.

As we look into 2024, the main event will be the June 2 general elections in Mexico. Alongside the presidential election there will also be legislative elections to fully renew the Lower House’s 500 seats, and the Senate’s 128 seats. President López Obrador has stated that a key objective in the June elections is to attain two-thirds qualified majorities in Congress that would allow Morena and allies to approve constitutional amendments. Given the current political dynamics and electoral rules, and without AMLO on the ballot box, even if the Morena candidate is the favorite to win the presidential election it will be challenging for Morena to reach such a large representation footprint in Congress. Political noise is likely to pick up and the overall policy mix may deteriorate after the 2024 election. Many investors fear that the federal government’s fiscal conservatism in recent years (not so much for 2024) was just an attribute/preference of President López Obrador that is not broadly shared by either his Morena political party, or its presidential candidate. Furthermore, no other candidate seems to have AMLO’s charisma, strong emotional connection with voters, and tight grip on the scrappy Morena party. Hence, the political transition in 2024 may entail non-trivial policy and political/governability risks. The presidential election in the US may turn into an additional driver of asset price volatility.

In Venezuela, the political dynamics remain very unsettled. On October 17, 2023 the opposition umbrella Unitary Platform and the Maduro administration signed an electoral roadmap and guarantees agreement. This was followed by the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) issuance of four General Licenses authorizing certain transactions otherwise prohibited pursuant to the Venezuela sanctions program. The opposition held well attended primaries in October, with former lawmaker Maria Corina Machado scoring an easy win with more than 90% of the vote. Ms. Machado is currently barred from running for public office until 2030. General elections are expected to be held sometime in 2H2024. Whether Ms. Machado is reinstated may be germane for whether the sanctions relief on oil and gas trading is extended beyond April 2024. In the meantime, the country has been experiencing a deep economic and humanitarian crisis that over the last nine years has led roughly a quarter of the population to emigrate.

In Brazil, municipal elections in October entail fiscal risks as the governing Workers Party (PT) seeks to recover part of the footprint lost in recent elections. In Argentina, the Milei administration will face significant political and social challenges to deliver on a very ambitious policy agenda to rebalance the economy and make it more efficient and market-oriented going forward.

In both Chile and Colombia, left-leaning administrations are still trying to push aggressive reform agendas, but weak political support will likely force more market-friendly compromises. Finally, in Peru, both the president and the national assembly are deeply unpopular, with policy paralysis and political bickering expected to continue and bear on market sentiment and macro performance.

Q10: Are the external accounts a source of concern/vulnerability?

No. Current account balances improved in 2023, in particular in Chile and Colombia where current account deficits reached very high levels in 2022.

We do not expect current account deficits to be a major policy constraint in 2024-25. Current accounts deficits widened significantly in 2021-22 but adjusted in 2023, particularly in Chile and Colombia (where the external imbalances reached very high levels in 2022), driven by weaker domestic demand and the lagged effect of currency depreciation. There was also a visible reduction of the current account deficit in Brazil (record trade surplus) and Peru (weak domestic demand), while in Argentina it is projected to widen by roughly 2ppt of GDP in 2023 due to a large negative shock to agricultural production. External resilience in Brazil and Mexico is high given robust external balance sheets.

For 2024, we expect an improvement of the current account position in Argentina (back to surplus territory), driven by currency depreciation, recessionary dynamics, and a stronger harvest. Elsewhere, we forecast current account deficits to hover at moderate levels easily funded by FDI inflows. However, we underscore that balance of payments and international reserves dynamics are key issues that investors should carefully monitor in both Argentina and dollarized Ecuador given the potential for tight(er) external funding/liquidity conditions.

Alberto Ramos is chief Latin American economist at Goldman Sachs Group.

This article is based on a client note by Goldman Sachs. Republished with permission.

 

 

 

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