MONTHLY

ECONOMICSNEWSLETTER

REGIONAL ANALYSISMAY 2020

Global Outlook

Brazil

Argentina

Mexico

Uruguay

By Ec. Javier de Haedo

One month ago, on this Newsletter’s previous edition, improvements on health indicators for China related to COVID-19 were revealed, the country where it all started months ago. One month later, the same can be verified in European countries like Italy and Spain, which were amongst the ones with more complications due to the virus. As pointed out a month ago, these developments have led to positive expectations of the crisis coming to an end, a crisis which has its worst indicators in the US and Brazil, where from a political leadership standpoint it appears as though the matter was not dealt with the seriousness it required.

Naturally, the economy usually follows this type of events with a certain lag, and at the same time the announcement of indicators also has a certain lag when compared to reality. Therefore, indicators tend to show bad results, confirming the severity of the impact that the health situation

has on the economy.

Let’s go over some of these indicators in the main economies of the world, which overall are showing strong contractions in economic activity and employment, as well as a slowdown of inflation.

For example, GDP in the US fell 4.8% during the first quarter and the unemployment rate went from 3.5% in February to 14.7% in April. In the Eurozone, PMI indicators plummeted between March and April (33.4 for the manufacturing indicator and 12.0 for the service one in April) and GDP also revealed a strong decline to 3.8% in the first quarter, when all this had just started. Meanwhile, in China, GDP for the first quarter had a much deeper contraction, given it included a longer crisis period, since it all started earlier there. In this case, the contraction was of 9.8%. However, the different timing of the crisis also shows the worst might be already behind: PMI

indicators hit their lows in February, and in April they are already at levels similar to those in January, with the exception of the service indicator, which includes the sectors most affected by the pandemic.

At this stage, what’s clear is that even in case of a quick recovery with a V-shaped exit, the slope of the ascending part of the V is going to be less steep tan the descending part. This had already become clear when analyzing the WEO data presented here a month ago, where one could see that the sum of all the growth forecasts for 2020 and 2021 was negative in many cases. Additionally, in all these cases the sum is less than the result from the forecasts before this pandemic.

MONTHLY ECONOMICS NEWSLETTER

May 2020

Global Outlook

It is also worth noting some relevant aspects when considering an exit from the crisis:

• Employment will react less proportionately than economic activity.

• States will need to keep on using government resources to strengthen social protection networks.

• Businesses will need to invest to go back to activity, so they will need to have access to credit.

• Consumers will be cautious and in a first instance they will seek to rebuild their wealth (many of them are dissaving during the crisis) and therefore they will not reactivate consumption to the levels before the pandemic.

• In this context, States will have more debt than before and they also will have weak fiscal situations, with pro market reforms in those cases that require them for the private sector can lead the recovery.

Regarding the countries monitored in this Newsletter, the impact on the growth forecasts for 2020 has been extraordinary. When comparing the forecasts from the expectations surveys for February with the latest ones revealed on 18 May, Mexico saw a decline of 8.0 points, Brazil of 7.3 points, Argentina of 5.8 points and Uruguay of 4.4 points.

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May 2020

Global Outlook

President Bolsonaro’s way of handling the crisis has been a wrong one, and it has already cost him two Ministers of Health. On the other hand, he also lost Minister of Justice Moro, over differences on hierarchy appointments within the Federal Police. The President’s behavior has been placed under scrutiny by the justice and political systems, and this has contributed to the current uncertainty in Brazil. Even though he doesn’t have Congress support, Bolsonaro still has over 30% approval from the general public.

The other front which has been open at times seems to have calmed down, with demonstrations of support towards Minister of the Economy Guedes.

The political noise, coupled with the global context and its impact on Brazil, resulted in a strong depreciation of the Brazilian real, from 4.35 units per

dollar in February to 4.89 in March and 5.34 in April. Moreover, duringthe first half of May it averaged 5.78.

On May 6, the Central Bank of Brazil (BCB) decided once again on an additional cut to the monetary policy Selic. This rate had been cut by half a percentage point by mid-March and now took a cut of three quarters of a point and stands at 3%.

Meanwhile, and despite the significant climb of the exchange rates – which as we’ve seen before had been steady for four months -, inflation has continued to decline and for the 12 months up to April stood at 2.40%, and at 2.91% for the core indicator which excludes energy and managed items. Forecasts (as per the Focus survey gathered weekly by the BCB) point to an inflation lower than 2% for this year, and to a Selic rate even half a point lower than the current level.Given the recession and the low

dollarization of the Brazilian economy, there has been hardly any impact (pass through) from dollar to prices.

Anyhow, expectations point to a lower dollar over the coming months: on Monday 18 the Focus survey revealed a forecast of BR$ 5.28 (median) by the end of the year, even though among those who get it right the most (“Top 5”) there are some who forecast BR$ 5.50.

Regarding economic activity, on Friday 15 the Central Bank revealed the IBC-Br, a monthly forward indicator for GDP. This time the March indicator was known, with a seasonally adjusted decline of 5.9% between February and March and 4.2% on a year-on-year basis between the respective months of March (see graph).

This indicator reinforces the forecasts of a fall in GDP that are being considered for this year, consistently

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Brazil

downgraded week to week. Since the last Focus survey from February, when the forecast for GDP growth was of 2.2% for 2020, and now the forecast is -5.12% in the survey from Monday 18.

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Brazil

the social and economic impact of the pandemic. Public debt – which had stopped growing last year – will surely climb steeply in 2020, returning to dangerous levels.

Source: Banco Central do Brasil

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IBC - BrSeasonally adjusted, 2002 = 100

In this context, fiscal deterioration is to be expected, much like what’s happening globally: both due to lower income given the economy slowdown, and higher expenditure to mitigate

Over the past few weeks, several measures from the worst Argentine “recipe book” have been adopted, aiming to address the effects of lousy policies instead of correcting the causes. This time, they were implemented to mitigate the demand for dollars in non-official markets (like the MEP or the blue chip swap “contado con liqui”) which led to a demand boost in the “blue” market, where the gap with the official dollar reached 100% on Friday 15. The aforementioned measures were applied to exporters who don’t cash in their exports by restricting their access to credit. Evidently, if an exporter sees such a gap – which anticipates what will happen with the “official” dollar in the not-so-distant future – he will tend to store instead of selling his production.

On the other hand, the first deadline for the acceptance of the debt swap proposed by the government has

passed, with a very low level ofacceptance, leading to the government extending the deadline and expressing willingness to receive counter proposals, starting last Friday 15th May. Argentine economists point out that a few signs of improvement in the government’s offer would be enough to make an agreement feasible. Signs that would obviously imply better terms in the proposed agreement, but would be far from having severe consequences on the future of public finances.

Back to the dollar, the official market displays a typical crawling peg evolution, having crawled during several months at a rate lower than inflation, recently reverting this situation. Anyhow, the dollar is “lagging” to a certain extent. Last 15 August, current President Alberto Fernández pointed out that he deemed a dollar at AR$ 60 would be reasonable (let’s call it “Beto dollar”).

That said, those sixty pesos adjusted by inflation, would now be AR$ 80. And if one considers that the neighbors´ currencies have depreciated in real terms, its value should be even higher. For instance, if one considers the real depreciation of the Uruguayan peso over the same period, the Beto dollar should be now at AR$ 89. Both figures compared to the current official dollar at AR$ 68.

The CPI increased only 1.5% in April, which mustn’t be taken as an indication of the latent inflationary process in Argentina. Beyond the well-known CPI (not inflation) containment instruments, there’s now the specific issue that several prices of the CPI basket – given the current context -could not be recorded or didn’t record any changes because no transactions were made. Frozen prices of public services, a lagging dollar, prices that are “overseen” (e.g. controlled) contribute to the CPI’s slow climb.

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Argentina

However, the strong monetary expansion - which for now is not translating into inflationary acceleration due to a reduced velocity of money circulation - imposed by circumstances, will sooner or later transform into accelerating inflation.

Despite the flow of pesos between the monetary base and sterilization

instruments (passes and leliqs), themonetary base is growing at an extraordinary pace. The origin of this monetary expansion undoubtedly lies in the transfers from the Central Bank of Argentina (BCRA) to the National Treasury. Over the first four months of the year, the amount of said transfers equals the increase in the monetary base, adjusted by the aforementioned

instruments. This adjusted base grew34% in four months (see graph).

Lastly, according to the REM Market Expectations Survey released Friday 6, a contraction of GDP of 7.0% is expected for 2020 (compared with -1.2% in February), an official dollar at AR$ 85.40 by December and inflation at 44.4%.

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Argentina

Source: Banco Central de la República Argentina

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Year-on-year change of the Monetary Base

Over the past few weeks, the Central Bank of Mexico continued to reduce the monetary policy rate. It did it twice since the last edition of this Newsletter, on 21 April and 14 May. In both cases the rate was cut by 50 basis points and the rate is now at 5.5% (see graph).

Banxico’s statement following its latest decision pointed out that “available information shows that economic activity in Mexico contracted significantly during the first quarter of the year, incorporating the effects associated with the pandemic in March, which affected the production of goods and services considerably. Although the magnitude and duration of the effects of the pandemic are still unknown, these are expected to intensify during the second quarter, and to result in a significant contraction of employment. Slack conditions thus continue to widen considerably, in a context in

which the balance of risks for growthis significantly biased to thedownside.” The slowdown of inflation is also highlighted “from 3.25 to 2.15% between March and April 2020 due to declines from 2.19 to -1.96% and from 3.60 to 3.50% in its non-core and core components, respectively”. It is considered that “a particularly relevant factor was the decline in the annual change of energy prices, particularly of gasoline. Short-term expectations for headline inflation have decreased, while those for long and medium terms have remained relatively stable, albeit at levels above the 3% target.” Lastly, it is pointed out that “the challenges for monetary policy posed by the pandemic include both the unprecedented impact on economic activity as well as those associated with the financial shock that we are currently facing”. Since there are risks of both rising and falling inflation, Banxico believes that “the balance of risks for inflation

remains uncertain”.

New forecasts for some of the main macroeconomic variables were revealed through an expectations survey conducted by the Central Bank of Mexico.

In April’s edition, the economic growth forecast for the year was once again severely affected, standing now at -7.1%. With a modest growth of 0.9% expected for February, a contraction of 3.5% was expected in March, and now the forecast is more than twice that fall. Meanwhile, a level of economic growth of 2.2% is expected for next year, which would leave a very negative net balance for the two-year period, with the evident consequences over employment and public finances, just to point out two items which would be most affected.

As for the exchange rate, the forecast for the end of this year increased, now

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Mexico

Regarding inflation, a rate of 2.90% is expected for the end of this year and 3.50% for the end of next year, in line with what’s being observed.

Lastly, the forecast for the interbank funding rate is 5% for the end of both years, half a percentage point lower than last month’s forecast.

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Mexico

Source: Banco de México

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Monetary Policy Rate

expected to be MXN 23.05 (21.95 in March). A higher exchange rate is also expected for the end of next year: MXN 22.39 (21.70 in March).

The Uruguayan government, which came into office last 1 March - two weeks before the first cases of coronavirus were detected in the country - has rejected all possibility of a mandatory lockdown of the population, based on the principle of the citizens’ freedom. Therefore its focus is on making recommendations, beyond the obvious lockdown of certain economic and social activities.

After obtaining good results on the health front, the government set out to gradually open up activities, but has already announced it will revert should the numbers get worse.

In this context, it is expected that the economy won’t contract as much as in other countries. In fact, Uruguay is among the countries where economic growth forecasts for this year was adjusted less, and also among the few where the net growth forecast for 2020 and 2021 is still positive.

The government, which has few resources given the fiscal situation handed down by the previous government (a deficit of around 5.5% of GDP), has been using them in an extremely focused way, distributed between three distinct paths: unemployment benefits, credit for businesses and social protection. President Lacalle Pou admits the fiscal deficit will increase this year, but refuses to impose taxes on the private sector since he trusts this sector will be the one to drive the country forward.

Meanwhile, Parliament is moving forward addressing the Urgent Consideration Bill which has tight approval deadlines and which includes some reforms which are important for the government: public education, social security, fiscal rule and public safety, among others. Even though the five party coalition that forms the government will approve the bill, it is

already known that some of the reforms laid out will be left behind. These are mostly reforms related to public monopolies which Lacalle’scoalition partners - who don’t share the same liberal convictions as the president – are unwilling to go along with.

The Central Bank of Uruguay (BCU) has let the exchange rate float, with purchase and sell interventions kept to a minimum to avoid excess volatility, as was previously announced. The Monetary Regulation Bills (Letras de Regulación Monetaria) are declining, and are now lower than the two digit inflation figure for April: 10.9% over the past 12 months (see graph). Uruguay has been very ineffective in managing inflation over the last years, with procyclical fiscal and monetary policies and strong indexation rules for wages and prices of non-tradable goods. In this context, everything points to the BCU changing

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Uruguay

the monetary policy instrument in the near future, leaving monetary aggregates behind and going back to using interest rates.

Over the past few weeks, credit rating agencies maintained Uruguay’s investment grade, though they warned about the fiscal situation and debt trajectory, which increased by ten points of GDP over the past six years. It is a well-known fact that the current context will only make the situation worse, therefore it will take longer to reach the results the elect government set out last November.

Regardless, the ratings were maintained, and in a way, the government was granted time to carry out the structural reforms it had already planned, both in the

aforementioned Urgent Consideration Bill and in the Budget Bill that will be sent to Parliament in August. The country’s institutionalism and its past behavior regarding debt are working in its favor.

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Uruguay

Source: Own elaboration based on INE data

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