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Emerging Markets Research

January 2011

Latin America and Caribbean Outlook 2011

Latin America Research Team¹


1 Fabio Akira, Neeraj Arora, Iker Cabiedes, Julio Callegari, Carlos Carranza, Gabriel Casillas, Laura Karpuska, Luis OganesAC, Felipe Pianetti, Benjamin
Ramsey, Tejal Ray, Franco Uccelli, and Vladimir Werning

See end pages for analyst certification and important disclosures, including investment banking relationships. J.P. Morgan does and seeks
to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that
could affect the objectivity of this report. Investors should consider this report as a single factor in making their investment decision.
Agenda

Output gaps close as growth remains above potential 2

Inflation acceleration to trigger policy tightening in 2011 9

Risks to monitor: China growth, Europe contagion, and FX intervention 16

Central America & Caribbean: Consolidating the recovery 25

Country overview 32

2
While G-3 growth will pick up in 2011, unemployment rates will still remain elevated
and justify the maintenance of policy stimulus



Real GDP (%q/q, saar) 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Developed market economies 3.3 3.0 2.4 1.7 2.6 2.7 2.7 2.6
United States 3.7 1.7 2.6 2.9 4.0 4.0 3.5 3.0
Japan 6.8 3.0 4.5 -1.5 1.0 2.0 2.5 2.0
Euro area 1.5 4.1 1.4 1.5 1.5 1.5 1.8 2.0


OUTPUT GAPS CLOSE AS GROWTH REMAINS ABOVE POTENTIAL


10

4
1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11



3
EM growth will average a still high 5.9% in 2011, with Emerging Asia (7.4%) once
again leading the pack, followed by Latin America (4.5%)



G-7 Emerging Economies

8.1 8.4
7.5 7.1 7.0
5.7 5.5 5.9 6.0

2.8 2.3 2.6 2.2 2.8 2.6 2.5


1.8 1.3
-0.1
OUTPUT GAPS CLOSE AS GROWTH REMAINS ABOVE POTENTIAL

-3.8

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012





Latin America Emerging Asia Emerging Europe

11.9 11.0 10.9


7.4 8.1 9.4 8.7 7.9 7.8 8.5 7.4
6.9 6.3 6.2 6.4 5.7
5.1 4.9 4.5 4.1 4.4 4.2 4.5 4.2 4.6
2.9 4.0 3.3 3.1 2.6 3.6
2.3

-0.8
-3.1

-10.9
-13.6
1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11


4
Latin America’s growth will slow in 2011 relative to 2010’s high 6%, but will remain
above potential at 4.5%; Argentina, Chile and Peru will display growth of 5-7%



2010 2011 2012 Potential GDP


1Q 2Q 3Q 4Q %oya 1Q 2Q 3Q 4Q %oya %oya %oya
Argentina 13.4 11.2 1.6 2.0 8.5 6.0 8.0 8.0 6.0 5.5 5.0 3.5
Brazil 9.4 7.2 2.1 4.2 7.7 5.4 4.4 4.0 5.2 4.5 4.5 4.0
Chile -5.2 19.5 8.1 4.0 5.3 5.0 5.0 5.0 4.5 6.0 4.5 4.2
Colombia 5.5 3.5 0.9 5.0 4.0 6.0 5.0 4.5 4.7 4.5 4.0 4.5
Ecuador 2.0 7.7 6.5 3.0 3.0 3.0 2.5 2.5 2.0 3.5 3.0 3.0
Mexico -0.2 9.5 3.0 4.1 5.4 3.0 8.0 2.8 3.1 4.5 3.5 2.5
Peru 8.2 13.0 6.7 8.0 8.8 5.5 5.0 5.5 5.0 6.5 6.0 6.0
OUTPUT GAPS CLOSE AS GROWTH REMAINS ABOVE POTENTIAL

Venezuela -3.4 6.7 0.1 1.0 -1.5 1.0 1.5 1.5 1.5 1.5 3.0 3.0
Latin America 4.9 8.7 2.6 3.9 6.0 4.4 5.6 3.9 4.3 4.5 4.1 3.6
Central America and Caribbean - - - - 4.0 - - - - 4.4 4.9 -



5
Latin America’s growth will continue to be driven by domestic consumption and
investment in 2011, with net exports remaining a drag factor amid rising imports

 
 

 
  

 

 

 

OUTPUT GAPS CLOSE AS GROWTH REMAINS ABOVE POTENTIAL

 

  

 

 

 

 
 



  
            



6
On the supply side, IP has been moderating across Latin America since mid-2010
along with global manufacturing, but signs of reacceleration emerged in November

 

 Brazil Chile Colombia Mexico Peru*


Jan -17.5 -9.0 -9.9 -10.5 -0.5 15

Feb -16.8 -11.5 -12.4 -12.1 -6.7


Mar -9.7 -7.1 0.4 -5.4 -5.5
10
Apr -14.8 -11.1 -14.7 -12.1 -13.6
May -11.2 -10.5 -6.9 -11.1 -8.0
Jun -10.9 -8.3 -7.1 -9.4 -13.1 5
Jul -9.9 -7.4 -6.6 -6.2 -12.2
OUTPUT GAPS CLOSE AS GROWTH REMAINS ABOVE POTENTIAL

Aug -7.1 -3.8 -3.9 -7.9 -10.4


0
Sep -7.6 -5.2 -4.0 -5.6 -8.3
Oct -3.1 -6.6 -3.6 -6.0 -5.9
Nov 5.3 1.0 1.8 -2.1 -2.6
-5
Dec 19.0 -0.3 2.1 0.9 1.6
2010
-1.1 1.6 3.4 0.7 -10
Jan 16.1
Feb 18.2 0.5 3.5 4.5 7.0

Mar 20.2 -17.4 6.7 7.6 15.6 -15


Apr 17.4 -1.3 7.5 6.7 16.0
May 14.8 4.2 7.9 8.5 14.2
June 11.1 2.9 8.6 8.4 22.1 -20
July 8.7 3.3 0.6 4.8 17.8 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10
Aug 8.6 6.9 4.7 7.6 19.5 
Sep 6.6 3.0 2.8 6.6 16.7 

Oct 1.8 1.7 2.7 3.5 14.7
Nov 5.3 2.5 4.5 5.3 14.4




7
On the demand side, retail sales continue to grow strongly in Brazil, Chile and Peru,
with Colombia catching up and Mexico still lagging

Latin America: Industrial production Latin America: Retail sales

Index level, January 2007 = 100, sa Index level, January 2007 = 100, sa
130 145
Brazil Chile Colombia Brazil Chile Colombia
Mexico Peru* Mexico Peru
140

120
135

130
110
OUTPUT GAPS CLOSE AS GROWTH REMAINS ABOVE POTENTIAL

125

100 120

115

90
110

105
80

100

70 95
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

*The manufacturing index from INEI serves as a proxy for Peru IP.
Source: J.P. Morgan

8
Agenda

Output gaps close as growth remains above potential 2

Inflation acceleration to trigger policy tightening in 2011 9

Risks to monitor: China growth, Europe contagion, and FX intervention 16

Central America & Caribbean: Consolidating the recovery 25

Country overview 32

9
Core inflation is joining the ride up across Latin America, as headline inflation has
risen to or above the mid-points of target

Latin America: Headline CPI (%oya) Latin America: Core CPI (%oya)

12 Brazil Chile Colombia 10


Brazil Chile Colombia
Mexico Peru
Mexico Peru Latin America
10
8
8
INFLATION ACCELERATION TO TRIGGER POLICY TIGHTENING IN 2011

6 6

4
4
2

0 2

-2
0
-4

-6 -2
Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10



10
The global commodity price rally is no longer being offset by currency appreciation,
so higher agricultural prices measured in local currency is pushing food prices up

Latin America: Agriculture & energy prices in LACI terms Latin America: Food inflation

Index level, Jan 2008 = 100 %oya


150 25
Brazil Chile Colombia
Agriculture Energy Mexico Peru
140
20
INFLATION ACCELERATION TO TRIGGER POLICY TIGHTENING IN 2011

130

120 15

110
10
100

90 5

80
0
70

60 -5
Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 Jan-08 Jun-08 Nov-08 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10



11
Although inflation targeters are expected to meet targets in 2011, inflation will stay
close to the upper bound of target ranges in most countries, with risks to the upside

 

2010 2011
Dec (%m/m) %Dec/Dec 4Q 1Q 2Q 3Q 4Q %Dec/Dec Inflation Target (%)
Argentina1 0.84 10.5 10.5 10.5 11.0 11.5 12.0 12.0 …
Brazil 0.63 5.9 5.6 5.8 5.9 6.4 5.6 5.4 4.5 ( 2)
Chile 0.12 3.0 3.2 3.4 4.0 4.9 5.5 5.5 3.0 ( 1)
Colombia 0.65 3.2 2.7 3.4 3.1 3.4 3.6 3.2 3.0 (+1)
0.51
INFLATION ACCELERATION TO TRIGGER POLICY TIGHTENING IN 2011

Ecuador 3.1 3.3 3.0 3.5 3.6 3.8 3.7 …


Mexico 0.5 4.4 4.2 3.6 3.6 3.7 3.7 3.7 3.0 ( 1)
Peru 0.18 2.1 2.1 2.4 2.5 2.0 2.4 2.5 2.0 ( 1)
Venezuela 1.67 27.5 27.3 30.4 29.0 30.6 33.8 35.0 …
Latin America 0.65 6.9 6.7 6.9 6.9 7.3 7.3 7.3
Inflation targeters2 0.54 4.9 4.6 4.6 4.6 5.0 4.7 4.5
1. Forecast is for official inflation measure.
2. Inflation targeters include Brazil, Chile, Colombia, Mexico and Peru


12
Tightening in Latin America of 125bp during 2011 will be highest among EM regions,
but cumulative hikes in 2010-2011 will only reverse 50% of cuts since Lehman



   


        
         
         
         
         
         
INFLATION ACCELERATION TO TRIGGER POLICY TIGHTENING IN 2011

         


         
         
         

         
         
         


13
Latin America is reversing the fiscal stimulus adopted in response to the crisis only
gradually, so the task of containing inflation will rest mostly on monetary policy









INFLATION ACCELERATION TO TRIGGER POLICY TIGHTENING IN 2011






           



  


   
   
   
   
   
   
   
   
   



14
Although fiscal policy will not be tightened aggressively in Latin America during 2011,
external borrowing needs will be lower than in 2010; net issuance will be negative



    

      


      
      
INFLATION ACCELERATION TO TRIGGER POLICY TIGHTENING IN 2011

      


      
      
      
      
      




15
Agenda

Output gaps close as growth remains above potential 2

Inflation acceleration to trigger policy tightening in 2011 9

Risks to monitor: China growth, Europe contagion, and FX intervention 16

Central America & Caribbean: Consolidating the recovery 25

Country overview 32

16
Risk to monitor #1: China growth: Latin America’s terms of trade and exports are
heavily driven by commodity prices, which in turn are driven by China’s growth cycle

Latin America: Export growth and commodity prices China growth cycle closely related to commodity demand

%oya %oya, 3mma %oya


CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION

60 25 60
China IP
Export growth Commodity prices J.P. Morgan commodity price index (rhs)
50

40
40 20

30
20

20 15

10 0

0 10

-20
-10

-20 5
-40

-30

-40 0 -60
1999 2000 2002 2004 2006 2008 2010 1994 1996 1998 2000 2002 2004 2006 2008 2010
RISKS TO MONITOR:

Source: J.P. Morgan Source: CEIC and J.P. Morgan estimates

17
Indeed, China is among the top destinations for exports from Brazil, Chile and Peru,
with trade links between China and other Latin American countries also growing fast




     


CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION

     


     
     
     
     
     
     
     
     





2005 2009
23.1

15.8
13.2
10.9 11.4

7.9 7.5
7.1
RISKS TO MONITOR:

5.8
2.9
2.2
0.9 0.5 1.0 1.1
0.1

Ecuador Mexico Colombia Argentina Venezuela Brazil Peru Chile

 18
Resilient terms of trade are particularly important for Latin America because export
volume growth is relatively low and current account deficits will widen further in 2011

Latin America export volume behind other EM regions Latin America (ex Mex): current account is back in deficit

2000=100; export volume % of GDP


CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION

300 2
Latin America
Emerging Asia
1
Central and Eastern Europe
250
0

-1
200

-2

150
-3

-4
100

-5

50 -6
2000 2003 2006 2009 1998 2000 2002 2004 2006 2008 2010 2012
RISKS TO MONITOR:

Source: J.P. Morgan Source: J.P. Morgan

19
The good news is that FDI will continue to finance current account deficits in 2011,
with the notable exception of Brazil where reliance on portfolio flows is increasing



CA balance FDI
CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION

(US$ billion) (US$ billion)


2010 2011 2012 2010 2011 2012
Latin America -51.1 -88.3 -126.2 80.5 99.0 105.0
Argentina 3.1 0.1 -8.9 3.0 2.0 4.0
Brazil -48.9 -69.1 -91.2 32.0 40.0 45.0
Chile -2.1 -9.2 -15.7 11.0 15.0 15.0
Colombia -5.7 -7.5 -8.6 9.0 11.0 11.0
Ecuador -0.4 0.6 1.3 0.5 0.5 0.5
Mexico -10.1 -18.0 -23.3 20.0 23.0 18.0
Peru -2.1 -4.9 -6.5 7.0 6.0 7.5
Venezuela1 15.2 19.6 26.6 -2.0 1.5 4.0
 

RISKS TO MONITOR:

20
Risk to monitor #2: Contagion from Europe: Latin America’s trade links with peripheral
Europe are highest with Spain but small overall; Spanish FDI is no longer as dominant

Latin America: exports to the EU and Spain Latin America trade balance with Spain

        


CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION


  
        

        
        
   
  
     
  

     
  
        
 


Stock of Spanish FDI in Latin America (% of total stock) Spanish FDI flows to Latin America (% of total flows)

   


160 25 30 70
Level Share (rhs) Level Share (rhs)
140 60
25
20
120
50
20
100 15
40
80 15
10 30
60
10
20
RISKS TO MONITOR:

40
5
5 10
20
0 0 0 0
1993 1996 1999 2002 2005 2008 1992 1995 1998 2001 2004

21
Large claims of Spanish banks in Latin America do not mean big outflow risks if bank
conditions in Europe deteriorate; Latin bank loans are mostly funded by local deposits

Claims of foreign banks in Latin America Latin America: credit profile (% of GDP)

   


CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION


        

           
           
           
           

           

           

           

           
 
 
Source: J.P. Morgan
Source: J.P. Morgan
RISKS TO MONITOR:

22
Risk to monitor #3: FX intervention: Growth, commodity prices and rate differentials
still support Latin FX and put pressure on policymakers to contain more appreciation

REER: Current versus 30-year average (except CEE3 12-year average and Peru since Jan 91)

34.0 33.6 31.7


CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION

24.2
21.0
17.8
15.2 14.0
13.3 13.2
10.2
7.0
4.3 3.5 3.2 3.1
1.6

-1.2 -3.1
-3.9
-5.9
-9.1 -9.8
-12.8

-21.4
-24.9

AUD BRL NOK NZD IDR CZK CHF INR COP ZAR CLP THB PLN HUF TRY PEN EUR JPY MXN PHP CAD MYR SEK GBP TWD KRW

Source: Bloomberg, J.P. Morgan

Latin America FX forecasts

End of Period 1Q11 2Q11 3Q11 4Q11


USD/ARS 4.10 4.10 4.15 4.35
USD/BRL 1.72 1.75 1.77 1.80
USD/CLP 480 470 455 455
USD/COP 1,850 1,850 1,850 1,850
RISKS TO MONITOR:

USD/MXN 12.50 12.25 12.25 12.25


USD/PEN 2.82 2.82 2.79 2.75
USD/VEF 4.30 4.30 4.30 4.30

Source: J.P. Morgan

23
Policymakers are trying to contain FX appreciation through aggressive intervention;
after Chile’s recent measures, the next country of market focus is Mexico

State of current FX regime, capital controls, and possible future intervention measures

Reserve Accumulation
CHINA GROWTH, EUROPE CONTAGION, AND FX INTERVENTION

2010* 2010 % Change


FX Regime Recent Measures Possible Future Measures (US$ billion) in Reserves
Argentina Non Convertible and capital outflow None None 3.2 7%
controls remain in place with a minimum
holding period of 1year and US$2mm
outflow per month
Brazil Non Convertible. Tax of 6% on foreign Increase IOF Tax on fixed Risks remain high for further 50 21%
fixed-income investment and 2% on income investment to 4% on interventions and possible
equity investment. Increase margin for Oct 4th, to 6% on Oct 18, new tax measures
derivative transactions increased reserve
requirements to 60% on bank
short USD position on Jan 6
and resumed reverse swap
intervention on January 13
Chile Non Convertible. No capital controls US$12 billion reserve None 2.5 10%
accumulation program for 2011
announced Jan 3, US$50
million per day intervention.
Colombia Non Convertible. 34% tax on income and USD purchases of $20mm day Risks remain high for further 3.0 12%
capital gains and 6% WHT on coupon and complementary actions interventions both in spot fx
payments for bonds with maturities up to (such as postponing the USD and potentially increases in
5 years and 4% for longer bonds. inflows from the official sector) Reserve Requirements for
foreign investors.
Mexico Free floating and deliverable. No FX None Increase in the size of 22.8 25%
controls. Banxico sells $600mm of USD/MXN put option
USDMXN puts per month. auctions per month or
outright spot USD purchases
possible if MXN rallies below
RISKS TO MONITOR:

11.9
Peru Non Convertible. Reserve Requirements USD purchases in the spot FX intervention should 11 33%
on foreign deposits (120%), 30% tax on market, increase in reserve remain high. Although tax
interest paid to non-residents. Limits on requirements on inflows from measures are unlikely, this
pension fund short USD positions abroad and sells PEN-linked possibility is still in the cards
USD CDs


24
Agenda

Output gaps close as growth remains above potential 2

Inflation acceleration to trigger policy tightening in 2011 9

Risks to monitor: China growth, Europe contagion, and FX intervention 16

Central America & Caribbean: Consolidating the recovery 25

Country overview 32

25
Growth in the Central America and Caribbean (CAC) region fared better than the
Latin American average during the 2009 recession…



  





CENTRAL AMERICA & CARIBBEAN: CONSOLIDATING THE RECOVERY

 
  
 
 

   

    
 
  











        




26
… But the CAC region has underperformed during the recovery phase in 2010 and
will likely perform in line with the Latin American average in 2011



   


    
    
    
    
    
CENTRAL AMERICA & CARIBBEAN: CONSOLIDATING THE RECOVERY

    


    
    
    
    
    


27
Regional inflation should remain broadly stable in the Caribbean and increase
moderately in Central America, but surging global food prices suggests upside risks






 



CENTRAL AMERICA & CARIBBEAN: CONSOLIDATING THE RECOVERY



  



     

 
  




        




28
Fiscal deficits in the CAC region should narrow in 2011 as countercyclical policies
are phased out and growth accelerates







 

CENTRAL AMERICA & CARIBBEAN: CONSOLIDATING THE RECOVERY


 

  

 
 
 
 
 

 
 
 

 


  

        




29
External public debt ratios will remain stable in 2011 as higher growth offsets
increased borrowing



  

  
 


 


CENTRAL AMERICA & CARIBBEAN: CONSOLIDATING THE RECOVERY


 
 
  
 
 
 







 
        




30
Increased external borrowing and FDI inflows should cover the CAC region’s
current account deficits, which will widen in 2011



  


 
 


 
CENTRAL AMERICA & CARIBBEAN: CONSOLIDATING THE RECOVERY

 

 
 

  


 

 
  
 
 

 


 
        





31
Agenda

Output gaps close as growth remains above potential 2

Inflation acceleration to trigger policy tightening in 2011 9

Risks to monitor: China growth, Europe contagion, and FX intervention 16

Central America & Caribbean: Consolidating the recovery 25

Country overview 32

32
Brazil: Full 2010 GDP growth revised up to 7.7% (from 7.5%)

 After suffering its sharpest recession in recent history,


 
Brazil’s growth began a remarkable rebound, and the
     
economy has been expanding at a pace much faster
     
than potential since 2Q09. Currently, we believe there
     
is little, if any, economic slack remaining in the
     
economy.      
     
 The economy slowed in 2Q10 and 3Q10, despite      
strong domestic demand, on the back of an inventory     
adjustment process and, mainly, external drag.     
However, 4Q indicators point to robust economic
activity at the end of last year, meaning full 2010 GDP
growth should approach 7.7% - higher than our last
forecast of 7.5%. 


 The stronger than expected 4Q10 activity performance 
along with support from the inventory cycle and a 
favorable global growth outlook put some upside risks

to our 4.5% GDP forecast for 2011 growth. At this point
we still think that the drag from net exports and some 

fiscal and monetary tightening will prevent higher GDP 



growth. 

 Therefore, while we are still factoring in some fiscal 


       
COUNTRY OVERVIEW

tightening in our forecasts for 2011 we reckon that this


is up in the air, and if this tightening fails to materialize
we should see a combination of stronger
growth/inflation and more monetary tightening than
currently envisioned (175bp by year-end).
33
Brazil: Central Bank to start a new tightening cycle

 Brazil’s Central Bank has begun the tightening cycle with 
liquidity and credit measures, following with an adjustment 
in the policy interest rate. The reserve requirement ratios        
on demand and time deposits have been increased, and
       
the capital requirements on household loans with
maturities above two years have also been lifted. It is hard        
to evaluate exactly the final impact of the measures, but        
they should contribute to the impact of the “traditional”        
tightening cycle via reference rate increase.
       
 After remaining on hold for six months, the COPOM        
resumed its tightening cycle this week with a 50bp hike in        
the Selic rate to 11.25%, as expected. The accompanying        
statement stressed that this hike was designed to        
contribute to the convergence of inflation to the targeted
       
trajectory, in tandem with the effects of macroprudential
measures (credit tightening measures). We understand
that the mention of the effects of macroprudential 
measures in the statement sends a signal that further 
credit tightening, rather than an acceleration in the pace of 
rate hikes, may be announced if inflation dynamics

continue to deteriorate..

 On the inflation front, the already high inflation level and

the combination of underlying pressures from above-trend
growth along with supply shocks derived from rising 
COUNTRY OVERVIEW

commodity prices raise some upsides risks to our already 


above-target inflation forecasts. While IPCA closed 2010
at 5.9%, we expect some accommodation to take place 
during 2011, taking the IPCA back to the 5.4% level. 
    
However, mounting evidences of still strong domestic
demand makes Brazil CPI too vulnerable to any new spike
34
in international prices.
Brazil: Debt dynamics not an issue, but fiscal trends are concerning

 With the sovereign now long USD in net terms, lower



real interest rates, and robust growth, there are no
solvency risks on the radar.
  

 Public debt has increased both in net terms (due to

BRL strengthening) and in gross terms (due to the
sterilization of USD purchases and debt issuance to 
capitalize BNDES). Although net debt at 40% of GDP 

does not raise solvency concerns, gross debt close to

a 60% level is very high by international standards,
creating downward rigidity in debt services. 

 
 The upsurge in tax collection with above-trend growth
        
has been offset by the strong pace of fiscal
expenditures. Even considering the strong
performance of the economy in the recent months, 
expenditures have still been growing firmly, indicating
that the 3.1% target for the primary surplus will be  

reached in 2010 only with the accounting of one-off 


  
revenues and subtracting up to 0.9% of GDP of

expenditures related to infrastructure projects – which 
is allowed by the budget. 


 The public sector primary surplus has been running at
COUNTRY OVERVIEW

2.5%of GDP in a 12-month sum since the Petrobras  


oil rights revenues have been accounted in the public        
sector balance.

35
Brazil: BRL should be quite sensitive to portfolio flows and risk assets ebbs and flows

 The large “market” BoP surplus (which excludes 


official FX transactions) registered in previous years
     
rested on either a CA surplus, or a modest deficit —
neither of which will be repeated in coming years (at      
     
least not until a BRL correction takes place). Indeed,      
even assuming relatively optimistic views on terms of
     
trade (flat at high levels) and FDI and portfolio inflows      
(about US$80 billion p.a.), and a cautiously upbeat      

assumption for corporate external debt issuance      
     
(150% of amortizations), the final result for net FX      
inflows for this year will depend critically on short-term      
capital inflows and the pace of Brazilian investment

abroad. 

 We think that strong capital inflows in the pipeline 
should keep USD/BRL toward 1.70, but FX
intervention (amid existing concerns about BRL 

overvaluation) should prevent significant appreciation 
beyond that level. That said, we do not see the 
government intervening in a way to push the spot to  
levels close to or above 1.90.
 
 The J.P. Morgan commodities group sees most
commodity prices roughly flat or slightly higher in 
COUNTRY OVERVIEW

2011, and the BRL should continue to move in line 



with the trend for commodity currencies, powered by 
its high-yield characteristics. 
       

36
Brazil: A popular president elects his successor; eyes on the cabinet formation

 The government supported candidate, Dilma Rousseff, got


56% of the vote versus 44% for Jose Serra. The focus now 
is on the transition and cabinet formation. The new
government's intention is to create a positive environment
within opinion makers after Lula's aggressive fiscal
expansion of late, but the signals are not so consistent at
this point.

 The President-elect Dilma Rousseff officially announced


her economic team, in line with what the media had been
reporting. Current Finance Minister Guido Mantega will
remain at that post, while Alexandre Tombini, who is
currently the BCB director for Norms and Organization, will
head the BCB, replacing Henrique Meirelles. In a short
press note, Rousseff announced these appointments and
reiterated that the new economic team would ensure the
continuity of macroeconomic policies based on the
inflation-targeting regime, a floating exchange rate, and
fiscal responsibility.

 The reappointed Finance Minister highlighted that the new


government will continue to target higher growth, but is
also focused on controlling inflation. He noted that the
government will make an effort to reduce current
expenditures and will provide fewer resources to BNDES
in 2011 (compared to 2010). We continue to believe that
COUNTRY OVERVIEW

implementation risks on the fiscal side remain very high,


given signs that the minimum wage will be raised to a level
higher than budgeted, and the recent reduction in the
primary surplus target.

37
Brazil: Economic projections


 After a sharp and short recession, Brazil’s GDP will
grow at an above-trend pace of 7.5% in 2010. This 
remarkable recovery is already resulting in inflationary     
pressures, and we reckon that the initial monetary
     
tightening implemented in 2010 will be extended this 
    

year. 

    

     
 The reduction in sovereign vulnerabilities opened room
     
for aggressive fiscal and monetary policy actions that      
soothed last year’s liquidity squeeze, and provided an      
important boost to final demand.      
     
 In response to local growth and the global recovery,
     
inflation accelerated in 2010, triggering tightening      
policies, mainly on the monetary front.      
     
 In the long term, a more stable macro scenario and
     
lower rates should boost private sector investments      
(with the development of capital markets) and 

    
household consumption (with the expansion of credit to      

consumers)      

     
 The lack of structural reforms reducing fiscal constraints 
and enhancing private sector competitiveness remains 
COUNTRY OVERVIEW

the main obstacle to faster growth. 




38
Mexico: A more promising scenario in the US has prompted us to rise our 2011
GDP growth forecast to 4.5%

Mexico and US manufacturing production


 The recent approval of the ‘Bush era’ tax cuts
%oya
prompted our US economist to revise his GDP growth 20
Mexico US
forecast for 2011 to 3.3% 15
10
 The adjustments included a significant revision to the 5
US manufacturing production forecast to 4.6%, from 0
-5
3.3% previously
-10
 Manufacturing is Mexico’s major economic link with -15
-20
the US
Jan-05 May-06 Oct-07 Feb-09 Jul-10
 This adds to stronger domestic demand, a Source: INEGI and US Federal Reserve
reinvigorated auto sector, a positive outlook for
banking credit, and the imminent beginning of
Mexico’s economic activity forecasts
construction on a number of infrastructure projects
%oya 2010 1Q11 2Q11 3Q11 4Q11 2011
 As a result, we now believe Mexico’s GDP will expand Aggregate D/S 9.4 6.5 5.8 6.0 5.4 5.9
4.5% in 2011, instead of 3.5% as projected previously GDP AS 5.4 4.7 4.5 4.4 4.2 4.5
Agriculture 4.8 6.2 3.3 3.3 4.9 4.4
 Furthermore, we expect the Mexican economy to grow Industrial 5.6 4.3 4.0 4.1 4.7 4.3
3.5% in 2012 Manufacturing 9.0 3.7 3.7 3.5 5.1 4.0
Other 1.3 5.1 4.4 4.8 4.3 4.6
Services 5.1 4.9 4.9 4.8 4.1 4.7
Imports 23.4 12.2 9.5 10.3 8.5 10.1
COUNTRY OVERVIEW

GDP AD 5.4 4.7 4.5 4.5 4.2 4.5


Consumption 5.3 4.8 4.7 4.4 4.0 4.5
GFI 2.7 2.2 4.8 5.3 5.1 4.4
Exports 20.5 8.7 8.8 8.4 8.6 8.6
Source: J.P. Morgan.

39
Mexico: A reinvigorated auto industry will continue to be the main driver of
manufacturing activity

 Auto production has averaged a strong year-to-date


Auto and manufacturing production, and auto exports
expansion of 61%oya in 2010, with exports being the
primary driver, averaging a rebound of 66%oya %oya, both axis
160 30
 We believe that the auto industry has been, and will Auto exports
120 20
continue to be, key to Mexico’s manufacturing activity Auto production
80 Manufacturing output (RHS) 10
 Several automakers across the world have reallocated
40
part of their production to Mexico to benefit from a 0
0
weaker peso, skilled Mexican labor, still-high transport -10
-40
costs, and the country’s strategic geographic location
-80 -20
 Moreover, this has also permeated into other Jan-07 Aug-07 Apr-08 Dec-08 Jul-09 Mar-10 Nov-10
manufacturing industries, such as appliances and Source: INEGI and AMIA
aeronautics

Recent investments in Mexico's auto sector


Auto sales

%oya Announced date US$, mn State


30 Total -- 4,950 --
20 Chrysler 1Q09 300 Coahuila
10 GM 3Q09 300 San Luis Potosi
0 Ford 4Q09 600 Chihuahua
Ford 4Q09 1,000 Cuatitlán
-10
Chrysler 1Q10 550 Toluca
COUNTRY OVERVIEW

-20
Volkswagen 1Q10 1,000 Puebla
-30
Mazda 4Q10 500 --
-40 Volkswagen 4Q10 550 Guanajuato
Jan-05 Mar-06 May-07 Jul-08 Sep-09 Nov-10
Toyota 4Q10 150 Coahuila
Source: AMIA Source: J.P.Morgan
40
Mexico: The credit system could be a key driver for domestic consumption

 Total commercial bank credit to the private sector Capitalization indices of major commercial banks
represents less than 15% of GDP Index

 Mexican banks are well capitalized 25 22.5


20.4
20 17.4 17.3 16.4 16.4
 Following a credit boom in 2003-2006, non-performing 15.2 15.1 15.1 14.7
15
loans increased significantly, forcing banks to rethink
10
their credit extension policies
5 Regulatory m inim um 8%
 Nevertheless, commercial banks have now 'cleaned 0

Banamex

Inbursa

Scotiabank

IXE

Santander

Banorte

Bancomer

Azteca

Afirme
up' their credit balances and employment conditions

HSBC

BBVA
have improved significantly over the past 12 months
 We believe that it is highly likely that all these factors
Source: National banking Commission (CNVB), Oct. 2010
will probably lead to an ascending trend in the
country's domestic credit cycle

Commercial bank credit Banking credit to the private sector

%oya in real term s % of total credit %oya


80 Credit card Delinquency rate (RHS) 20 40
60 30
40 15 20
20 10 Total
10 Consumer credit
COUNTRY OVERVIEW

0 0
-20 -10 Housing credit
5
-20 Credit to firms
-40
-60 0 -30
Jan-00 Jun-10 Nov-10 Apr-10 Sep-10 Feb-10 Jul-10 Dec-10 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Nov-10

Source: J.P.Morgan with data from Banxico Source: J.P.Morgan with data from Banxico

41
Mexico: We highlight three risks to our optimistic growth outlook

 In our view, there are three important risks to our Elections in 2011
positive appraisal of Mexico’s growth in 2011: Governor Local Congress Date

1. A potential escalation of drug-related violence Guerrero X -- 30-Jan

2. More potentially negative issues emerging from the Baja California Sur X X 6-Feb

Euro area periphery countries Coahuila X X 3-Jul

3. The possibility of less vigorous growth in the US Estado de México X -- 3-Jul

 In our view, the government has been consistently Nayarit X X 3-Jul

cracking down on the major drug cartels, an Michoacán X X 13-Nov


important step in the government’s efforts to combat
Source: IFE (Federal Electoral institute)
organized crime. However, there are still risks,
particularly with the gubernatorial elections that will
 Unfortunately, the large GDP growth rates that the
take place this year in six states
country has observed in 2010 and will probably
 On the other hand, we have downplayed the direct observe in 2011 appear to be providing a ‘false sense
effects of a major sovereign crisis in the Euro area, of security’ to government officials, particularly
we believe that the escalation of drug-related legislators, who have now downplayed the need for
violence is indeed curbing Mexico’s growth potential reforms in Mexico
 There is no doubt that Mexico needs several  Furthermore, with gubernatorial elections due in six
structural reforms, particularly meaningful fiscal and states this year, particularly in the highly-populated
labor-market reforms as well as new guidelines to and politically-sensitive State of Mexico (Estado de
COUNTRY OVERVIEW

empower antitrust officials to dilute monopolies and México), we believe it is going to be difficult to secure
foster competitiveness. We strongly believe that the congressional approval for these key reforms that the
lack of these structural reforms is restraining country truly needs
domestic demand, and Mexico’s potential GDP

42
Mexico: The US Fed’s long pause, moderate inflation, and well-anchored inflation
expectations will keep Banxico on hold until 2Q12

 All the indications are that global grain prices will remain Headline inflation
high throughout 2011. This is an important risk to our %oya
Banxico's inlfation target
inflation call for end-2011 of 3.7%oya 7.0
Forecasts
6.0
 Nevertheless, well-anchored medium-term inflation
5.0
expectations (around 3.6%), and moderate wage increases
4.0
clearly support our 'low-for-long' monetary policy call, in
3.0
which we anticipate that the first hike will not take place
2.0
until 2Q12 (Consensus: 1Q12)
1.0
Jan-07 Jul-08 Jan-10 Jul-11
 On the inflation front, we have observed an important
Source: J.P.Morgan with data from Banxico
structural change coming from two sources: ‘the Wal-Mart
effect’, and the ‘Viva Aerobus effect’
Inflation expectations and wages in Mexico

 Wal-Mart has been consistently opening stores in Mexico in %oya


7.0 1-year ahead inflation expectations*
the past few years. We believe this has been an important
6.5 Minimum wage
reason why we have observed a higher degree of 6.0
Wage negotiations
competition among retailers in Mexico 5.5
5.0
 In the past few months we have observed that even though 4.5
4.0
Mexicana, once a leading airline in Mexico, shut its doors
3.5
about six months ago, air fares have not only not increased, 3.0
COUNTRY OVERVIEW

but have actually declined. We attribute this 'new' dynamic 2002 2003 2004 2006 2007 2008 2010 2011

to Viva Aerobus, a somewhat newly created 'low-cost' Source: Banxico, Ministry of Labor, CONASAMI, and J.P.Morgan.
*The series was moved 1-year forward
airline that, in our view, has taken Mexicana’s bankruptcy
as a strategic opportunity to gain market share

43
Mexico: CPI calculation improvements could partially isolate inflation from
commodity price swings

 Banxico has announced important modifications to the CPI goods and services components
methodology for calculating the CPI Contribution to 12-month headline inflation
7.0
 We highlight that the central bank will publish the new
6.0
component weights for the new CPI on January 24
5.0

 These methodological modifications respond mainly to 4.0

changes in consumption patterns fostered by technological 3.0

and structural changes 2.0

1.0
 The new way to calculate housing prices could reduce the Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
influence of commodity price swings in the new CPI Source: J.P.Morgan with data from Banxico

 In this new framework, Banxico will calculate the use of Most important modifications to the CPI calculation
housing price inflation using rental prices, instead of input 1 Change of CPI base year to 2H-Dec 2010, from 2H-Jun 2002
prices (e.g. cement, copper, iron, etc.) 2 Use of INEGI’s income-expenditure survey (ENIGH) of 2008,
instead of the one conducted back in year 2000. This could have
 On the other hand, we note that rental prices have a very important changes in the CPI weights as the income shares
assigned to different goods and services have changed in time
low variance compared to commodity prices. In Mexico, for 3 Some ‘specific items’ will be grouped as ‘generic items’ in order to
reduce any potential bias emerging from regional differences
example, rental prices are usually modified once a year by 4 Some ‘generic items’ will be ungrouped with ‘specific items’
landlords. As a result, this change could help inflation to be
5 Some items will be moved to other groups
less responsive to the recent rise in global commodity
6 Some groups will be renamed to become more transparent,
prices, and provides support to our current 3.7% inflation
COUNTRY OVERVIEW

modern, and to continue incorporating best practices worldwide


7 The ‘services’ component will have a larger weight in the new
forecast for year-end 2011
CPI, relative to the current methodology
Source: Banxico
 INEGI will take over the calculation of consumer price
inflation in July 2011, instead of Banxico

44
Mexico: Still positive on the peso, we expect USD/MXN at 12.25 by year-end.
However, we believe it could trade at lower levels in the short-term
Major emerging currencies index
 Market participants should continue to look to countries with
relatively positive growth potential and no fiscal problems Index Jan (2000 = 100) Mexican peso South Korean won
140 Peruvian sol Brazilian real
Colombian peso Southafrican rand
 Healthy public finances, low rates for an extended period of 130

time worldwide, and the inclusion of Mbonos into the Citigroup’s 120
110
World Government Bond Index (WGBI), suggest that Mexico
100
should continue to benefit from foreign flows in 2011
90
80
 In this context we expect USD/MXN at 12.25 by year, but we
70
believe it will trade stronger in the short-term
60
50
 In our view, while the uncertainty on the US economy
40
‘punished’ the peso since the crisis started back in 2008, a Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
more constructive growth scenario for the US with Mexico's
Source: Bloomberg and J.P.Morgan
prudent fiscal stance and healthy external accounts may
support the peso’s strength MXN net long positioning vis-à-vis the US dollar1

 Going forward, the fact that other EM currencies have US$, billion
6
strengthened more than the peso vis-à-vis the US dollar, as
5
well as the US Fed’s QE2 and the market-friendlier FX stance
4
of the Mexican authorities, could continue to allow the Mexican 3
peso to gain ground 2
1
 In this context, we believe USD/MXN could reach 11.50 by end- 0
2012 -1
COUNTRY OVERVIEW

-2
 However, we acknowledge that the main risk to our call would -3
be a significant escalation in drug-related violence, as the Jan-00 Feb-02 Mar-04 Apr-06 May-08 Jun-10
USD/MXN market has proved very sensitive 1. Calculated using CME non-commercial positions
Source: J.P. Morgan with data from Bloomberg

45
Mexico: Economic projections

 We believe there are five reasons to be positive on 


Mexico’s growth in 2011: 
    
1.The recent approval of the ‘Bush era’ tax cuts
      
2.Stronger domestic demand      
     
     
3.A reinvigorated auto sector
      
      
4.A positive outlook for banking credit; and       
      
5.Major infrastructure projects to begin construction
     
 As a result, we recently revised our GDP forecast to 4.5%      
     
in 2011, instead of 3.5% that we had projected before      
      
 We identify three risks to our optimistic growth call:      
     
6.Potential escalation of drug-related violence      
      
      
7.Further negative news from European periphery countries
      

8.The Possibility of less vigorous growth in the US  


   
  
 The US Fed’s long pause, moderate inflation, and well-
COUNTRY OVERVIEW


anchored inflation expectations will keep Banxico on hold

46
Argentina: After having peaked, growth remains strong and inflation is accelerating
again but the President’s positive image is recovered

 Energy rationing and labor disputes genuinely hurt industrial



performance in 3Q, while import growth continues to advance.
But the economy is expected to have rebounded in 4Q and
averaged 8.5% real GDP in 2010.   

 Neighboring economies like Brazil are booming, low global 
rates have helped to mitigate capital flight (even as domestic 
policy volatility has persisted), terms of trade are favorable, the 
agricultural sector is enjoying a strong rebound in the harvest 
industrial inventories have come down sharply (as demand 
recovers), and import barriers have increased (allowing local 
producers a temporary advantage) 
     
 Growth will decelerate in 2011 to 5.5% as dry weather is
affecting the harvest yield . 

 The post-2009 legislative election environment has


consolidated a muddle-through scenario on macro policy and
intensifying of regulation on specific business sectors in micro- 
policy. The opposition has gained a majority in the legislature
but remains fragmented and coordination is thus difficult.

 The 1Q inflation acceleration owed to food prices and


particularly beef but inflation moderated in 2Q. After averaging
1.5% m/m in 3Q(measured by private sources) , inflation is
running at 1.8% m/m average October-November.

 Cristina Kirchners image, which benefited strongly from the


recovery (while not suffering from high inflation) has been
COUNTRY OVERVIEW

boosted to 56% from 36% following the death of her husband


and ex-president Nestor Kirchner. At the end of 2009 her
positive image was 21%. The evolution of this trend will be
critical in defining the peronist party candidate for the 2011 
presidential elections (primaries: August, election: October).

47
Argentina: Trade surplus is still providing a solid cushion for the balance of payments;
ARS is the nominal anchor ahead of elections

 Private sector capital flight halted in 4Q. While a recovery in


capital flows seemed likely for 2010, political conflicts dampened 
the outlook and capital outflows resumed in early 2010. But by %oya Private , 3mma (ar)
mid year the outflows had again receded. This not only facilitates 
reserve accumulation but is also a plus for the economy.   Private, oya
 
 The 1Q inflation acceleration owed to food prices and particularly

beef but inflation moderated in 2Q. After averaging 1.5% m/m in
3Q(measured by private sources) , inflation is running at 1.8% 
m/m average October-November. The peso has been 
appreciating in real terms due to high inflation and is a concern  Official, oya
for the future. 

 In 2010, strong external demand and a larger soy harvest    


boosted exports while imports (partly curbed by administrative
restrictions) boomed The trade surplus is $13.8 billion, down only

moderately from $16. 2 billion at year end 2009. In 2011 export
volumes will be hurt by smaller harvest but increases in
international prices of agricultural commodities will compensate, 
allowing Argentina to rely on a high trade surplus again.
12-mo sum, US$ billion
 Reserves have been growing at a steady, yet moderate, pace  Commodity price boom
despite use of CB reserves by the Treasury to pay down debt.  
The central bank has been buying dollars in the spot market and 

futures market.

 FX policy is geared to tightly managing spot ARS as an anchor
 12-mo. sum

for inflation expectations and to maintain central bank reserves  3mma, saar Farmers’ strike
high given the reliance of fiscal authorities on BCRA as a lender 
COUNTRY OVERVIEW

of last resort (LOLR). 

 Authorities are unlikely to allow a sharp adjustment in ARS      


ahead of October 2011 presidential elections. ARS is likely to
end 2011 at 4.20 

48
Argentina: Fiscal accounts get cyclical uplift; Treasury relies on BCRA; liability
management may lag due to politics

 The primary fiscal surplus will narrow to 1.1% in 2010 after


reaching 1.5% in 2009. Fiscal revenues are rising strongly but 
spending has remained elevated until recent months. The
primary surplus is running at 1.6%. %oya, 3mma

 High growth and higher inflation suggest upside risk to the
Primary spending

primary fiscal surplus forecast of 1.1% of GDP. But central bank

profits and Anses interest earnings exaggerate the reported
primary balance. 

 The one-off revenues that boosted the 2009 result make it
difficult to foresee an improvement in 2010 despite the rebound  Reported revenues
in growth. Note that while the primary surplus is currently above 
the year end forecast, the extraordinary 0.7% point improvement    
of the fiscal surplus in December 2009 will fall out of the 12-
month sum in December 2010. 

 The public sectors lack of voluntary market access remains a


liability—but at current yields Argentina could issue debt in
voluntary markets if it decided to. For now, the Treasury 
continues prefering to rely on BCRA reserves as lender of last
resort (LoLR) for financing needs. % of GDP

 Following the debt swap for untendered bonds Argentinas

Treasury was looking to reaccess markets with an international Reported
bond issue ($1 bn); to swap local short-term USD bonds for 
longer foreign law USD bonds for cashflow and NPV gains, swap

EUR paper for USD paper for NPV gains. However, political
events have led Argentina to (informally) postpone these  Adjusted
COUNTRY OVERVIEW

objectives. In contrast, Paris Club talks have been restarted and



April is the government’s target for striking a deal.
  



49
Argentina: Economic projections

 The economy has fully recovered to pre-global crisis levels. The slowing of
activity in 3Q was followed by a rebound in 4Q. 

 Inflation is running at a 24-25%oya pace 


    
 Activity is benefiting more than inflation is punishing the image of the
government. In public opinion polls the president’s image peaked in July to      
37% from 21% in late 2009 and was 36% in August. The death of ex-      
     
president Nestor Kirchner further raised the positive image of president
     
Cristina Kirchner to 56%.With the opposition still fragmented this trend will
     
be important to monitor ahead of the October 2011 elections.
     
     
 Private sector capital flight has moderated. A large trade surplus continues
     
to provide a cushion for the balance of payments. A lower harvest estimate
     
in 2011 will be compensated by higher commodity export prices.
     
 The loss of competitiveness is a problem for the future but for now the      
     
government is effectively using ARS as a nominal anchor for inflation
     
expectations. A gradual crawl remains BCRA’s primary FX strategy. ARS
     
likely at 4.20 since ahead of October 2011 elections the government will
     
prefer not to rock the boat.      
     
 Fiscal accounts are improving and the primary balance stands at 1.6% of
     
GDP. The primary fiscal balance will narrow to 1.1% in 2010 as one-off
     
support is reduced. The strength of the Treasury’s payment capacity is
found “below the line” given the support from BCRA as a lender of last 
resort. Argentina’s decision to not tap markets is dictated by the comfort 
that BCRA support provides the Treasury. In 2011 the government will use 
$7.5 billion reserves to pay down debt (after using $6.5 billion in 2010). As
long as the balance of payments allows BCRA to maintain or accumulate 
COUNTRY OVERVIEW

reserves the market will sympathize with this policy choice.

 Politics can delay the liability management objectives. However, Paris


Club talks have been restarted and the government hopes that a final
settlement could be reached by April.

50
Chile: The economy is growing strong and the administration has the benefit of the
doubt from the business community

 GDP growth should average 5.2% in 2010 and 6.0% in 2011. 
Yet it is the high double-digit domestic demand boom that is the
most eye-catching. Activity will accelerate sharply to an 8-9% %change
pace on an over-year-ago basis in 1Q due to base effects from 
the earthquake earlier this year. 
Real retail sales
 The backbone of the recovery is domestic: a substantial 
monetary and fiscal stimulus. The earthquake reconstruction 
effort will further boost domestic demand for non-tradable goods.

 Mood among businesses picked up visibly as president Pieras 
pro-growth agenda raises expectations. In fact, the positive mood  Activity
persisted despite the earthquake.

 Mood among consumers has been affected negatively by the        
earthquake but is now fully recovered, although some slippage
ocurred a the end of 2010. Tightening labor markets and benign 
inflation have helped support a recovery in household confidence
yet inflation could pick up more visibly ahead.

 Pieras original plans were to provide macroeconomic
incentives for investment (accelerated amortization) and level
reinvestment (shifting of income tax to distributed, rather than
 Consumer confidence Business confidence
accrued, profits) as well as microeconomic incentives for raising

efficiency in the public (reorganizing state companies) and

private sector (environmental and labor reforms). The

administration, however, does not have a majority in Congress. 
 Fiscal policy will make room for reconstruction spending but will
 Earthquake

COUNTRY OVERVIEW

shift to a tightening bias earlier than expected as the government



redefines the fiscal rule and targets narrowing the structural
deficit     



51
Chile: Inflation remains within the target band but in 2011, but in the aftermath of FX
intervention, inflation risks are rising and BCCh may not meet its target

 BCCh expects the output gap to close in 1H11 and continues to



reaffirm its tightening bias. Unemployment continues to decline at
a rapid pace and wage pressures, quite benign until mid-year, are
now starting to build. Moreover, global agricultural prices are likely
    
to lift domestic food prices visibly in coming quarters. We expect
     
inflation of 5.5%Dec/Dec (above target) in 2011 and
     
3.8%Dec/Dec (within the +/-1% tolerance range of the 3% target)
     
in 2012.
     
 For the time being inflation has remained benign. The peso’s      
appreciation has played a large part in anchoring inflation. As      
tradable goods were up only 0.5% while non-tradable goods were
up 5.6%.      
     
 CPI continued to climb in November to 2.5%oya compared to
Septembers reading of 2.0%oya. The acceleration in core CPI 
has been gradual and lagging that of the headline while relevant
inflation expectations remain well behaved. BCChs preferred 
measure of core CPI is at -0.5%oya. In the next months CPI %
August 21, 2008 = 100
should continue to print low readings.

 Due to CLP appreciation, excess demand pressures will partly

manifest themselves through stronger imports and a deterioration
of Chiles external balance rather than just a higher CPI inflation. 

 BCCh’s announcement of FX intervention in early January involves 


a $12 billion full-year reserve accumulation program (50% larger

than the announced intervention in 2008). The daily USD
purchases of $50 million can bee fine-tuned by BCCh according to 
COUNTRY OVERVIEW

developments.
      
 We expect that BCCh will continue tightening The forecast sees a
3.75% policy rate by 1Q11, 4.5% by 2Q11, 6.0% by 3Q11 and

6.5% by 4Q11.

52
Chile: Economic projections

 GDP growth should average 5.2% in 2010 (with downside risk 
given weak October) and 6.0% in 2011. Yet it is the high double-

digit domestic demand boom that is the most eye-catching. The
    
acceleration of activity can be partly attributed to the temporary      
boost from post-earthquake spending but business and      
household confidence is strong and notwithstanding a      
deceleration, demand should remain strong.      
     
 Fiscal policy will make room for reconstruction spending but will      
shift to a tightening bias earlier than expected as the government      
redefines the fiscal rule and targets narrowing the structural      
     
deficit
     
 Inflation has remained benign but in 2011 domestic and external      
     
factors risk pushing CPI to 5.5% (above the 3% target).
     
 BCCh’s intervention in the FX market and the “tactical” rate      
     
pause in the january policy meeting highlight the challenge that
     
multiple objectives could present for BCCh if inflation does
     
accelerate as forecasted. BCCh can calibrate FX intervention      
through adjustments to daily purchases even as the annual      
target is fixed at $12 billion reserve accumulation.

 Given the updated CPI inflation forecast, we expect that BCCh 
will continue tightening to 6.5% by end 2010 and the peso to 
appreciate to 455. This scenario prompted a revision to 2012
growth to 4.5%

COUNTRY OVERVIEW

53
Colombia: Mixed messages from activity readings, but growth should regain
traction in 2011
 GDP growth came in at an underwhelming 3.6%oya pace in 3Q10, 
with the drag coming largely from a -10.5%oya performance in
construction due to a fall in public works. 
 
 Supply-side data suggest that manufacturing remains subdued,
while domestic demand gains momentum. The gradual recovery in 
employment, credit expansion and improving consumer confidence 
have been supporting a strong expansion in retail sales. In the 
opposite direction, industrial production growth continues to fade 
(first chart).. Our assessment is that the increasing perception of 
“high” inventories along with the strong COP in 3Q and the start of 
4Q have hurt the manufacturing sector, despite relatively high

business confidence.
     
 The weak 3Q10 result prompted us to change the full-year 2010

growth forecast to 4.0% (from 4.3%). Public investment should not
improve much in 4Q, even though it will likely be less of a drag

compared to 3Q. At the same time we should continue to see the  
retail sector flourishing and IP underperforming.

 We maintain our 4.5% growth forecast for 2011. Recent floods
should drive higher public investments in 1Q11, while the inventory

cycle and some modest recovery of exports to Venezuela could
help boost the manufacturing sector in 1H11. Finally, we expect
private consumption to remain supported by a gradual 
improvement in the labor market and credit expansion
(underpinned by loose monetary policy). Therefore it remains 
reasonable to expect some reacceleration in activity next year.

 Employment continues to expand in the retail sector, but remains 


COUNTRY OVERVIEW

subdued in the manufacturing sector. Employment in the retail


     
sector has been showing a vigorous expansion, with real wages
improving considerably. However, employment in the 
manufacturing sector continues to shrink, at the same time that real
wages also lose momentum after the surge recorded in 1H10.

54
Colombia: BanRep on hold during 1Q11, but will likely hike rates in 2Q11

 Colombian domestic demand has been rebounding in recent   
quarters, while both inflation and inflation expectations had—until
December—been subdued. Despite end-year food price
pressure, core inflation remains contained and economic activity   
is showing some mixed signals (namely, lagging manufacturing
activity). This should lead BanRep to keep the policy rate at its

current (admittedly stimulative) level over the near term.

 Recent headline inflation numbers have been accelerating on the



back of higher food prices, while core figures remain benign.
This acceleration was a result of some pass-through from the
recent spike in international commodity prices, which has 
coincided with extreme weather conditions in Colombia (harsh        
rains and flooding) that have added pressure on fresh food

items. Inflation is poised to accelerate even further in the coming
quarters as food prices should reflect the pressure in external 
markets, while domestic demand is expected to remain on a
strong footing. 
 BanRep has been highlighting that its technical team projects  
“with a high degree of confidence” that inflation will remain inside
the target range in 2011. BanRep’s official forecast was looking
for 2011 inflation only slightly above 2.0%, but this seems overly 
optimistic, especially after the recent spike in local food inflation.

 Market expectations are for inflation to finish 2011 well above


3%, and the downward trend in these forecasts has reversed 
COUNTRY OVERVIEW

sharply in January following December’s upward surprise


(second chart).       

 We continue to see BanRep beginning to remove monetary


stimulus with an initial 25bp hike in April amid higher inflation and 
activity data. We see the policy rate finishing 2011 at 5.5%.

55
Colombia: Should get the Investment Grade stamp this year

 Reforms point to a better fiscal outlook, but Congress may still 
water down key projects. The Santos administration has
presented a full plate of inter-related fiscal reforms to Congress,

including constitutional reforms to the royalties system and to
elevate fiscal stability to a constitutional right (on par with health 
care); a fiscal rule proposal; and a so-called “mini-fiscal reform” 
to reduce tax exemptions and eliminate loopholes. The originally 
stated goal of the fiscal rule would be to reduce Colombia’s 
central government debt from 39.4% of GDP in 2010 to 28.4% in 
2015 via a very gradual move toward a primary surplus by the 
end of Santos’ term. 
 The reform of laws governing energy/mining sector royalties      
intends to better channel and manage the expected boom in the

coming years, including the creation of a centrally managed
counter-cyclical stabilization fund. The constitutional reforms
passed both houses of Congress in the 2H10 legislative session,

and now, as required under Colombian law, must be taken up
again in the 1H11 session. Royalties reform has good
momentum but could face further watering down, as local 
interests push back against centralized control of the windfall.
The constitutional reform on fiscal stability is more controversial 
and could face stepped up opposition. Overall, many crucial
details are set to be defined this year. 

 All three major rating agencies have Colombia’s rating one notch 
below Investment Grade, with a positive outlook. The approval      
and implementation of fiscal reforms may be a catalyst of rating 
COUNTRY OVERVIEW

agency action. But at this point even a less-than-ideal final


reform package could earn Colombia an Investment Grade 
rating, given the agencies’ overall positive assessment of
Colombia’s macroeconomic resilience and positive policy 
agenda.

56
Colombia: Government has been fighting COP gains, but oil boom helps keep
external accounts robust

 Since last September, BanRep has been buying US$20 million


 
per day in the FX spot market, a policy that has been extended
through March. The government also announced in November a 
series of measures intended to curb COP appreciation, including     
the postponement of monetization of external debt in 2010,      
eventual purchases of USD in the forward markets to meet      
external debt obligations, and the elimination of the exemption of      
a 33% withholding tax on the interest payments for external      
credit lines. If the COP/USD regains momentum, “tougher      
measures” cannot be ruled out—like the resumption of capital      
controls, last used in 2007.      
     
 Colombian President Santos, and Venezuelan President Chavez      
have agreed to restore diplomatic ties. The bilateral frictions      
intensified in the last years of the Uribe administration, causing      
severe strain on bilateral trade in particular. The bulk of the      
negative impact on Colombian exports was felt in 2009, but so      
far there has been no recovery. At this point this means that      
Venezuela is neither a drag on Colombian growth (on a      
     
sequential basis) nor supportive of it.
     
 The drop in Colombian exports has helped to tame inflation in      
Colombia by increasing the domestic supply of food. If exports to      
Venezuela regain traction, this could benefit Colombian industry 
at the same time that it should add some pressure to food 
inflation in Colombia. 

 Colombia’s external accounts have shown resilience despite the


Venezuela shock, as growth in “traditional exports”—mainly 
COUNTRY OVERVIEW

commodities—have more than compensated the Venezuela-


related fall in “non-traditional” exports. Not only have terms of
trade been supportive, but Colombia has been increasing its
production and its exports—particularly in the oil sector. Crude
oil production was up 16.9% in 2010, having reached 825kbd by
December.
57
Ecuador: Correa has dominated a three-year political cycle but is finally facing
some noisy political challenges

 President Correa won reelection under the new constitution in April


2009 in the first round vote. His four-year domination of Ecuadors 
political landscape appeared until recently to represent a historic break
 
from the deadlocks and instability of the previous decade
 
 Following his 2006 election, Correa managed to rewrite the constitution 

and marginalize the traditional political parties 

 The constitution tilted the balance of power toward the executive; the
 
concern is that Ecuador is following a familiar illiberal model that has
undermined checks and balances and left institutions highly politicized  

 Public investment and popular social initiatives have helped keep a 
floor under Correa’s approval ratings. Indeed, despite some erosion,  
no Ecuadorean president in recent memory has had popularity this 
resilient this far into his mandate
 
 Correas popularity has declined in 2010 given corruption scandals, 
tensions with specific social groups (teachers, indigenous,
environmentalists), and most importantly a sluggish economy. 
 The police mutiny of September 2010 (characterized by Correa as a
coup attempt) puts traditional Ecuadorean political turbulence back 
in the spotlight. The confrontation with rebel police units, who had  
rejected benefit cuts in the context of a larger civil service reform, was 
the first major institutional challenge of Ecuadors new constitution

 Correa survived the episode thanks to loyalists in the armed forces,
and his popularity even improved. But the presidents confrontational

style and relentless drive to take on what he perceives to be overly
COUNTRY OVERVIEW

influential interest groups means tension could flare up again



 In 2011 we cannot rule out Correa playing the card of muerte
cruzada or the constitutional right to dissolve the legislature and 
simultaneously call for new presidential and legislative elections
   



58
Ecuador: Current account is deteriorating, but dollarization supported by
reserves, China lending
 The political commitment to dollarization seems strong but depends on
oil-generated current account surpluses or foreign lending. Structural 
weaknesses in the balance of payments (ie an increasingly large non-oil

trade deficit) are exacerbated by loose fiscal policy.
  
 The 2011 budget reveals an aggressive fiscal stance. The budget’s large
  
outlays for public investment and growing current expenditure leave
US$5.4 bon (9.5% of GDP) of financing needs—US$3.7 bn deficit plus  
another US$1.6 bn of amortizations. US$1.1 bn of this would be raised
 
domestically while US$3.9 bn would be multilateral and bilateral lending.
 
 Ecuador has also signed more than US$3.6 bn of lending deals since
 
2009 with China, which are paid with flows of crude. In 2010 these
include a US$1.7 bn loan for a large hydroelectric project, and a 4-year  
US$1 bn loan to the Finance Ministry.  
 The government also continues to tap the liquidity in the public sector,      
mainly from the state social security institute (IESS). This practice
impacts CB “reserves”, which are actually assets of the Treasury, local 
governments, the IESS, and the private banking system. 
 All told, Ecuador’s lack of market access will constrain the ability to run $m n
such large deficits. Correa has stated in recent interviews that Ecuador 
could look to return to international bond markets, but lingering ill-will 
from the 2009 default makes this unlikely in the short term. 
 
 The trade deficit, which was almost zero at the end of 1H10, has swung

into a US$1.1 billion deficit during 3Q. Imports are soaring, with growth in
non-oil imports accelerating from a 22%oya growth pace in 1H10 to 
44%oya in 3Q10. Exports are not keeping up with imports’ torrid pace.

COUNTRY OVERVIEW

 Workers’ remittances—a traditional buffer for the BoP—remain 


depressed (down 5% in 1H10 to US$1.1 billion). Despite the higher oil
prices observed since QE2, we now see the current account posting a 
deficit in the order of US$400 million (0.7% of GDP) in 2010; our call for a      
return to surplus in 2011 (1% of GDP) is reliant on J.P. Morgan’s oil price
forecast of $93/bbl for WTI (versus $80 in 2010). 
59
Ecuador: The economy is rebounding, but strong domestic demand is leading to
external imbalances that will keep dollarization concerns alive

 The government favors a highly state-centric economic model with


strong regulation. The government has taken a stronger stance and 
rewritten contracts with a number of sectors.

 The toughest discussions have been in the oil sector, where the     
government forced foreign firms to adopt service provider contracts.      
Five companies agreed to stay and increase investment, while four      
companies (including Petrobras) decided to leave.      
     
 Overall oil production is down 5% since 2008 to an average of      
480kbd in 2010. However public production has reached a new      
historical high and private production—down more that 20%—may      
rebound now that there is a resolution of the contract issue.      
     
 Growth is recovering. Ecuador reported 4.3%oya growth in 3Q10 up
     
from 2.7%oya in 2Q, and 0.65%oya in 1Q.      
 We revised our 2010 full-year forecast up to 3% from 2.5% given
     
     
the solid rebound in the region, firm commodity prices, and ongoing
     
public investment. For 2011 we now see 3.5%.
     
 Domestic demand is surging, growing at 8.5% in the first three      
quarters over the same period in 2009, behind private consumption      
(7.1%) and investment (9%), most of which is coming from the      
public sector. Meanwhile, net exports are an increasing drag, with      
real imports up 18%oya in the first three quarters of the year, 

compared to 2.5% for exports.

 Public sector investment continues to be the main engine of growth, 
as private sector demand has recovered but remains constrained.
The government’s investment program calls for roughly 15% of
COUNTRY OVERVIEW

GDP in public investment expenditure annually, which is only


possible in an environment where oil prices rise exponentially or
large-scale Chinese lending continues.

 Ultimately, external financing constraints and perhaps renewed


fears over dollarization will be a limitation on growth

60
Peru: Elections dominates the political landscape, but risks seem subdued

 The first round of presidential elections will take place on April 
10, 2011, with a likely second round taking place on June 5
 
 The early frontrunners in electoral polls (Keiko Fujimori, Luis   
Castañeda and ex-President Toledo) are unlikely to make  

meaningful changes to Peru’s market-oriented
 
macroeconomic policy. Moreover, even if nationalist candidate  
Humala (currently with 10-12% in the polls) does make it to a 
second round, he has been trying to distance himself from 
 
Chavez-style policies, highlighting instead that he would
respect private property, preserve the independence of the 
BCRP, not pursue expropriations, not seek reelection, etc. 

 Other candidates to watch include former finance minister       
Pedro Pablo Kuczynski, who joined ranks with prominent

political leaders of northern Peru, as well as a candidate from 
the center-left Fuerza Social party of the newly elected mayor

of Lima Susana Villaran. At this point, however, they seem
unlikely to make it to a second round.
51 55 51
 We recognize that polling trends can still change dramatically Castaneda
in the months ahead, but at this point we see a relatively low 38
risk of exaggerated political noise around the 2011 vote. Toledo
31 32

 There could be some modest political noise surrounding a K. Fujimori


proposal in Congress to lift mining royalties—potentially
including companies with stability contracts—which could
become a factor in the electoral debate
COUNTRY OVERVIEW

Scenario 1 Scenario 2 Scenario 3




61
Peru: BCRP took a “preventive” 25bp hike; policy rate to reach 4.5% by year-end

 The BCRP hiked the policy rate by 25bp to 3.25% at the



first meeting of 2011. The move was described as
“preventive” in the face of the strong tone of domestic  
demand as well as rising international food/energy prices.  

 2010 inflation ended at 2.1%, and we see the CPI reaching 
2.5% in 2011. The BCRP has mentioned the recent spike 
in international food and energy prices, stating that the 
preventive rate hike aims to avoid any impact on 

inflationary expectations.

 We see GDP growing 8.8% in 2010, while the strong tone 
of private investment should sustain growth at about 6.0%       
in 2011. The BCRP updated the official 2010 GDP forecast
to 8.8% in the December Inflation Report from the 8.0% 
forecast in the September Report. The Board has

mentioned that recent economic activity indicators have

been pointing to a strong expansion.


 The recent measures that were taken by the BCRP—

increase in reserve requirements and the preventive rate 
hike in January—should allow the Board to pause again 
and take stock before starting a hiking cycle in earnest. 

 Given the latest move was “preventive” and that inflation 
should remain relatively tame in the short-term, we keep 
our call for the next rate hike to take place in April, with the      
COUNTRY OVERVIEW

policy rate eventually rising to 4.5% by year-end. However,


if inflation or inflation expectations start to deteriorate, 
BCRP has shown that it could react by adjusting monetary
policy again sooner than our base-case scenario—
especially as the output gap is poised to turn positive.

62
Peru: PEN should strengthen amid low volatility; further rating upgrades likely

 The continued increase in commodity prices has been 


limiting the deterioration in external accounts despite the

strong growth of domestic demand, and the current
    
account deficit should remain below 3% of GDP in 2011.
     
 Constructive external accounts, limited evidence of      
     
overvaluation of the PEN on a REER basis, a strong
     
growth outlook, additional monetary tightening and mild
     
and temporary election noise all augur well for further PEN      
appreciation this year. We expect the strong measures      
enacted by the authorities to keep PEN appreciation      
gradual—but we see USD/PEN gradually appreciating to      
2.75 by end-2011.      
     
 Fiscal expenditures surged in 2009 and in 1H10 on the      
back of the fiscal stimulus program announced in 2008, but      
started to moderate in 3Q10. In 2010 as a whole, the fiscal      
stimulus should still add 1.2%-pts to 2010 GDP growth, but      
     
the recent moderation in public expenditures will result in
     
fiscal tightening in 2011. Peru’s government is now aiming
     
to reduce public spending further, which could bring the      
overall fiscal deficit to about 0.5% of GDP in 2011. 

 Rating agencies could well upgrade Peru in 2011. S&P

and Fitch both revised Peru’s rating outlook to positive in
2010, reflecting strong growth and fiscal and external 
COUNTRY OVERVIEW

accounts that compare well against ratings peers

63
Venezuela: Politics have become more competitive—and thus will be even
noisier than usual heading toward 2012 presidential elections

 President Chavez faced myriad challenges in 2010: sharp 


stagflation, electricity rationing that exposed underinvestment
and mismanagement in the sector, a mini-banking crisis and
Chavez Opposition*
related scandals, and fallout from an unwieldy fx policy, including 7.31
a long-resisted formal devaluation and USD scarcity for the 6.31
private sector after closure of the parallel fx market 5.78
5.19 5.44
4.29 4.38 4.5
 The business climate continues to be tense, marked by a new
wave of nationalizationsmany in the food distribution sectors
following 2009s takeover of some oil service providers

 The on-again, off again confrontation with Colombia has


surprisingly eased with the election of Santos, but bilateral trade
remains depressed and the current dtente may be fleeting Presidential Constitutional Term-limits National
election - 2006 referendum - referendum - Assembly - 2010
 2010s political challenges were in contrast to 2009, when 2007 2009
Chavez was flying high after a February 2009 referendum victory

left him free to run in 2012 presidential elections 

 Polls now show Chavezs popularity below 50%, and most 
pollsters show the public remains skeptical of radicalization.

 Chavezs PSUV still managed to maintain the simple majority in


the September 2010 National Assembly election, but the 
opposition broke the qualified 2/3 majority and relegated the 
PSUV to a minority in the popular vote 

 Lest one be tempted to believe the relatively strong opposition 


showing would restore some semblance of checks and balances, 
the lame-duck Assembly handicapped the incoming body by 
COUNTRY OVERVIEW

granting Chavez decree power for 18 months 


 Chavez also asserted his power post-election with a new wave of 
nationalizations. This suggests a double-down radicalization 
strategy, though Chavez must balance this with better economic       
performance if he hopes to recover popularity


64
Venezuela: Despite operational concerns, oil price rebound provides oxygen and
Orinoco reopening provides a long-term anchor

 Oil accounts for over 90% of exports and half of government revenues 

 Although state oil company PDVSA consistently claims to be producing 


close to 3 million bpd, OPEC data shows crude production down to just

over 2 million bpd 

 Highly subsidized domestic consumption has steadily increased even as
production has fallen, leading to concern that actual exports fall short of
the official figurespotentially contaminating official macroeconomic data 
 PDVSA cash flow difficulties intensified in 2009 along with the drop in oil
prices, as the company has been overburdened supporting social 
spending, and struggled to devote enough money to CAPEX

 PDVSA nationalized some 70 service provider in 2009. The episode



further undermined production and highlighted the risks of doing business
in Venezuela. PDVSA still faces potential multi-billion contingent legal         
liabilities stemming from the 2007 nationalizations (Exxon / Conoco)

 Higher oil prices and the official devaluation of the VEF versus the USD
in January 2010 should have helped PDVSAs cashflow in 2010 but there 
are signs that operational difficulties persist

 PDVSA has turned to China and Japan for financing, which it repays with 
shipments of oil. In April, China confirmed $20 billion of new 10-year 
lending. Since 2009, PDVSA placed almost US$11bn of bonded debt. 

 Despite the nationalization episodes of 2007-09, foreign oil companies 


(IOCs and NOCs alike) in 2010 signed JVs with PDVSA to further 
develop the Orinoco heavy crude block. Foreign companies with a long
term perspective note that Venezuela may have over 200 billion barrels 
COUNTRY OVERVIEW

of reserves when including the unconventional heavy crudeputting the



country on par with Saudi Arabia

 The bidding for the Orinoco’s prized Carabobo fields finally advanced in
     
2010 after months of delays, and several new JVs have been formed.
Even so, actual increases in production of heavy crude may only occur 
by 2012-13, assuming companies agree to go ahead with multi-billion
dollar investments 65
Venezuela: Devaluation should ease fiscal pressure in 2011, but the FX regime
remains cumbersome
 On December 30, 2010, Venezuela’s economic team announced that
it was unifying the official FX rate at 4.3, eliminating the preferential 
2.6 rate that prevailed in 2010. The move is effectively a devaluation.
  
 On December 30, 2010, Venezuela’s economic team announced that 
it was unifying the official FX rate at 4.3, eliminating the preferential      
2.6 rate that prevailed in 2010. The move is effectively a devaluation. 
      
 Venezuela has operated under capital controls with a fixed FX regime       
for much of the 2000s, and between 2005 and early 2010 the official       
FX rate was pegged at 2.15.       
      
 In January 2010, the government announced dual official rates, with
FX controls agency CADIVI disbursing official-rate USD at an FX rate       
      
of 2.6 for some “essential” and 4.3 other FX needs
      

 Several months later, the government effectively closed a broker-led 

private parallel FX market (that had blossomed after 2006) and

replaced it with a much more constrained “alternative” FX market 
called SITME, which is heavily managed by the Central Bank (BCV).

 SITME functions by providing a secondary market platform where
USD-denominated international Venezuela and PDVSA bonds can be  
purchased by locals (via local banks) in exchange for local currency  
 
(VEF) at an implied FX rate of 5.3. 

 In addition, Venezuela’s public sector has continued to supplement
 
the local demand for FX by selling new issues of USD-denominated

external debt directly to locals (outside of SITME) at an implied FX

rate that generally falls in between the official and parallel rates.

 Finally, while the grey parallel market became illegal in 2010, by all 
COUNTRY OVERVIEW

local accounts an underground parallel market continues to exist. 



 Devaluation is positive for fiscal accounts. In theory it magnifies the
local currency value of the USD-denominated oil revenues flowing         

into the governments budget (though in practice more cash may be 
flowing into parallel budget structures).

66
Venezuela: Growth should turn modestly positive in 2011 after two years of recession,
but capital flight remains a drag on GDP and the BoP

 Venezuela was the last and the slowest country in Latin America to exit
recession. A return to the double-digit growth pace seen earlier in the

decade is unlikely. Loose fiscal and monetary policies are no longer
getting much traction, given stubbornly high inflation (close to 30%), 
ongoing supply side constraints from restrictive price controls and the     
FX regime, and a prevailing environment of private sector fear and      
uncertainty stemming from the government’s ongoing nationalization      
campaign.      
     
 GDP fell 0.4%oya in 3Q10. This was the sixth consecutive quarter      
posting an oya decline, but a smaller contraction than the 3.5%oya fall      
in 1H10.      
     
 Domestic demand is rebounding—4.1%oya in 3Q was the first positive      
print since 1Q09—led by public sector consumption (+3.4%oya) and      
investment (+4.4%oya). However, private consumption remains      
depressed and net exports have swung from a cushion to GDP to a      
drag as export volumes stagnate and imports recover.      
     
 With the release of the 3Q data, we have tweaked our 2010 outlook to a      
1.5% decline in GDP (from -2.2% previously and compared to the      
BCV’s preview of -1.9%). Our 2011 GDP forecast stands at 1.5%      
meager increase. Supply side bottlenecks and loose monetary policy      
leave inflation entrenched at close to 30% despite the recession      

 We expect a full-year US$15 billion current account surplus in 2010, or 
some 7.5% of GDP. Our 9.5% of GDP surplus forecast for 2011 
depends on J.P. Morgan’s positive scenario for oil prices (over $90/bbl)

 Current account surpluses have been more than consumed by capital
COUNTRY OVERVIEW

account deficits. Unlike the 2006-08 period, when the government was
exporting capital on a net basis to off-budget funds, the capital account
deficit is now a story of private sector capital flight financed by a
deterioration of the sovereign balance sheet.

 Public debt to GDP is now close to 45% (including China lending).

67
Uruguay: Consolidating its fundamental outperformance

 Real GDP continues to exceed expectations and post impressive numbers, with 
growth reaching 8.8%oya in January-September 2010 supported by all economic
sectors. Based on the latest trends, we have raised our real GDP growth forecast to 0.0
8.5% for 2010, a level that would mark a significant improvement on last year’s 0.0
2.9%, and to 6.2% for 2011
-0.5
-0.5 -0.5
 Consumer prices rose 0.5%m/m in December, matching the level posted a year
earlier, causing annual inflation to remain unchanged at 6.9% from November. Our -0.7
-0.8
current forecast calls for inflation to moderate to 6.5% in 2011, an improvement on -1.0

last year, but not enough to meet the official 5% (+/-1%) target

 The unemployment rate fell to a record low 6.1% in November from 6.2% in October -1.5
-1.5
and 7.0% a year earlier. While the decline in November was driven largely by
-1.7
improved labor market conditions in Montevideo, it is in the interior regions of the
-2.0 -1.9
country where the improvement has been more pronounced. We view the steady 2004 2005 2006 2007 2008 2009E 2010F 2011F
decline in unemployment as a testament to the strength of the economy
Sources: MEF, J.P. Morgan
 The consolidated fiscal deficit for the 12 months through November came in at 1.1%
of GDP (US$449 million), lower than the 1.3% of GDP shortfall posted in October. Uruguay 2008 2009 2010F 2011F
As both the economy and fiscal revenues expanded and the government returned to
a neutral fiscal stance after absorbing extraordinary one-off expenses related to a Nominal GDP (US$MM) 31,199 31,553 40,050 43,728

severe drought, we believe the fiscal deficit likely moderated to around 0.8% of GDP Real GDP (% change) 8.5 2.9 8.5 6.2
in full 2010. We expect positive economic and fiscal momentum to underpin a
Inflation (% change y/y) 9.2 5.9 6.9 6.5
further decline in the deficit to 0.5% of GDP in 2011
FX Rate (Pesos/US$, eop) 24.4 19.6 20.1 20.4
 The trade deficit narrowed 0.7%oya in the first ten months of 2010, underpinned by
a 23.4%oya surge in exports and an 18.6%oya increase in imports. Exports totaled Fiscal Balance (% GDP) -1.5 -1.7 -0.8 -0.5
US$5.56 billion, and imports amounted to US$6.67 billion between January and Trade Balance (US$MM) -3,128 -1,521 -1,491 -2,750
October, resulting in a trade deficit of US$1.11 billion, down from a US$1.12 billion
shortfall during the corresponding period of 2009. While we expect a 2%y/y Current Account (US$MM) -1,486 215 175 -850
narrowing to US$1.49 billion (3.7% of GDP) in last year’s trade deficit to contribute Current Account /GDP (%) -4.8 0.7 0.4 -1.9
to a 0.4% of GDP full-2010 current account surplus, we believe this year's trade
shortfall will almost double to US$2.75 billion (6.3% of GDP), contributing to a 1.9% Pub. Sec. Ext. Debt (% GDP) 34.4 40.5 32.7 30.5
of GDP current account deficit in 2011
COUNTRY OVERVIEW

Pub. Sec. Dom. Debt (% GDP) 18.6 28.9 24.7 23.1

 Bolstered by a 14.9%oya rise to 1.7 million in tourist arrivals, tourism revenues Pub. Sec. Total Debt (% GDP) 53.0 69.4 57.4 53.6
surged 15.2%oya to US$1.1 billion during the first nine months of 2010. The year-
Net Int. Reserves (US$MM) 6,360 7,987 7,650 7,875
to-date totals put the tourism sector on track to extend the favorable performance it
registered in 2009, when tourist arrivals climbed 5%y/y to 2.1 million and tourism
Sources: MEF, BCU, J.P. Morgan
earnings jumped 26% to US$1.3 billion.

68
Dominican Republic: Outlook improves
 Fitch on January 5 revised the outlook on DomRep’s B rating to positive from stable. 
The revision was prompted by three factors: (1) the economy’s resilience during the
global financial crisis, which was supported by a Stand-by Arrangement with the IMF,
12 10.7
(2) improving export prospects, and (3) structural improvements in public debt
management. Following the favorable rating action, DomRep now has positive 10 9.3
outlooks from Fitch and S&P, both of which have a B rating on the country, one notch 8.5
7.8
lower than Moody’s B1 (stable outlook). Given DomRep’s recent fundamental 8
outperformance, like Fitch, we too view the country as an improving credit story 6.0
6 5.3
 Real GDP grew by a higher-than-expected 7.8% in 2010. While all major sectors of 3.5
the economy registered positive growth last year, the strongest performance was 4
posted by the commerce (+12.1%y/y), financial services (+11.3%y/y), local
manufacturing (+8.6%y/y), and communications (+8.4%y/y) categories. Positive
2
momentum and an improvement in the external environment should enable the
0
Dominican economy to expand by a robust 6%y/y in 2011
2005 2006 2007 2008 2009 2010F 2011F
 Tourism revenues surged US$188 million (4.6%y/y) to US$4.24 billion in 2010,
registering a significant improvement on the US$115 million (2.8%y/y) contraction to 
US$4.06 billion they posted in 2009. Last year’s increase in earnings was supported
Dominican Republic 2008 2009 2010F 2011F
by a recovery in foreign tourist arrivals, which rose 3.3%oya through November after
falling 0.9%y/y to 3.42 million in 2009. Official estimates call for growth in travel Nominal GDP (US$MM) 45,718 46,712 51,900 55,800
receipts to strengthen in 2011, boosting them to US$4.54 billion, up 7.1%y/y
Real GDP (% change) 5.3 3.5 7.8 6.0

 Remittances shrank 2.8% (US$85 million) to US$2.96 billion in 2010 from US$3.04 Inflation (% change y/y) 4.5 5.8 6.2 6.0
billion in 2009. The deterioration was driven primarily by declines in the second FX Rate (Pesos/US$) 35.4 36.1 37.6 38.9
(-6.2%oya) and third (-8.1%oya) quarters, with figures for the first quarter showing a
Fiscal Balance (% GDP)* -4.4 -4.5 -3.8 -3.0
negligible 0.1%oya drop and the final tally for the fourth quarter likely to show a
3.3%oya expansion. Based on recent trends, we expect remittances to increase Trade Balance (US$MM) -9,245 -6,741 -8,191 -8,220
5.0%y/y to US$3.07 billion this year Current Account (US$MM) -4,519 -2,159 -3,865 -3,542

 Foreign direct investment (FDI) fell 26.0% to US$1.53 billion (2.9 of GDP) in 2010 Current Account /GDP (%) -9.9 -4.6 -7.4 -6.3
from US$2.07 billion (4.4% of GDP) in 2009, when inflows had already contracted Pub. Sec. Ext. Debt (% GDP)* 15.8 17.6 18.2 17.9
28%y/y. The government expects FDI to surge 30%y/y to US$1.99 billion (3.6% of
Pub. Sec. Dom. Debt (% GDP)* 20.0 22.3 21.2 20.1
projected GDP) in 2011
COUNTRY OVERVIEW

Total Pub. Sec. Debt (% GDP)* 35.8 39.9 39.4 38.0

Foreign Reserves (US$MM)** 2,165 2,852 3,343 3,650

*Consolidated public sector deficit. **NIR. Sources: Central Bank, Ministry of Finance, J.P. Morgan

69
El Salvador: Recovering slowly but surely
 The central bank’s monthly index of economic activity (IVAE) rose 2.5%oya (sa) in 
October, bouncing back significantly from the 5.8%oya (sa) decline it posted a year
earlier. The latest monthly reading took the 12-month moving average to 0.4%oya,
up from -0.3%oya in September. Real GDP shrank 3.5% in 2009, in line with our 4.2 4.3
5
forecast. Hopeful that a US recovery will provide a boost to the domestic economy, 3.3
4
the government expects real GDP to expand 1% in 2010 and 2.5% in 2011, higher 2.4
3
than our projections of 0.5% and 1.8%, respectively 1.8
2
1 0.5
 A 0.1%m/m fall in the December CPI, compared with a 0.4%m/m contraction a year
earlier, led annual inflation to rise to 2.1% from 1.8% in November. Boosted by a 0
recovery, albeit modest, in domestic demand, the full 2010 reading was higher than -1
2009’s -0.2% annual print, yet still lower than the official 2.5-3.5% projection. We -2
expect annual inflation to remain relatively low (~2.8%) in 2011, owing largely to -3
below-potential real GDP growth (~1.8%) and anticipated USD strength in the near -4
-3.5
term -5
2005 2006 2007 2008 2009 2010F 2011F
 The deficit of the non-financial public sector (NFPS) narrowed 25.9% to US$673 
million (3.1% of GDP) during the first eleven months of 2010 from US$909 million

(4.3% of GDP) a year earlier. The NFPS deficit climbed to 5.6% of GDP in 2009 from
3.1% of GDP in 2008 amid the global financial crisis. The Funes administration El Salvador 2008 2009 2010F 2011F
believes the fiscal shortfall likely declined to 4.8% of GDP last year supported by a
recovery in economic activity (which contracted 3.5%y/y in 2009) and tax revenues Nominal GDP (US$MM) 22,107 21,101 21,796 22,953
(which shrank 9.6%y/y in 2009), and expects it to fall to 3.5% of GDP in 2011
Real GDP (% change) 2.4 -3.5 0.5 1.8

 Remittances rose 4.0% to US$273 million in November from US$263 million a year Inflation (% change y/y) 5.5 -0.2 2.1 2.8
earlier, boosting the tally for the first eleven months of 2010 to US$3.2 billion, 2.3%
FX Rate (US$/US$) 1.0 1.0 1.0 1.0
higher than during the corresponding period of 2009. Remittances totaled US$3.47
billion in 2009, posting an 8.5%y/y decrease, compared with a 2.5%y/y increase in Fiscal Balance (% GDP) -3.1 -5.6 -4.8 -3.5

2008. Prompted by a recovery in economic activity in the US, where an estimated Trade Balance (US$MM) -5,205 -3,457 -4,011 -4,667
2.5 million Salvadorans reside, we project remittances to increase 2.5%y/y to
Current Account (US$MM) -1,682 -374 -605 -710
US$3.55 billion in 2010 and by a further 4.5%y/y to US$3.71 billion in 2011
Current Account/GDP (%) -7.6 -1.8 -2.8 -3.1
 The trade deficit widened 17.3%oya during the first eleven months of 2010,
Pub. Sec. Ext. Debt (% GDP)* 26.4 31.0 31.7 31.6
underpinned by a 16.9%oya rise in exports and a 17.1%oya increase in imports. The
COUNTRY OVERVIEW

trade deficit shrank 33.6%y/y to US$3.5 billion (16.4% of GDP) in 2009, as a Pub. Sec. Dom. Debt (% GDP)* 17.6 21.9 22.5 22.4
25.6%y/y plunge in imports outweighed a 16.5%y/y decrease in exports. As a
Total Pub. Sec. Debt (% GDP)* 44.0 53.0 54.1 54.0
recovery in global and domestic demand boosts both exports and imports, we expect
the trade deficit to increase 16.0%y/y to US$4.0 billion (18.4% of GDP) in 2010 and Foreign Reserves (US$MM) 2,541 2,985 2,815 2,935

by an additional 16.4%y/y to US$4.7 billion (20.3% of GDP) in 2011 *NFPS. Sources: BCR, MinFin, EIU, J.P. Morgan

70
Jamaica: IMF program still on track

 Real GDP contracted 1.3%oya through September 2010 owing to the slow 
pace of global recovery and a drop in activity due to the security operations
in Kingston in 2Q10. We believe the economy contracted again in the  
Real GDP CPI
fourth quarter mostly due to the damage caused by the recent tropical 5 20
3.5 3.0 1.4
storms, resulting in a full-year contraction of 1-1.5%, marking the third
3 1.4
consecutive year of recession. A recovery in remittances, which would 1.1 1.0 15
boost private consumption, and a rebound in the mining and tourism 1
10
sectors should aid growth in 2011. However, we expect growth to be -1
lackluster and project weak positive growth of 1.0% in 2011 owing to the -0.9
-3 -1.0 5
still gradual global recovery and the IMF-mandated austerity measures
-3.0
-5 0
 Fiscal consolidation may be challenging in 2011. The central government
2003 2004 2005 2006 2007 2008 2009 2010F 2011F
posted a deficit of US$585 million, or 4.3% of GDP, through the first eight
months of FY10/11. Fiscal accounts have outperformed in recent months,
mostly on the back of expenditure restraint, but the recent tropical storms
and the still-weak economy suggest that this outperformance is unlikely to 
last. After posting a deficit of 10.8% in FY09/10 and an expected 7.5% in
FY10/11, we expect the deficit to narrow further, to 5.5% of GDP, in

FY11/12. Our estimates are higher than what is programmed in the IMF
SBA given our less optimistic growth forecasts
Overall Fiscal B alance (FY)
 Jamaica comfortably met its third set of quarterly targets under the IMF  Current A cco unt B alance
program at the end of November, but the risk of noncompliance in 2011, -2.0
especially with fiscal targets, is rising given the costs related to storm -3.3
-6.0 -4.3-5.0
damage, weak tax collections and potential inability to implement public -5.2 -5.5 -5.5 -5.5
-6.4
sector job cuts. Program disbursements so far amount to US$838 million, -10.0 -6.9-8.1 -6.8
-7.2-7.5
or 66% of the total loan. The next disbursement of US$200 million, in -9.6 -9.9
-14.0 -10.8
February 2011, will be based on end-December targets
-18.0 -15.7
 The CAD will likely widen in 2011, in line with rising import demand. We
-22.0 -20.0
COUNTRY OVERVIEW

expect the CAD to narrow from US$912 million (7.2% of GDP) in 2009 to
US$725 million (5.5% of GDP) in 2010 but to widen to US$930 million 2003 2005 2007 2009 2011F
(6.4% of GDP) in 2011 as oil prices remain high and exports weak on
sluggish external demand


71
Panama: Shining bright

 Seasonally-adjusted growth in the monthly index of economic activity (IMAE) came 
in at 7.0%oya in October, a considerable improvement on the modest 0.5%oya
expansion it posted a year earlier. Real GDP growth averaged 9.1% between 2004
6.0
and 2008 and while it slowed to 3.2% in 2009 amid the global recession, the
government estimates that the economy expanded more than 7% in 2010 bolstered 3.5
4.0
by the ongoing expansion of the Canal and an ambitious public investment
program. We expect positive momentum to underpin growth of 6.3% in 2011 2.0 0.5 0.5
0.4 0.0
 The non-financial public sector (NFPS) deficit came in at 1.8% of GDP (US$489 0.0
million) in January-September 2010, down from 2.4% (US$575 million) during the
first nine months of 2009. We believe that higher revenues (including sizeable year- -2.0 -1.1
end public transfers) and tight expenditure controls will enable the Martinelli
administration to deliver a balanced result for full 2010, which we expect to become -4.0 -3.2
a small surplus (0.5% of GDP) in 2011 -6.0
 A 6.6%oya increase in cargo tonnage traveling through the Canal drove toll 2005 2006 2007 2008 2009 2010F 2011F
revenues to expand 6.8%oya in October to US$144 million. October’s favorable
performance took the toll tally for the first ten months of 2010 to US$1.24 billion,

2.1% higher than in the same period of 2009. Toll revenues totaled US$1.47 billion
in 2009, posting a 7.9% improvement on 2008. Increased canal traffic, which
Panama 2008 2009 2010F 2011F
according to ACP estimates may grow 1.5%y/y in 2011 as global trade recovers,
and higher toll rates should boost revenues going forward. The government
Nominal GDP (US$MM) 23,184 24,349 26,541 29,062
expects to receive US$839 million (2.9% of GDP) in transfers from the ACP in 2011
Real GDP (% change) 10.1 3.2 7.2 6.3
 Tourist arrivals rose 4.4%oya to 134,000 in October, taking the total number of
Inflation (% change eop) 6.8 1.9 4.9 4.5
visitors for the first ten months of 2010 to 1.35 million, or 10.1%oya higher than a
year earlier. Bolstered by a significant increase in arrivals for the month, tourism FX Rate (Balboas/US$) 1.0 1.0 1.0 1.0

revenues rose 9.7%oya to US$141 million in October, taking the year-to-date tally Fiscal Balance (% GDP)* 0.4 -1.1 0.0 0.5
to US$1.37 billion, or 14.2% higher than in January-October 2009. While the
Trade Balance (US$MM) -4,546 -2,123 -4,750 -4,350
number of visitors fell 0.8%y/y in 2009 to 1.56 million, tourism earnings increased to
a record US$1.48 billion last year, 5.3% higher than the year before. Based on Current Account (US$MM) -2,722 -44 -3,125 -2,275
recent trends, we expect the number of foreign visitors to increase ~10%y/y in Current Account /GDP (%) -11.7 -0.2 -11.8 -7.8
2010, boosting tourism revenues by 13.5%y/y to US$1.7 billion
Pub. Sec. Ext. Debt (% GDP) 36.6 41.7 38.4 36.5
COUNTRY OVERVIEW

Pub. Sec. Dom. Debt (% of GDP) 8.5 3.4 5.6 5.7

Pub. Sec. Total Debt (% GDP) 45.0 45.1 44.0 42.2

Foreign Reserves (US$MM) 2,424 3,082 3,525 3,825

*NFPS. Sources: Comptroller General's Office, Ministry of Economy and Finance, J.P. Morgan

72
Latin America economic forecasts



   


            
            
            
            
            
            
            
            
 



   


            
            
            
            
            
            
            
            


COUNTRY OVERVIEW

73
Latin America economic forecasts (cont.)

  

            

            

            

            

             

            

            

            



  

           

            

            

            

            

            

            

            


  

            

           

           

           

           

           

           

           


   
COUNTRY OVERVIEW

           

           

           

           

           

          

           

           

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COUNTRY OVERVIEW

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COUNTRY OVERVIEW

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