Update Country Report Curaçao 05 Feb 2020

• Although uncertainty persists around the eventual path of the novel coronavirus (2019-nCoV) and its effect on China and the global economy, there is already evidence of an impact on emerging-market financial markets and on commodities. If past experience is a guide, this will transmit rapidly to Latin America and, in particular, to South America's large commodity exporters.
• The Economist Intelligence Unit believes that the decline in prices of key commodities for the region, such as oil and copper, will prove transitory, and some recovery based on our provisional baseline scenario for the spread of coronavirus in China would be expected in the second half of 2020.
• Even this scenario raises questions as to how much policy space Latin America has to support growth in the face of weaker demand from China and weaker commodity prices in the near term. Most Latin American economies are in monetary easing mode but, looking ahead, currency weakening will complicate policy; space for fiscal stimulus will be even more limited, with a few exceptions.
• For now, downward revisions to our GDP growth forecasts are likely to be limited to countries most exposed to commodity prices and to demand from China, including Chile and Peru. However, substantial downside risks to other large economies in the region, including Brazil, Argentina and Colombia, are clear.

Our China analysts have set out four scenarios for the economic impact of coronavirus. These assess the date by which the outbreak will come under control within China, and range from an optimistic scenario that estimates a controlled outbreak by end-February, to a "nightmare" scenario in which the outbreak is not contained this year. Under the baseline scenario that we provisionally expect to adopt in our next forecasting round, the virus will come under control in China by end-March, and our 2020 real GDP forecast for China will be revised down, from 5.9% to 5.4%.

China sneezes, Latin America catches a cold

The disruption to China's economy from coronavirus will have direct and indirect impacts on Latin America this year. We expect coronavirus to dampen China's consumption, private investment, and export and import growth, which will have a direct impact on Latin American economies that rely on trade and investment with China to drive growth. Among Latin America's six big economies, this reliance varies dramatically. Mexico's exports to China represent less than 2% of its total; in Peru and Brazil, exports to China account for over 25% of all exports, and in Chile they account for over 33% of the total. However, the direct impact will also depend on how important trade is to these economies, and again this varies substantially among countries. Trade accounts for only around 30% of GDP in Brazil and Argentina; in Peru it accounts for almost 50% of GDP and in Chile it accounts for almost 60% of GDP. On balance, Chile and Peru appear to be most exposed to the direct impact of weaker import demand from China.

There will be indirect impacts too from commodity prices, exchange rate movements, and the uncertainty effect on business investment both globally and within Latin America. China is a major driver of demand for oil and for hard commodities such as copper, and its major manufacturing export centres are being disrupted by coronavirus. This has been reflected in a substantial drop in oil and copper prices in recent weeks. From their recent mid-January peaks, copper prices have fallen by over 10%. Meanwhile, from its December 2019 peak, Brent crude has fallen by around 15%, or US$10/barrel, to US$55/barrel. This will be damaging for nations like Chile, where copper accounts for a whopping 48% of export earnings; Colombia, where oil accounts for 40% of exports; and Peru, where copper accounts for close to 30% of exports (although the effects will be partly outweighed by gold export earnings; gold accounts for a further 20% of Peru's exports, and prices are high and rising amid a flight to safety).

Brazil has a more diversified export basket than many countries in the region, but still relies on primary commodities for almost half of its exports. A large part of these exports are in the form of soft commodities, which have so far been more resilient than hard commodities in the face of coronavirus concerns (soybean prices fell by around 5% in January). However, iron ore accounts for about 10% of Brazil's exports, and prices tumbled at the start of February as coronavirus concerns ratcheted up.

Weaker currencies and a policy dilemma

Investor fears around Latin America's exposure to weaker Chinese demand and commodity prices are evident in currency movements in recent weeks. There are certainly some domestic factors at play (such as Chile's political turmoil and a fall in the policy rate to record lows in Brazil). However, depreciation pressures have clearly been building since the start of the year (they are in fact more evident in Latin America than in many of China's Asian trading partners), and will at least partly reflect concerns around the region's vulnerability to a weaker global economy and weaker commodity prices in particular. The main exception among the big economies has been Mexico, where the peso has in the past few days weakened only very mildly, following an extended period of strengthening related to the boost from the recent approval in the US Congress of the US-Mexico-Canada Agreement (the successor to the North America Free Trade Agreement). Mexico is much less exposed to China and to commodities than its regional peers. Oil accounts for only slightly more than 5% of export earnings and for less than 5% of fiscal revenue. Trade with China is weak and, in theory, Mexico could see some export increase if US importers seek to adapt their supply chains further away from China (although ultimately, we think that Mexico's prospects will be limited by still sluggish US manufacturing and goods import demand).

For most of the region, currency weakening will complicate the policy response to what will be a poor first quarter. It is clear that there is limited space for fiscal stimulus in most economies in the region. Owing to reforms around the time of Latin America's 2015-16 recession to raise revenue or cut spending, reliance on fiscal revenue from commodities has been lessened in much of the region. However, this does not mean that there is scope for fiscal stimulus. In Brazil, Colombia and Argentina, although fiscal results have been improving, public debt ratios remain high (to varying degrees) and governments are still in consolidation mode. In Mexico, although the public finances appear relatively solid (despite an upward drift in the debt/GDP ratio), the government has little scope to boost spending without scaring investors who are already extremely wary of policy under the president, Andrés Manuel López Obrador. The main exceptions are Chile, and to a lesser extent Peru, where public debt ratios and fiscal deficits are relatively low, providing some scope for fiscal stimulus. Chile has, of course, already committed to a big rise in spending in 2020 in response to the mass public protests of late 2019.

Despite these exceptions, a complicated fiscal picture will place a burden on monetary policy to stimulate the economy. Latin America's many inflation-targetting central banks now have a hard-won reputation for successfully bringing about price stability (and inflation expectations remain well anchored so far). However, depreciation pressures will-to the extent that they persist or intensify-narrow the scope for further monetary easing after sustained rate cuts over the course of 2019. Although we still expect most central banks in the region to remain in cutting mode, reductions will be less steep than in 2019, and will be highly data-dependent. As in 2015-16, there is a risk that Latin American central banks will actually need to undertake procyclical monetary tightening to counter currency pressures (although this is not our baseline forecast). In Peru and Chile, which appear the most exposed to the economic impacts of coronavirus, we expect rates to remain on hold, partly reflecting concerns over the impact of currency weakening pressures on inflation.

A temporary and relatively mild impact, but with large downside risks

Currency and commodity price movements highlight market concerns over the potential impact of coronavirus, and we share these concerns. The big commodity exporters of South America are clearly vulnerable. However, it should be emphasised that-assuming our baseline forecast around the path of coronavirus prove correct-the economic effects will be temporary. After a very weak first quarter, we would expect recovery to gather pace in the second half of 2020, and for pent-up demand to produce a rebound in China's import demand and in commodity prices. This recovery will not be enough to prevent a downgrade to our China forecasts or a downward revision to our 2020 commodity price forecasts. However, it means that in vulnerable economies in the region, such as Chile and Peru, we are unlikely (for now) to make coronavirus-related downward revisions of more than 0.1-0.3 percentage points to our 2020 GDP forecasts. There is, however, a strong risk that these assumptions around the spread of coronavirus ultimately prove too benign, and we will be following events closely in coming weeks.