Head Winds in External Factors Are Picking Up

New Approaches to Closing the Fiscal Gap Chapter 1 Are We Back to Normal Yet?

Second, the crisis set back progress on health as well. While progress was made in vaccination against Covid-19, the pandemic disrupted ongoing prevention programs and essential services for all age groups. For instance, despite its central role on children’s future health and wellbeing, vaccination rates for Diphtheria tetanus toxoid and pertussis (DTP3) among 1-year-olds dropped and by 2021 these have not recovered.

On the health side, studies from Mexico show that food insecurity during the pandemic, particularly in households without transfers, led to pronounced increases in child stunting and premature deaths as well as large losses in productivity (Unar-Munguía et al. 2022). There is simply no possibility of longer-term equity or growth if these problems are not addressed.

The decline in growth forecasts is largely driven by less favorable movements in four factors - change in the Fed Funds rate, G-7 growth, China growth, and change in commodity prices - that can account for almost 90 percent of LAC GDP movements (figure 1.9). The war in Ukraine, contractionary policies to fight inflation, and China’s continued struggle with COVID-19 have slowed the recovery in the Group of Seven industrialized nations (G-7) and China, translating into dampened demand for LAC’s exports. At the same time, the sharp rise in interest rates by the US Federal Reserve and the European Central Bank dampen capital inflows and make foreign financing more expensive.

Figure 1.9. Four Main External Factors Drive Movements of GDP in LAC

a. Commodity price index

Index, 2016:Q2 = 100 300 250 200 150 100 50 0

2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022f:Q4 2023f:Q4 2024f:Q4

b. G-7 growth

Percent

15 10 5 0 -5 -10 -15

2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022f:Q4 2023f:Q4 2024f:Q4

c. Fed funds rate and 10-year US Treasury yields

Percent 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0

2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022:Q1 2022:Q2 2022f:Q3 2022f:Q4

Fed Funds Rate Real Yield on 10-year U.S. Treasury T-note 2023f:Q4 2024f:Q4

d. China growth

Percent 20 15 10 5 0 -5 -10

2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022f:Q4 2023f:Q4 2024f:Q4

New Approaches to Closing the Fiscal Gap Chapter 1 Are We Back to Normal Yet?

Figure 1.10. The Rise in Commodities Had Opposite Effects in Terms of Trade Across the Region

Percent 15

10

5

0

-5

-10

-15

-20

Jamaica Honduras Dominican Republic Costa Rica Panama Uruguay Mexico Brazil

2020:Apr vs 2022:Apr Argentina Chile Peru Colombia Ecuador

Source: International Monetary Fund.

The rise in commodity prices, especially for energy and food, continues to benefit large net commodity exporters in the Southern Cone. The terms of trade continue to be favorable for these countries compared to the situation before and at the beginning of the pandemic, even as some countries such as Brazil and Chile have experienced declines over the past year (figure 1.10). On the other hand, Central American and Caribbean countries, which are typically large importers of energy and food, have suffered more than most.

Following previous Semiannual Reports, figure 1.11 presents output estimations based on a simple model capturing the part of GDP growth explained by external variables common to all countries in the region. In this simple model of external factors, real global factors are represented by the growth of China and the G-7, in conjunction with the change in commodity prices. Financial factors are represented by international interest rates. As seen in figure 1.11, with external factors wavering, the model predicts head winds for the region, with growth associated with external factors predicted to be 1 percent in 2024, down almost 5 points since 2021. The final performance in the economy will depend on the resilience of internal demand factors.

Figure 1.11. The Share of Actual Growth in LAC Explained by External Factors Is Declining

Percent 20 15 10

5

0 -5 -10 -15 -20 2019:Q1 2019:Q2 2019:Q3 2019:Q4 2020:Q1 2020:Q2 2020:Q3 2020:Q4 2021:Q1 2021:Q2 2021:Q3 2021:Q4 2022:Q1 2022f:Q4 2023f:Q4 2024f:Q4

Actual real GDP growth Real GDP growth explained by external factors