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The Brazilian economy has been surprisingly resilient given the challenging sanitary situation it faced in Q1. A more supportive external environment, a stronger recovery in services and a rebound in confidence, should help support the short-term outlook – especially as the epidemic slows down with improving vaccination coverage. Accelerating inflation continues to be a concern and could lead to a more vigorous tightening of monetary policy at the end of the summer. While the currency and portfolio investments stand to benefit from more aggressive rate hikes, the latter also risk slowing down the recovery and adversely affecting public finances. So far though, the sovereign has recorded better fiscal metrics than expected, which have translated into lower risk premiums.

The economy should rebound strongly in 2021 thanks to a successful vaccination campaign, improved prospects for global growth and higher copper prices. According to the monthly economic index, in early Q2, real GDP returned to the pre-pandemic level of December 2019. Looking beyond 2021, economic growth prospects could be marred by persistent political tensions plaguing the country. Debates over the presidential election on the one hand and the process of drawing up a new constitution on the other will probably disrupt the implementation of economic policy as well as private sector investment decisions by both resident and non-resident investors.

Close to 2/3 of public debt in Central America* is owed to non-residents. Costa Rica is the least dependent on external funding. Nicaragua and Panama are the most dependent – however with diametrically opposed creditor profiles. The former’s external commitments are due to official creditors (e.g. multilaterals or bilateral creditors such as Taiwan) while ¾ of the latter’s are owed to private creditors (primary bondholders) – a share comparable to Latin America’s third largest sovereign bond issuer in 2020 – the Dominican Republic.  In a context of increasing debt burdens (+12 percentage points across the region in 2020), a high dependence on external funding is a source of financial vulnerability – especially for those countries whose external debt is mostly held by private creditors (e.g. El Salvador, Costa Rica, Dominican Republic, Panama). Unfortunately, for many economies, structural factors will continue to constrain the development of local public debt markets: small investor base, shortfalls in the institutional and legal setting, lack of financial infrastructure, fragility of macroeconomic policies. High levels of financial dollarization and large current account deficits also force many countries to durably rely on foreign-currency debt flows to close external financing gaps.  * We include the Dominican Republic (DR). Although a formal part of the Caribbean, the DR is also a member of the Central American Integration System (SICA).  

The improvement in global growth prospects and the success of the vaccination campaign have helped sustain the recovery in Chile’s growth seen since Q3 2020, despite the reintroduction of relatively strict health protection measures in the early part of 2021. Household consumption grew strongly and is likely to continue to drive growth, boosted by stimulus measures and the opportunity given to a large number of employees to draw on their pension savings. In all, GDP is likely to grow by 6% in 2021, after a 5.8% drop in 2020. This said, the risks are on the downside. External risks relate mainly to trends in the pandemic and progress in vaccination on a global level. Domestic risks centre on the debate about rewriting the constitution (a process likely to last until mid-2022) and the campaign for the presidential election in November 2021. These factors could depress the outlook for both domestic and international investment.

The health crisis continues to worsen – undermining the economy to a point of entertaining a recessionary risk in the first half of 2021. In this context, confidence has plummeted and financial markets have retreated. The vaccination campaign – after facing significant logistical challenges – has finally begun to accelerate since mid-March and with the concomitant introduction of new restrictive measures, the hope is that the epidemic curve will reach an inflection point over the next two months. Faced with rising inflation and inflation expectations, the Central Bank launched its monetary tightening cycle, which – against a backdrop of slowing economic activity and a high sovereign interest burden – has exacerbated budgetary pressures and risks. Although weakened by the crisis, financial soundness indicators of the banking sector remain very favourable.

Thanks to a strong Q4 rebound, the contraction in real GDP was limited to 8.2% in 2020, the public deficit did not swell as much as expected, and 2021 growth prospects were given a boost. Yet the recovery is still fragile: private consumption and investment have both taken a lasting hit from the 2020 crisis, and the export sector will not benefit fully from the expected rebound in US growth. The crisis also exacerbated concerns about the vulnerability of public finances and the decline in investment, which will undermine medium to long-term growth prospects.

In 2020, the Brazilian main equity index – the B3 Ibovespa – recovered swiftly from the commotion caused by the pandemic. After hitting record highs in January, the index lost 50% of its value in March before ending the year on a 3% gain. The year also ended with a record number of initial public offerings (26 IPOs and nearly USD 8 bn in funds raised – the highest level since 2007). The proceeds of these offerings were used to acquire assets or equity interests, cover working capital needs, pay down debt and invest in infrastructure – in that order. Global factors have facilitated this rapid bounce back.  Liquidity injections and record low interest rates across the globe in addition to vaccines development helped spur an increase in risk appetite. The local story was however more dominant in explaining the quick recovery. First, foreign funds allocations to Brazilian equities and IPOs have been low by historical standards (previous IPO booms were primarily driven by foreign investors). Second, the large drop in the policy rate (the SELIC has been cut by some 12 percentage points since 2016 including 250 bps in 2020) has also encouraged local investors to allocate more heavily towards equities. Finally, the rally was supported by the large increase in the number of local retail investors — which has more than quadrupled since December 2018, aided by a dynamic Fintech industry which has facilitated the growth of online brokers and trading platforms.

An active economic policy has helped attenuate the magnitude of the recessionary shock in 2020. The recovery in Q3 was vigorous and was prolonged into Q4. However, the economy showed signs of slowing down towards year-end. Brazil’s external vulnerability did not deteriorate despite high volatility of both portfolio and direct investments as well as a sharp depreciation of the real in 2020. In 2021, the economy will benefit from the recovery in commodity prices and the maintenance of accommodative measures on the monetary side. However, the resurgence of the Covid-19 epidemic coupled with delays in rolling out vaccinations as well as uncertainty regarding the fiscal consolidation process and the lack of progress on reforms are likely to be sources of stress in financial markets and potential destabilising forces for the recovery.

Peru is one of the Latin American countries to have suffered most from the Covid-19 crisis. After a sharp contraction in Q2 2020, the recovery that began in Q3 has continued. This said, economic activity is unlikely to regain its pre-crisis level before the end of 2022. The economic contraction and the massive stimulus programme introduced by the government have hit public finances, but the deterioration is likely to remain manageable, for the short term at least. However, the deterioration of the political climate seen over the past few years is affecting the medium-term outlook.