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Analysis
Latin America can secure 2018 recovery

Latin America can secure 2018 recovery

Reform and investment essential to lift growth

by Otaviano Canuto in Washington

Fri 26 Jan 2018

Last year, Latin America enjoyed its first positive GDP growth rate since 2014, mainly reflecting recoveries from recession in Brazil and Argentina. In 2018, growth is not only expected to continue accelerating, but to become more diffused.

There are some external risks, such as the possibility of a disorderly adjustment following the normalisation of US monetary policy, or disruption stemming from renegotiations of the North American Free Trade Agreement. But the baseline scenario for Latin America is one of a strengthening and domestically led economic recovery. Both the International Monetary Fund and the World Bank forecast regional GDP growth of close to 2% for 2018.

With the help of adjustment from floating exchange rates, current account deficits have narrowed from their 2015 peaks. Commodity exporters have gone through policy adjustments to the end of the super cycle. Except in Mexico and Argentina, disinflationary trends are giving scope for the softening of monetary policy. Fiscal policy remains a challenge for most countries, but is not expected to curb demand.

The speed of the recovery may be constrained by the low levels of investment over the last few years. The prolonged fall in investment in Latin America, together with demographic changes and weak productivity rises, have marked down growth in most countries.

Governments across the region are promoting agendas to lift investment and productivity. Closing infrastructure gaps would raise the pace of physical capital accumulation and eliminate widespread bottlenecks that bind productivity increases. Structural reforms aimed at bringing 'informal' labour market activities into the mainstream economy should raise efficiency and productivity. Improving governance standards and reining in corruption are similarly essential to getting higher returns on investment. Opportunities for deeper regional trade and financial integration should be explored.

Achieving these goals will require perseverance in fiscal adjustment and the adoption of investment-friendly policies. The balance in terms of policy orientation in the region has tilted in that direction, particularly in the light of developments in Argentina, Chile and Brazil. Nevertheless, domestic political risks may yet loom over the resurrection of investments.

The region's elections this year could portend difficulties to continuing – or risk of reversal of – reform in important countries. This uncertainty reinforces investors' wait-and-see attitude. Brazil and Mexico are glaring examples of political risk coming to the fore.

In Brazil, the public spending cap approved by Congress in 2016 needs to be backed by pension reforms at a moment when most politicians are facing a popular backlash amid broad corruption investigations and heightened polarisation between the far-right and left wings. In Mexico, prospects for an anti-establishment victory are rising, thanks, at least in part, to the combative rhetoric of US President Donald Trump. In both Mexico and Brazil, private investment is likely to remain subdued in the near term.

The slowdown in Latin America since 2012 has been accompanied by weak and slightly decelerating potential growth, reflecting sluggish productivity, scarcity of fixed investments and demographic changes. Positive global economic prospects for 2018, the regional cyclical recovery, and policy initiatives to lift productivity are presenting Latin America's leaders with the opportunity to alter that trajectory. One must hope that this year's many elections will help to reinforce the region's recovery.

Otaviano Canuto is an Executive Director of the World Bank and a Member of the OMFIF Advisory Council. The opinions expressed in this article are his own, and first appeared in the January edition of The Bulletin.

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