posted on 12.18.14

Need to Know . . .

The MAPI Foundation manufacturing forecast for Latin America has been revised downward from our July 2014 report; we predict no growth in 2014 and a still shy 1.8% in 2015

In 2014, the lone bright spots are carmakers in Mexico, the more stable food and beverages industry, and electronic equipment factories

The tepid rebound in 2015 is a result of solid growth across Mexico’s industries combined with weak activity in Brazil and Argentina

Introduction
This biannual report examines the latest trends in selected manufacturing industries in Latin America and provides related forecasts. The focus is on Latin America’s three largest economies—Brazil, Mexico, and Argentina—as these countries account for more than 80% of the region’s manufacturing output. Annual production indexes for each manufacturing industry are weighted-average indexes, with the weights determined by each country’s value-added in U.S. dollar terms in each of the 14 sectors under analysis.1 All data come from national statistical agencies: the Mexican Institute of Statistics, Geography, and Informatics (INEGI); the Brazilian Institute of Geography and Statistics (IBGE); and Argentina’s Institute of Statistics and Census (INDEC).

The first section of the report offers a general overview of the region’s current manufacturing activity and the MAPI Foundation’s forecast for 2014 and 2015. Significant developments affecting our forecasts are also examined. The second section sketches the positions of selected manufacturing industries along a cyclical path divided between phases of growth and decline. The final section details the MAPI Foundation’s production forecasts for the subsectors by country.

The State of Latin America Manufacturing and Its Outlook
Regional Summary
The MAPI Foundation’s manufacturing production index for Latin America is expected to show no growth in 2014—instead, it is forecast to decline a slight 0.1%. This challenging regional picture masks sizable differences across countries, however. The poor performance of our index is explained by recessions in Brazil and Argentina that have offset the good performance of Mexican factories.

As we anticipated in our last report, the export-oriented carmaking industry was the growth engine in Mexico, but there is now strong evidence of broader-based manufacturing growth. I estimate that this broad-based expansion across Mexico’s industrial supply chain will continue in 2015. In Brazil, plummeting motor vehicles manufacturing dragged down growth across the country’s industrial complex, with few exceptions. Similarly, Argentina’s manufacturing weakness is explained by a sharp retreat in car production, as domestic sales and exports to Brazil continue to decline.

The MAPI Foundation’s Latin America manufacturing index is expected to rise a modest 1.8% in 2015 (a downward revision from our previous forecast of 2.1%). We remain confident that Mexico will remain the manufacturing growth leader in the region. Demand from U.S. factories will fuel manufacturing growth in Mexico, although homegrown political factors will put a ceiling on Mexico’s expansion. We forecast weak manufacturing expansion in Brazil at best and a moderate manufacturing recession in Argentina.

Brazil
Brazil’s economy is in stagflation mode—a mix of recession and inflation. Manufacturing activity decreased 6% year over year during the last six months and business and consumer confidence plummeted. After being re-elected in a ballotage by the narrowest margin in the country’s history, President Dilma Rousseff and her new economic advisors will have to make tough policy decisions to take the economy out of the slump, lower inflation, and address the deteriorating fiscal picture.

Brazil is at a crossroads, and it will be difficult for recently appointed Finance Minister Joaquim Levy to implement the proper policy mix given the negative short-term implications that those policies will entail. Higher interest rates and a sizable cut in public spending may be needed to curb inflation and improve the country’s finances. Although these policies are needed to correct the current macroeconomic imbalances and restore long-term economic growth, they will further damage economic activity in the short term, negatively affecting employment. Policymakers will have to cope with higher unemployment in the short term in order to set the stage for stronger growth in the long term; I question the government’s willingness to go through that painful process.

Brazil’s manufacturing industry (48.7% weight in our index) stopped growing four years ago. Output decreased by 3% in the first 10 months of this year, taking a toll on our overall Latin America manufacturing index. An 18% decline in motor vehicles production during that period is at the heart of the country’s industrial recession. The weak carmaking industry has depressed activity in most intermediate industries; considerable output declines are seen in fabricated metals, basic metals, rubber and plastics, electrical machinery, and machinery and equipment. With business sentiment at its lowest levels in a decade, it is not surprising to see plunging demand for durable industrial goods and capital goods.

The recent decision by the central bank to raise the reference interest rate from 11.25% to 11.75% will further hurt manufacturing in the next few months as credit becomes more expensive. On top of that, risks of electricity rationing are mounting, a situation that is dependent on the weather since most of Brazil’s electricity is generated by hydroelectric dams, where below-average rain levels this year have led to worrisome water levels.

As a result, our Brazil manufacturing forecast for this year and next was adjusted downward. We anticipate that Brazil’s manufacturing production will decline 1.8% this year, with the carmaking industry expected to post a significant 14.6% plunge in production levels. The MAPI Foundation’s 2015 forecast for Brazil’s manufacturing production shows modest 1.6% growth. I suspect that the automotive industry will recover some of this year’s losses, although I see only a tepid rebound. The more stable food and beverages industry is expected to be the largest contributor to next year’s industrial growth in Brazil.

Mexico
Mexico’s manufacturing output (38.7% of our index) increased by a relatively strong 3.4% during January-September 2014. The automotive sector was the growth engine, expanding output 11% in this period and leading to sizable expansions in key supplying industries. In line with expectations, basic metals factories posted strong 10.3% output growth and fabricated metal plants increased production 6.1%. The rubber and plastics, electronic equipment, and electrical machinery industries have also shown above-average output gains so far this year.

While the structural reforms undertaken by the Peña Nieto administration are setting the stage for stronger long-term growth, the economy is also benefiting from a positive cycle. The encouraging outlook for manufacturing in the United States is driving up confidence among Mexico’s manufacturing leaders. The MAPI Foundation’s December 2014 economic forecast—a key input for our forecast for Mexican factories—predicts solid 3.5% and 3.9% manufacturing output growth in 2015 and 2016, respectively.

Similarly, recent leading indicators in Mexico suggest robust manufacturing in upcoming quarters. In the November 2014 Purchasing Managers Index published by INEGI, almost all subcomponents were above the 50-point mark, calling for output growth over the next few months. New orders, production levels, employment, and inventory levels remain supportive; the supplier deliveries index remains the only subcomponent below 50. The latest INEGI Producer Confidence Index for the manufacturing sector indicates that Mexico’s captains of industry are confident about prospects for the near future.

The ongoing security-related and political turmoil will put a ceiling on Mexico’s manufacturing growth, however. On the security front, the tragic events in the town of Iguala—where 43 students were kidnapped by the local police and then murdered by drug traffickers—led to massive protests across the country. Mexicans took this tragedy as a symbol of the failure of the current government to make security a priority. The continued turmoil will negatively affect consumer and business sentiment, limiting growth in the near future but also impinging on the long-term outlook. In a recurring central bank survey of private sector analysts, insecurity is the most cited factor inhibiting long-term growth. Corruption is also making a dent on Mexico’s positive cyclical story. The country’s investment prospects suffered when the government canceled a contract for a high-speed train that was awarded to the sole bidder, a consortium of Chinese and Mexican companies—including a construction firm with links to President Peña Nieto.

I have built these recent negative factors into our model, placing my estimates below consensus. Our econometric modeling indicates that Mexico’s manufacturing industry will expand output by 2.9% in 2014 and 3% in 2015 (Consensus Economics predicts 3.2% manufacturing production growth in 2014 and 4.1% growth next year). This year’s growth leaders include the auto sector, basic metals, and fabricated metals. In 2015, I expect gains to be more evenly distributed across all manufacturing sectors, as shown in Table 3.

Argentina
Argentina’s manufacturing industry (12.6% of our index) contracted 2.6% during January-October 2014, a consequence of the 21.6% collapse in auto production. Having reached record-high production in 2013, carmakers are suffering from plummeting demand from Brazil and domestic sales. Stricter import restrictions are negatively affecting auto plants, as a vast proportion of parts and components are sourced abroad. Tighter control on imports is shaping numerous other industries, such as the electronic equipment factories in the Tierra del Fuego free trade zone. Factories are shutting down plants in anticipation of maintenance work and employee vacations. Other manufacturers are laying off workers.

In addition to the major retreat in car production—an engine of industrial growth in this part of the world—consumer and business confidence are at their lowest levels in a decade. The cost of default continues to increase, as there are no clear signs on the government’s strategy vis-à-vis the holdouts. While I believe that Argentina will work toward an agreement with the holdouts in the first half of 2015, many other observers do not foresee a deal. Reaching a debt agreement will offer Argentina the possibility of tapping into international credit in an attempt to stop the drainage of international reserves and restore some confidence.

The economy is in stagflation mode, a mix of recession and inflation. The government is focused on preserving international reserves by tightening import controls and access to foreign exchange. While this policy mix is helping the government avoid a more profound economic crisis, especially in light of next year’s presidential elections, it does nothing to solve the mounting macroeconomic imbalances. It seems clear that the objective is to hand the problems to the next administration. In the meantime, authorities blame the relatively mild recession on lower terms of trade and weaker demand from China and Brazil.

I believe that economic growth in general and manufacturing in particular will remain stagnant this year and next. Our model points to manufacturing contractions of 2.4% and 0.7% in 2014 and 2015, respectively. In order to avoid a balance of payments crisis, the government will continue to limit everything that generates dollar outflows, particularly imports, in turn affecting manufacturing production. Auto factories and electronic equipment plants—two industries that are heavily dependent on imported components—explain most of this year’s recession. This narrative remains valid for 2015, although the size of the contraction should be smaller.

The MAPI Foundation’s Latin America Manufacturing Forecasts
Our manufacturing forecast for Latin America has been revised downward from our July 2014 report. I expect the region’s factories to show no growth in 2014 (the July growth estimate was 2%) and a shy 1.8% expansion in 2015 (versus 2.1% in July). Most of the manufacturing growth predicted for this year and next is supported by Mexican factories, since industrial activity in Brazil and Argentina remains weak.

Roughly half of the 14 manufacturing industries tracked by the MAPI Foundation will post a recession in 2014. The industries explaining most of the overall weak picture are motor vehicles (due to plummeting production in Brazil and Argentina), machinery and equipment, fabricated metals, and electrical machinery and apparatus. Expansions in food and beverages and electronic equipment offset some of these losses. Growth is muted in numerous sectors, such as refined petroleum products, basic metals, chemicals, rubber and plastics, nonmetallic minerals, and other transport equipment. In most cases, this muted growth masks significant country disparities.

The 1.8% manufacturing growth expected in 2015 is clearly a consequence of the good prospects among Mexico’s intermediate industries, which will have to expand production to satisfy the projected solid demand from carmakers. A shy rebound in Brazil’s motor vehicles industry helps explain the improved overall backdrop for next year. In addition, the large food and beverages industry is expected to gain some traction, pushing up our overall manufacturing index. Twelve of the 14 industries are forecast to expand output in 2015.

Table 1 – Manufacturing Production Forecast, 2014-2015 (Annual Percent Change)

F=Forecast
Source(s): MAPI Foundation

Manufacturing Subsectors in the Current Business Cycle
Figure 1 illustrates a model business cycle that summarizes the current economic performance of the 14 subsectors under study. Specifically, it shows the approximate cyclical positions of these industries as of September 2014 based on our rate-of-change analysis (the smaller inset figure shows these industries’ positions in March 2014). The cyclical position of a particular industry may signal a point within a growth subcycle (up and down variations of production that are not technically a recession) as opposed to the conventional business cycle. It should be emphasized that the three countries being examined may be at dissimilar stages of the cycle or in different growth subcycles.

The manufacturing picture in Latin America as of September 2014 deteriorated compared with what was depicted in our last report, which used March 2014 data. Some large industries moved from the growing phases to the declining phases, explaining the downward revision to our forecasts. In September 2014, zero industries are in the accelerating growth phase compared with six in March 2014. There were eight sectors in the decelerating growth phase of the cycle in September versus seven in March. Those eight sectors are: food and beverages; wood products; paper and paper products; coke, refined petroleum products, and nuclear fuel; chemicals and chemical products; basic metals; computing machinery, communications, and electronic equipment; and other transport equipment.

As of September 2014, there were three industries in the accelerating decline phase of the cycle compared with zero in March. Those three industries are: rubber and plastics, machinery and equipment, and electrical machinery and apparatus. Finally, three industries appear in the decelerating decline phase of the cycle as of September versus just one in March: nonmetallic minerals, fabricated metals, and motor vehicles.

Country Forecasts

Table 2 – Brazil: Manufacturing Production Forecast, 2014-2015 (Annual Percent Change)

F=Forecast
Source(s): MAPI Foundation

Table 3 – Mexico: Manufacturing Production Forecast, 2014-2015 (Annual Percent Change)

F=Forecast
Source(s): MAPI Foundation

Table 4 – Argentina: Manufacturing Production Forecast, 2014-2015 (Annual Percent Change)

Article and Video Provided in partnership with MAPI.  Article and video written by Fernando Sedano PhD.