Economic Survey of Latin America and the Caribbean 1997-1998

3. Economic performance

A significant slowdown is expected in GDP growth

The recovery in the level of economic activity that had begun in 1996 in Latin America and the Caribbean gathered speed in 1997, but in 1998 it has slackened considerably. Consequently, the 5.3% growth rate posted in 1997 --one of the highest to be recorded since the late 1970s-- is expected to drop to about 3% in 1998, thereby returning to the more modest trend that prevailed at the start of the decade. Per capita GDP is expected to rise by only around 1%.

This uneven performance on the part of the region’s economies has in large part been a reflection of the behaviour of capital flows. The huge volume of such inflows in 1997 no doubt contributed to the buoyancy exhibited that year by the Latin American and Caribbean economies. The sudden contraction of those flows in October when the Asian crisis worsened had a dampening effect on economic activity, and a number of Governments were forced to implement harsh adjustment measures, since this new situation came at a time when they had large deficits on their external accounts. The severe deterioration in the terms of trade, especially for oil- and copper-exporting countries, is also playing a role in the poor performance of some countries in 1998.

Almost all the countries of the region shared in the expansion of economic activity seen in 1997; Jamaica was the only country to experience a setback in this regard. Five countries (Argentina, Chile, the Dominican Republic, Mexico and Peru) posted GDP growth of over 6%, and another six economies had rates of between 4% and 6%. In the rest, GDP expanded by between 1% and 4% (see figure I.4).

The rapid growth of the Latin American and Caribbean economies in 1997 was largely attributable to investment and exports, which grew much faster than GDP. Gross capital formation expanded particularly sharply in Argentina, Bolivia, the Dominican Republic and Mexico, while exports were an important element in promoting growth in the Dominican Republic, El Salvador, Guatemala, Mexico, Peru, Uruguay and Venezuela. Consumption rose more slowly, in most cases by less than GDP growth. Nevertheless, as a consequence of the liberalization policies of recent years and, above all, the steady real appreciation in most countries' currencies, a considerable portion of domestic demand was diverted to imports. Although this undermined economic dynamism, it also served to alleviate pressure on prices in a context where high growth was leading to full use of productive capacity.

GDP growth is expected to decrease significantly in most of the region in 1998. Some of the Central American and Caribbean countries may be an exception, however, since the Asian crisis has had less of an impact on them and the decline in oil prices has provided some relief in terms of their external accounts. Because of its size, the drop in Brazil's growth rate to just 1.5% will drive down the region's overall rate considerably, but reductions are also expected in Argentina, Mexico, Peru and Venezuela, all of whose economies flourished in 1997. The slowdown in GDP growth in 1998 can be traced to a slump in domestic demand (especially for capital goods), which has been hurt by the adjustment plans implemented in response to the adverse impacts of the Asian crisis.

Inflation levels off at an annual rate of slightly above 10%

The slow rate of price increases in recent years has been one of the main economic policy accomplishments of the Latin American and Caribbean countries. The average rate of inflation for the region as a whole fell from 18% in 1996 to slightly over 10% in 1997, the second lowest figure in the last 50 years. A slight increase was seen in the first half of 1998, but this did not imply a reversal of the achievements of recent years. In addition to the reduction in the overall rate, it is notable that low figures were registered by a large number of countries in 1997 and 1998: 10 of the 19 countries for which data are available had single-digit inflation in both of these years, and another seven had rates of between 10% and 20%. The only countries that had higher rates --between 30% and 40%-- were Ecuador and Venezuela (see figure I.5).

These results are especially significant in view of the fact that they coincided with rapid GDP growth in the region in 1997. The inflationary pressures generated by the steep upswing in domestic demand were neutralized, thanks to the existence of idle capacity and a considerable increase in external supply. By the same token, the expansion of the workforce helped to curb the rise in wages prompted by stronger demand for labour.

The small amount of ground lost in the 12 months to June 1998 in terms of inflation control was a reflection of developments in only a few countries. Nicaragua registered a rate of 14%, which was double the 1997 figure, and in Paraguay inflation jumped by over five percentage points to nearly 12%. Colombia's inflation rate for the year is expected to be slightly higher than in 1997, but it is hoped that it will still be below 20%. In contrast, the Dominican Republic and Uruguay succeeded in bringing its inflation rate down sharply, and Chile registered somewhat smaller reductions. In the rest of the countries inflation either leveled off or rose slightly.

The increase in inflation rates in some countries and the failure of others to achieve any further reduction are partially attributable to the effects of El Niño, which heavily damaged many crops, thereby driving up the prices of some widely used staple foods. There were also other specific factors at work in some cases, such as government-regulated rate adjustments for public utilities and the devaluation of a few currencies. On the other hand, lower prices for some imports, especially oil, have contributed to stabilization efforts.

Labour markets are likely to forfeit recent gains

Within the context of the high economic growth rates achieved in 1997, the labour market's performance was fairly good, with significant increases in both employment and labour productivity, a small decline in unemployment and a moderate rise in real wages. All this helped to offset part of the deterioration witnessed in the preceding two years. However, although these improvements were sustained during the first half of 1998, it is likely that they will be reversed in the second half of the year.

The favourable results for 1997 were shared by the great majority of the countries in the region. Improved job opportunities, as reflected in a striking increase in employment, stimulated the growth of the labour supply, and the decrease in open unemployment was therefore only moderate. The main exception to this bright picture was Brazil, where sluggish job creation resulted in higher unemployment even though the labour force participation rate declined.

During the first half of 1998 the situation was much the same. In all the countries for which data are available except Brazil, employment levels were higher than they had been during the first half of 1997, and the regional average, weighted by the size of the working-age population, remained constant (see figure I.6a). The improvement in the employment situation was also reflected in average real wages, which climbed slightly in most of the few countries that have statistics available on this variable.

As a consequence of the trend in employment levels, the rate of unemployment fell during the first half of the year in most of the countries for which data are available (Argentina, Chile, Mexico, Panama, Uruguay and Venezuela), but rose again in Brazil and Colombia. As had also been true in the second half of 1997, in Colombia this was due to a sizeable increase in the labour supply, but in Brazil it was the result of slack job creation. Because of the steep rise in unemployment in Brazil and that economy's strong influence on weighted regional figures by virtue of its size, the average rate of unemployment for the eight countries for which data are available climbed from 7.5% in the first half of 1997 to 8.1% for the corresponding period of 1998, whereas the simple average for these same countries fell from 10.5% to 10.1% (see figure I.6b).

Hence, as of mid-1998, Brazil's labour market was the only one that had been hurt to any significant degree by the slowdown in growth. Nonetheless, it is expected that during the second half of the year the adjustment measures which many countries began to implement in late 1997 or during 1998 may curb job creation and boost unemployment. Consequently, after two bad years (1995 and 1996) and one year of improvements (1997) in terms of the quantity of jobs and, to a partial extent, job quality, the labour market is in danger of suffering another setback.

The current account deficit continues to widen

The current account deficit for the Latin American and Caribbean region as a whole has expanded in both 1997 and 1998, as imports continue to rise faster than exports. With the high rate of GDP growth registered in 1997, the gap widened to US$ 63 billion (3.2% of GDP as compared to 2.0% in 1996). In 1998, the deficit is projected at around US$ 75 billion (3.7% of GDP). Plentiful capital inflows continue to provide more than enough funds to cover the deficit (see figure I.7).

The expansion of foreign trade in 1997 was one of the largest of the last two decades. Exports climbed by 11% in volume and by 10% in value, while imports rose even more rapidly, by 19% in volume and by 18% in value. The figures for 1998, however, are likely to be much lower.

The growth of trade volume in 1997 was driven by the strength of demand. In the case of imports, this was based on internal demand, which swelled by 7%, thus stimulating GDP, which grew by slightly more than 5%. The significant role played by investment in GDP growth was reflected in the dynamism shown by capital goods imports. Meanwhile, export demand was generated by a world economy that managed to maintain a high growth rate of 4.1% and to boost international trade by 9%; intraregional trade also showed considerable dynamism. In addition to the income effect on the volume of international trade, the real appreciation of regional currencies contributed to an increase in imports while, at the same time, there is no evidence that it hurt exports.

Commodity price trends were mixed in 1997 as the net result of two opposing factors: the positive influence exerted by the buoyancy of the world economy and, in the second half of the year, the negative influence of the Asian crisis. All in all, for most countries, the unit value of exports rose while that of their imports fell, and a widespread improvement was consequently seen in the terms of trade.

Taking into account the above trends, it can be seen that variations in volume were the major factor influencing the value of trade. Nearly all the countries registered increases in their trade deficits, and trade surpluses narrowed in the few countries that had them. As a result, the 1996 trade surplus for the region as a whole gave way to a deficit in 1997.

In the second half of 1997 and the first half of 1998, the Asian crisis has affected trade in three ways:

(i) Lower prices for some commodities (primarily minerals and agricultural raw materials): According to the IMF, the crisis has been the main cause of the downturn in the prices of copper, nickel, natural rubber, wool, leather and rice; it has also been a significant factor in the descent of lead, wood and oil prices. Most of the decrease in copper prices occurred in the second half of 1997, but the slump in oil prices has been concentrated in 1998.

(ii) Lower export value: Given the lower prices of many products exported by the region, it is likely that export value will fall in a number of countries. During the first half of the year, this was the case in Chile, Ecuador, Peru and Venezuela. Part of the contraction will be accounted for by a reduction in exports to Asia, although the impact of such a trend will be mitigated by the fact that Asia buys only a small fraction of the exports of Latin American and Caribbean countries, except in the cases of Chile and Peru (see figure I.8). A slowing in the growth of intraregional exports, especially within Mercosur, is also expected.

(iii) Reduced import value: Imports may slacken as a consequence of the monetary and fiscal measures implemented in order to slow down spending and support local currencies, especially in Brazil, Chile and Venezuela. The figures that are available so far, however, indicate only that imports were down in Brazil (–2% in the first half of 1998).

The Asian crisis notwithstanding, in 1997 and the first half of 1998 foreign capital continued to flow into Latin America and the Caribbean, providing more than enough funds to cover the countries' mounting current account deficits. What is more, the trend first seen in 1995, whereby the composition of these flows is shifting towards an increasing proportion of medium- and long-term capital, has been strengthening, and the information available as of mid-1998 suggests that this trend will hold firm during the second half of the year.

The past 18 months can be divided into two different phases in terms of the level and cost of the external financing available to the region. During the first phase, which covers the period from January to September 1997, capital inflows were copious and borrowing costs were moving downward. The second phase, from October 1997 to mid-1998, can be subdivided into two parts. In the final quarter of 1997, capital flows contracted sharply, while in the first half of 1998, the volume of these flows rebounded but the cost of external financing rose.

The hefty capital inflows seen during the first of these phases --over US$ 90 billion by September 1997-- benefited nearly all countries in the region. The bulk of the flows was made up of long-term capital, particularly foreign direct investment (FDI) which reached an all-time high of nearly US$ 56 billion for the year as a whole. The funds brought into the region in connection with privatization operations in Brazil and Colombia were an important part of the FDI figure. Bond issues (involving significant sums in the cases of Argentina, Brazil and Mexico) also provided medium- and long-term financing; the average maturity of the bonds issued by regional borrowers in 1997 was approximately 15 years. The proportion of short-term credit remained at around 20% of total capital inflows; in most countries these flows consisted mainly of trade finance. Another indicator of the boom characterizing this phase was the rise of 30% in equity values on local stock markets between January and September 1997.

The second phase began when the Asian crisis started to worsen in late October 1997, and equity prices tumbled on stock exchanges in Asia and, to a lesser extent, Latin America (see figure I.9). The slump in stock prices between the beginning of October 1997 and the end of June 1998 was widespread in the major Latin American economies, and the regional average for this period reversed its earlier gains and fell by 30%. In terms of volume during this second phase, the most severely affected component of capital flows was equity investment. Other types of short-term capital also contracted, especially in Brazil, Chile, Colombia and Venezuela, and much of this reduction was reflected in a decline in international reserves in these countries.

Bond financing was down sharply in the fourth quarter of 1997, but it rebounded during the first half of 1998. The terms of bond issues, however, were less favourable in the first half of 1998 than in the corresponding period of 1997 (see figure I.10). Average maturities shortened from 15 years to just half that figure, and spreads widened by between 150 and 200 basis points, with issues by non-financial private-sector entities suffering the most. The terms and conditions of bank loans deteriorated less than those of bonds.

Although foreign direct investment shrank in some countries during the first half of 1998, it is expected to recover in the second half. The privatization of Brazil's telecommunications system (Telebras) (2) in July 1998 was the largest such operation in Latin America's history and constituted a milestone in terms of the level of confidence in the region's biggest economy, which should have positive repercussions on other countries. It is therefore expected that total FDI for the region in 1998 will be within the same range as the exceedingly high figure registered for 1997.

Foreign saving provides the dynamism for investment

The data for 1997 indicate that economic growth and stabilization in the countries of the region were coupled with an extraordinary degree of dynamism in investment and saving (especially external saving). In all the countries except Haiti, the expansion of gross fixed investment outpaced GDP growth, and this was reflected in an across-the-board increase in gross fixed investment coefficients. Thus, gross capital formation reached 23.5% of GDP in current prices, one of the highest levels seen since the early 1980s.

In the closing months of 1997, however, GDP growth began to slow down, and this trend has grown stronger in 1998. An estimate prepared by ECLAC, which is consistent with the fact that investment tends to be more volatile than output, suggests that the growth rate of investment will decrease substantially in 1998 (see figure I.11).

Although considerable progress has been made in the area of financial liberalization in Latin America and the Caribbean, the region's domestic savings rates have stabilized at around 20% of GDP (in current prices). External saving therefore continues to be the most dynamic component of financing for gross capital formation. In 1997 external saving accounted for about 13% of gross capital formation, or 3.2% of GDP. Foreign direct investment, in turn, is the strongest component of external saving, and in 1997 represented three fourths of the total. External saving is expected to continue to expand in 1998, although at a slower pace than the year before.

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Note:

(2) Revenues from this operation amounted to US$ 19 billion, most of which was foreign capital; 40% of this sum was to be paid in 1998 and the balance was to be disbursed in the course of the following two years.