Latin America Manufacturing Outlook July 2015

Monday, July 13, 2015

Latin America Manufacturing Outlook:
Brazil's Deepening Recession Masks Mexico's Solid Performance


Need to Know . . .

  • The MAPI Foundation's Latin America manufacturing index is expected to decline 0.9% this year and to expand 1.9% in 2016
  • In 2015, a sizable recession across Brazil's industrial complex is offsetting the expansion of Mexico's manufacturing
  • Mexico will continue to lead manufacturing growth in 2016; factories in Brazil and Argentina will post a timid rebound

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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 forecasts for 2015 and 2016. 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 decline 0.9% in 2015, although this regional picture masks sizable differences across countries. The poor performance of our regional index is explained by the deeper than expected recession in Brazil that is offsetting the solid performance of Mexican factories. Argentina’s manufacturers are also in recession, but it is milder than Brazil’s.

The export-oriented carmaking industry in Mexico remains the bright spot and continues to spur growth across intermediate industries. Only the refined petroleum products sector is unable to expand this year in Mexico. In Brazil, plummeting motor vehicles manufacturing dragged down growth across the country’s industrial complex, with few exceptions. The size and the duration of Brazil’s manufacturing recession are worse than expected by most observers. Similarly, Argentina’s manufacturing weakness is explained by a sharp retreat in car production, as domestic sales and exports to Brazil continued their downward trend in the first four months of 2015.

The MAPI Foundation’s Latin America manufacturing index is expected to rise a modest 1.9% in 2016. A pickup in U.S. manufacturing activity next year will be a contributing factor, extending the solid performance of Mexico’s factories, which are expected to experience accelerated output growth late this year and into 2016. We continue to anticipate that Mexico will remain the manufacturing growth leader in the region. A shy rebound in Brazil and Argentina will bring our overall index into positive territory.

Brazil
Brazil’s recession is deepening, according to the most recently released statistics. The government’s austerity program aimed at restoring the country’s fiscal stance and fighting rising inflation—while maintaining Brazil’s investment grade status—is filtering through the economy. Tighter fiscal and monetary policies are clearly affecting activity and taking a toll on consumer and business confidence levels, which are further damaged by the unfolding of the Petrobras corruption scandal. During the first three months of 2015, Brazil’s GDP contracted by 0.2% quarter over quarter and 1.6% year over year; both readings signal a downward spiral in overall economic activity.

Brazil’s manufacturing industry (48.7% weight in our index) is also in deep recession. Output decreased by 8.4% year over year between January and April 2015. Even more worrisome is the continued decline in month-over-month readings, suggesting that the contraction continues to gain strength as I write this report. A 21.3% decline in motor vehicles production during that period is at the heart of the country’s industrial recession. The weak carmaking industry continues to negatively affect activity in most intermediate industries. The office and electronic equipment, refined petroleum products, and pharmaceutical industries are among the largest drags to growth. The demand for durable industrial goods and capital goods is plummeting.

Prospects for this year remain dark. Our Brazil manufacturing forecast for 2015 points to a 3.8% recession, on top of last year’s 3.9% contraction. The auto industry will be the largest drag on growth, albeit at moderate levels in the second half of this year. The MAPI Foundation’s 2016 forecast for Brazil’s manufacturing production shows a timid rebound: our index is expected to rise 0.7%. Our model points to a shy rebound in the carmaking sector, barely pushing most intermediate industries out of recession.

Mexico
Mexico’s manufacturing output (38.7% of our index) increased 3.2% during January through April 2015. The automotive sector remained the growth engine, expanding output 11.1% in this period and leading to solid growth in some of its supplying industries. For example, fabricated metal plants increased production by 8.8% and rubber and plastics producers saw their output rise 4.5% in the first four months of 2015. Other industries, such as electronic equipment products and electrical machinery, continued to show above-average output gains. On the other hand, the persistent decline in Mexico’s oil output led to a sizable plunge in refined petroleum products manufacturing (-9.3% output growth in the January to April 2015 time frame). The chemicals industry saw production decline by 1.8% in the first four months of this year.

Mexico’s robust manufacturing performance in the January to April 2015 period is difficult to explain in the wake of weakness across U.S. factories early this year. I suspect that this sort of decoupling of Mexico’s industry from its U.S. counterpart could be attributable to the weaker peso relative to the U.S. dollar, which made Mexican-made manufactured goods more competitive. With the latest MAPI Foundation U.S. Industrial Outlook pointing to a slow rebound in factory output for the rest of the year, I suspect that Mexico’s manufacturers will see their output growth slow over the next few months, although growth will remain firm.

Recently released leading indicators suggest solid manufacturing activity in the next few months. For example, in the May 2015 Purchasing Managers Index published by INEGI, almost all subcomponents were above the 50-point mark. New orders, production levels, employment, and inventory levels remain supportive; the supplier deliveries index remains the only subcomponent below 50. Similarly, 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.

Our econometric modeling indicates that Mexico’s manufacturing industry will expand output by 2.8% in 2015 and 3.4% in 2016. The expectations of stronger manufacturing growth in the U.S. next year are positively affecting our Mexican forecasts. This year, the auto sector will continue to be the engine of industrial growth. In 2016, 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 1.7% year over year during January through May 2015, a consequence of the 15.8% collapse in auto production. Carmakers, which ship 60% of their production to Brazil, are clearly affected by the deepening of Brazil’s recession, on top of muted domestic demand. Although Argentina’s manufacturing remains in negative territory, the pace of decline has eased recently. The April and May manufacturing production readings increased on a month-over-month basis, reinforcing the idea that a weak rebound is in the works.

With the upcoming presidential elections in October, the government is focused on taking the economy out of recession by increasing public spending, keeping interest rates at negative real (inflation-adjusted) rates, and striking deals with major companies to maintain employment levels. The hard work of solving the numerous economic imbalances, most notably an overvalued currency, a widening and unsustainable fiscal deficit (thanks in part to unnecessary subsidies), and elevated inflation, will be left to the next president and his economic team. So far, the government’s candidate Daniel Scioli leads the polls, followed by Mauricio Macri, the most pro-business candidate. Although both presidential candidates and their teams understand the need for what could be a painful economic adjustment, Scioli promises a gradual approach while Macri a more orthodox and straightforward adjustment. Gradualism always captures votes, but I am not sure if waiting to attack the problems of Argentina’s economy is the right path forward.

I believe that economic growth in general and manufacturing in particular will remain stagnant this year and next. Our model points to a 0.9% manufacturing recession in 2015 and a weak 1.8% expansion in 2016. Auto factories and supplying industries such as basic metals and fabricated metal products explain the bulk of this year’s contraction. Once the uncertainty brought about by the presidential election is over and once the new government announces its exchange rate and economic policy, consumers and businesses should bring spending back to more normal levels. This explains our expectations of a weak rebound in 2016, which could be downgraded if the needed adjustment is full-blown (like in Brazil) rather than gradual.

The MAPI Foundation’s Latin America Manufacturing Forecasts
Our manufacturing forecast for Latin America has been revised downward as a result of the deepening recession in Brazil. I expect the region’s factories to decrease production by 0.9% in 2015, dragged down by a 3.8% contraction in manufacturing output in Brazil. The 2.8% growth estimated for Mexico’s manufacturing is not enough to compensate for the sizable plunge in Brazil; Argentina’s forecast points to a 0.9% recession this year.

For 2016, we forecast that our Latin America manufacturing index will expand 1.9%. Growth among Mexican factories will accelerate to 3.4% next year, in line with stronger U.S. activity. The auto industry in Mexico will continue to drive manufacturing growth. A shy rebound in Brazil (+0.7%) will push our overall index into positive territory. Argentina’s factories are also expected to grow next year (+1.8%), although there are downside risks to our outlook.

Ten out of the 14 manufacturing industries tracked by the MAPI Foundation will post a recession in 2015. The industries explaining most of the regional weakness are computing and electronic equipment, other transport equipment, refined petroleum products, and machinery and equipment. A shy expansion in the carmaking industry (thanks to the solid growth in Mexico), growth in the more stable food and beverages sector, and a rise in nonmetallic mineral production will offset some of the losses.

The 1.9% manufacturing growth expected in 2016 is clearly a consequence of the improved backdrop for the auto industries in Brazil and Argentina. Mexican auto plants will continue to thrive next year and will remain the growth engine. Most intermediate industries will return to positive territory as Brazil manufacturers start recovering from this year’s recession. Twelve of the 14 industries are forecast to expand output in 2016.

Table 1 – Manufacturing Production Forecast, 2015-2016 (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 March 2015 based on our rate-of-change analysis (the smaller inset figure shows these industries’ positions in September 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 March 2015 deteriorated compared with the one depicted in our last report, which used September 2014 data. Only two industries—food and beverages and paper and paper products—are in the growth phase, although both were in decelerating mode in March (compared with eight industries in September 2014). Nine industries were in the accelerating decline phase: wood products; coke, refined petroleum products, and nuclear fuel; chemicals and chemical products; rubber and plastics; basic metals; machinery and equipment; computing machinery, communications, and electronic equipment; motor vehicles; and other transport equipment (compared with three industries in September 2014). Finally, there were three industries in the decelerating decline phase of the cycle: nonmetallic minerals, fabricated metals, and electrical machinery and apparatus.

Country Forecasts

Table 2 – Brazil: Manufacturing Production Forecast, 2015-2016 (Annual Percent Change)

F=Forecast
Source(s): MAPI Foundation

Table 3 – Mexico: Manufacturing Production Forecast, 2015-2016 (Annual Percent Change)

F=Forecast
Source(s): MAPI Foundation

Table 4 – Argentina: Manufacturing Production Forecast, 2015-2016 (Annual Percent Change)

F=Forecast
Source(s): MAPI Foundation

  • 1. Local currency value-added is translated to dollar terms using the period's average nominal exchange rate.