Goldman On Brazil

Latin America Economic Analyst
Issue No: 11/19 September 23, 2011

Goldman Sachs Global Economics, Commodities and Strategy Research at https://360.gs.com
High Growth in Argentina and Crisis Management Experiences in Brazil

Argentina grew by 9.5% in 1H2011, driven by significant pre-electoral policy stimulus and a favorable external environment. Above-trend expansion of domestic demand kept inflation at 20%-plus (private sector estimates). High inflation and overly stimulated demand appreciated the real exchange rate and reduced the trade surplus, likely triggering a faster rate of ARS depreciation after the October elections. President Kirchners reelection bid is clearly benefiting from high growth and a divided opposition. Polls suggest that President Kirchner will be easily reelected (likely in the October 23 first round) and that her political party may even regain control of Congress. President Kirchner has advocated deepening the current model during a second term. The Kirchner policy model is characterized by ad-hoc and unsystematic policy moves geared to maximizing domestic growth/consumption. However, we expect policymakers to face significantly deeper macro challenges ahead, particularly if the external backdrop worsens. In light of the deterioration of the financial situation in Europe, it is timely to understand how the Brazilian authorities would respond to a new global financial crisis. Brazil is capable of dealing with financial shocks because the fiscal and external accounts are in reasonable shape; the domestic banking system is strong; the stock of reserves is large; and there is ample fiscal and monetary leeway to implement countercyclical macro policies. In addition, the economic team is experienced at crisis management. Strong external financial shocks would shift the BoP to a deficit, weaken the BRL, reduce credit growth, and strain the banking system. This would reduce real GDP growth, open an output gap and probably reduce inflation, opening the scope for lowering interest rates. The Rousseff administration is likely to implement a countercyclical policy response similar to that used in 2008. However, they are likely to be more proactive, easing macroeconomic policies sooner, perhaps attempting more aggressive sectororiented policies than before. We believe that the authorities should implement ambitious structural reforms aimed at boosting total factor productivity and real GDP growth, making the economy more resilient to global business cycles in the future.
Chart 1 - Argentina: Output Gap in Positive Territory (%)
10 5 0 -5 -10 -15 93 95 97 99 01 03 05 07 09 11
Source: Goldman Sachs estimates.
HP Output gap 1: 93Q1-11Q2 HP Output gap 2: 93Q1-08Q2
Paulo Leme paulo.leme@gs.com +1 305 755 1038 Alberto Ramos alberto.ramos@gs.com +1 212 357 5768 Eduardo Cavallo eduardo.cavallo@gs.com +1 212 357 5772 Petya Kehayova petya.kehayova@gs.com +212-934-0199
Chart 2 - Brazil: The Participation of Foreign and European Banks in the Brazilian Banking System is Small
(% of total) European banks 35 30 25 20 15 10 5 0 Total Assets Source: Sisbacen. Loans Net Worth 14.1 4.1 25.7 18.5 1.7 7.7 Other foreign banks
Important disclosures appear at the back of this document.
Contents
Focus: Argentina - High Growth Likely to Deliver President Kirchner an Easy Reelection and Potentially Also Control of Congress 1 Introduction ............................................................................................................................................................................................................... 1 The Real Economy Preformed Strongly During 1H2011 ...................................................................................................................................... 1 Growth Maximization Implied Loss of Monetary Anchor and Gradually of Also the External Anchor......................................................... 3 President Cristina Kirchner Expected to be Easily Reelected for Another 4-Year Term ................................................................................ 5 Government May Regain Control of Congress ..................................................................................................................................................... 5 Focus: Brazil - Potential Effects and Policy Response to the European Crisis ..................................................................................................... 7 The Effects of the European Crisis in Brazil .......................................................................................................................................................... 7 Transmission Channels of External Shocks to Brazil .......................................................................................................................................... 7 Transmission of the Lehman Shock to Brazil in 2008........................................................................................................................................... 9 Lessons from the Lehman Shock ......................................................................................................................................................................... 12 Policy Response to Global Financial Shocks by the Rousseff Administration ............................................................................................... 12 Conclusions ............................................................................................................................................................................................................. 14 Country Views and Forecasts .................................................................................................................................................................................... 15 Argentina ............................................................................................................................................................................................................ 15 Brazil.................................................................................................................................................................................................................... 16 Chile ..................................................................................................................................................................................................................... 17 Colombia ............................................................................................................................................................................................................. 18 Dominican Republic .......................................................................................................................................................................................... 19 Ecuador ............................................................................................................................................................................................................... 20 Mexico ................................................................................................................................................................................................................ 21 Panama ............................................................................................................................................................................................................... 22 Peru ..................................................................................................................................................................................................................... 23 Venezuela ........................................................................................................................................................................................................... 24 Main Financial Forecasts ........................................................................................................................................................................................... 25 Forthcoming Data Releases from Latin America .................................................................................................................................................... 25 Calendar of Economic and Political Events ............................................................................................................................................................. 26 Global Macroeconomic Outlook................................................................................................................................................................................ 27
Issue No: 11/19
September 23, 2011
Goldman Sachs Economic Research
Focus: Argentina
High Growth Likely to Deliver President Kirchner an Easy Reelection and Potentially Also Control of Congress
The economy expanded at a very exuberant pace during 1H2011 (+9.5% yoy) driven by significant pre-electoral policy stimulus and an admittedly favorable external environment. Against a backdrop of a positive output gap, the clearly above-trend expansion of domestic demand kept inflation well entrenched at 20%-plus (according private sector estimates released by a group of congressmen). A combination of high inflation and overly stimulated demand led to visible real currency appreciation and erosion of the trade surplus. This combination is likely to trigger a faster rate of ARS depreciation after the October elections. President Kirchners reelection bid is clearly benefiting from the dividends of an expanding economy and the fact that the opposition camp remains deeply divided. Voters do not seem unhappy with the short-term high-growth / high-inflation trade-off. Recent polls suggest that President Kirchner will be easily reelected for another 4-year term (likely in the October 23 first round) and that her political party may even regain control of Congress. President Kirchner has not presented a well-articulated governing program and has instead advocated, in rather general terms, deepening the current model during a likely second term. This is, in our view, a strong indication of broad policy continuity. The Kirchner policy model has been characterized by ad-hoc and unsystematic policy moves geared to maximizing domestic growth/consumption. However, we expect policymakers to face significantly deeper macro challenges ahead that those faced currently as the current policy mix is showing increasing signs of distress even under a still-favorable external environment. The policy trade-offs would become more severe if the external backdrop turns adverse. I never think of the future - it comes soon enough. Albert Einstein (German-born American physicist; Nobel Prize for Physics in 1921; 1879-1955)
Introduction
According to the official Indec real activity figures, the economy is headed for a banner year in terms of real GDP growth in 2011. In fact, the economy may expand close to 20% in real terms during 2010-11. Nongovernment estimates also attest to the buoyancy of the economy, but they tend to show real GDP growth up to 200bp below the official National Statistics Institute (Indec) estimates. The source of the perceived upward bias of the official figures seems to be a likely underestimation of the activity deflators, particularly for private consumption. If the external backdrop improves somewhat before the end of the year a double-digit expansion of the economy in 2011 is within reach, although colored by very high inflation readings (20%-plus) and a current account balance that is expected to dip into deficit given the surge in imports driven by overly stimulated domestic demand and real currency appreciation. Those are telling macro signs of an economy that is clearly growing beyond its structural speed limit (see Chart 1). That is, it is admittedly far easier to deliver high short-term growth than sustainable high noninflationary growth over the medium term.
The Real Economy Performed Strongly During 1H2011

Aggressive pre-electoral policy stimulus and a distinctly favorable external backdrop (high commodity prices and solid external demand for non-commodities, particularly from Brazil) levered the performance of the economy during 1H2011, all the way into admittedly overheating territory (see Charts 1 and 2).
Chart 1: Economy Started to Overheat in 2010
(ARS bn) 450 400 350 300 250 200 00 01 02 03 04 05 06 07 08 09 10 11
Actual GDP SA HP trend 1: 93Q1-11Q2 HP trend 2: 93Q1-08Q2
Issue No: 11/19
September 23, 2011
Chart 2: Output Gap in Positive Territory

(%) HP Output gap 1: 93Q1-11Q2 10 5 0 -5 -10 -15 93 95 97 99 01 03 05 07 09 11
HP Output gap 2: 93Q1-08Q2
According to Indec, real GDP grew a significantly higher-than-expected 9.1% yoy during 2Q2011, moderating only slightly from the high 9.9% yoy expansion recorded during 1Q2011. The market was positively surprised by the very high 2Q yoy expansion given that the monthly real GDP series (EMAE) was pointing to just 7.8% yoy growth.1
Chart 3: Solid Real GDP Growth
(% yoy; n.s.a.) 14 12 10 8 6 4 2 0 -2 1Q08 3Q08 -0.8 -0.3 1Q09 3Q09 1Q10 3Q10 1Q11 8.5 7.8 8.6 6.9 4.1 2.0 2.6 6.8 9.2 11.8 9.9 9.1
The economys strong cyclical expansion has been driven by overly stimulated domestic demand. Private consumption spending grew a large +11.5% yoy during 2Q2011, little changed from 11.3% yoy during 1Q2011 and 11.5% yoy during 4Q2010. In sequential terms private consumption is reported to have expanded 2.4% QoQ sa during 2Q2011, and an impressive 2.6% QoQ on average over the last seven quarters (for a 20% cumulative expansion since 3Q2009). Public consumption has also been notoriously dynamic: accelerated to 11.9% yoy (5.6% QoQ sa) during 2Q2011 from 9.9% yoy during 1Q2011. Investment spending has also been expanding at high rates: +23.8% yoy, with investment in construction up 9.7% yoy and investment in machinery and equipment increasing a large 41.3% yoy. Finally, the GDP component measuring the accumulation of inventories and statistical error subtracted 1.7 percentage points of GDP to growth during 2Q2011 (more than -0.9 of a percentage point of GDP during 1Q2011). Net trade continues to be a drag on growth given the ongoing ARS appreciation in real terms and abovetrend domestic demand expansion. Export growth decelerated sharply to 0.5% yoy during 2Q (from 7.1% yoy during 1Q) while import growth accelerated to a very high (+24.9% yoy, and a very large 9.8% QoQ sa). Hence, the drag of net exports on growth deepened to -3.1 percentage points of GDP during 2Q2011, from -1.9 percentage points of GDP during 1Q2011. On the supply side, industrial production growth remained strong (13.7% yoy) but the agriculture and livestock sector contracted 5.5% yoy. We also highlight the buoyancy of transportation and communications (+9.9% yoy during 1Q), retail (+17.3% yoy), and financial intermediation (+18.3% yoy). Finally, the construction sector cyclical expansion firmed to 10.8% yoy from 8.8% yoy during 1Q2011.
Chart 4: Dom. Demand Driven Growth
(% GDP; based on YoY s.a. growth)
Inventories/Stat.Error Public C Net Exports Prv C Investment Real GDP
Source: Haver Analytics.
The growth momentum also remained high in sequential terms: +2.47% QoQ sa (10.2% annualized) moderating from 3.14% QoQ sa during 1Q2011 (13.1% annualized). 2 In all, the economy was able to maintain so far during 2011 the very high buoyancy seen late in 2010: between 4Q2010 and 2Q2011 the economy expanded on average at a very high 2.9% QoQ sa rate (11.9% annualized); which is much higher than our estimated 1.0% QoQ sa trend growth.
15 10 5 0 -5 -10
The accuracy and integrity of the official (Indec) real sector, labor market, and inflation data have been questioned. The widely held perception is that the official real sector statistics somewhat overstate the level of activity (by about 1 to 2 percentage points) given the likely underestimation of the GDP deflator.
2
1Q09
3Q09
1Q10
3Q10
1Q11
The 1Q2011 sequential growth rate was revised upwards from 2.82% qoq sa (11.8% annualized) to 3.14% qoq s.a. (13.1% annualized). 2
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Table 1: Argentina - Real GDP

(% change yoy) Real GDP QoQ s.a. Consumption Private Public Investment Construction Equipment Exports Imports External sector contribution to growth Source: Indec. 09Q4 2.6 2.3 2.9 7.7 -3.4 -1.2 -6.6 2.5 -4.1 0.5 7.2 -10.2 -3.6 -18.7 -6.4 -19.0 2009 0.9 1Q10 6.8 3.6 7.3 8.4 13.1 5.1 25.5 4.2 30.1 2Q10 11.8 2.9 8.1 12.9 18.9 8.1 35.5 18.2 35.6 3Q10 8.6 0.6 8.9 8.5 26.6 6.8 55.4 27.8 37.4 4Q10 9.2 2.97 11.5 7.7 24.7 12.1 44.5 7.4 32.7 9.0 9.4 21.2 8.2 41.1 14.6 34.0 2010 9.2 1Q11 9.9 3.14 11.3 9.9 19.5 8.8 33.4 7.1 20.4 2Q11 9.1 2.47 11.5 11.9 23.8 9.7 41.3 0.5 24.9
0.8
1.8
-2.9
-1.4
-0.9
-3.1
-2.1
-1.9
-3.1
Table 2: Argentina - Contribution to YoY Real GDP

(% change yoy) Real GDP Consumption Private Public Investment Construction Equipment Net Exports Exports Imports Inventories/Stat.Error Source: Indec. 4Q09 2.6 2.8 1.9 1.0 -0.8 -0.2 -0.6 0.8 0.3 0.5 -0.3 2009 0.9 1.1 0.3 0.9 -2.4 -0.5 -1.9 1.8 -0.9 2.7 0.2 1Q10 6.8 5.9 4.9 1.0 2.5 0.6 1.9 -2.9 0.5 -3.4 1.3 2Q10 11.8 6.8 5.2 1.6 3.9 1.0 2.9 -1.4 2.3 -3.7 2.5 3Q10 8.6 6.8 5.7 1.1 5.6 0.9 4.8 -0.9 3.4 -4.3 -2.9 4Q10 9.2 8.5 7.5 1.0 5.3 1.6 3.7 -3.1 0.9 -4.0 -1.4 2010 9.2 7.0 5.9 1.2 4.4 1.0 3.3 -2.1 1.8 -3.9 -0.2 1Q11 9.9 8.8 7.6 1.2 3.9 1.0 2.9 -1.9 0.9 -2.8 -0.9 2Q11 9.1 8.7 7.1 1.5 5.2 1.2 4.1 -3.1 0.1 -3.2 -1.7
Real GDP Growth in 2011 to Rival the Expansion Recorded in 2010

The economy was exceptionally dynamic in yoy and sequential terms during 1H2011 on the back of very significant fiscal and monetary stimulus, solid external demand (particularly for industrial goods from Brazil) and very favorable terms of trade. Furthermore, fiscal and monetary policy has remained highly stimulative so far during 3Q2011 given the approaching October 23 presidential elections (negative real rates and public spending expanding at very high rates). Given the upward revision to the sequential growth rate during 1Q2011 and the better-than-expected 2Q2011 performance, the statistical carry-over for 2011 growth is now at a high 8.44%. That is, even if the economy were to remain flat at the 2Q2011 level, average real GDP growth in 2011 would already reach 8.44%. In all, the revision to 1Q data and the 2Q2011 positive growth surprise bump (automatically) our forecast for real GDP growth in 2011 to 8.9% from the previous 8.2%. In fact, the 8.9% growth forecast assumes a conservative path for sequential real GDP growth during 2H2011in order to factor in a challenging
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external backdrop, softening external demand from Brazil, and post-election easing of the fiscal impulse. However, the risk to the current 8.9% real GDP growth forecast is skewed to the upside and we could envisage scenarios leading to double-digit real GDP growth in 2011 (e.g., demand from Brazil and commodity prices remains resilient, and the drag from net imports and inventory accumulation eases during 2H2011).
Growth Maximization Implied Loss of Monetary Anchor and Also Gradually of the External Anchor
The mercantilist trade stance and very lax macro policy environmentcharacterized by a populist fiscal approach easily accommodated by monetary policy continues to generate intense inflationary pressures which are undermining the sustainability of the current growth cycle and the strength of the external balance sheet. In fact, the current account is moving into deficit under the weight of surging imports (driven by abovetrend domestic demand growth amid significant real currency appreciation), which more than offsets significant terms of trade gains. The erosion of the trade surplus has been noticeable and has triggered the
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adoption of a number of protectionist measures by the authorities. In current Dollars, the trade balance surplus declined 21% yoy during January-July (to US$6.5 billion) but when measured at constant 2010 prices (i.e., unchanged terms of trade) the trade surplus declined a much large 64% yoy (to US$3.0 billion from US$8.2 billion during January-July 2010) (see Table 3).
Chart 5: Favorable Terms of Trade
(2000=100) 180 160 140 120 100 1Q07 4Q07 3Q08 2Q09 1Q10 4Q10
Export Prices Terms of Trade (n.s.a.)
Chart 6: Buoyancy of Imports Eroding Trade Surplus

(Bn. US$, 12-mo rolling total)
Trade Balance (lhs) Exports 20 Imports 18 16 14 12 10 8 6 4 2 0 Jan-08 Aug-08 Mar-09 Oct-09 May-10 Dec-10
90 80 70 60 50 40 30 20 10 0
Source: Indec.
Inflation Remains the Most Visible Macro Imbalance

Entrenched high inflation remains the clearest symptom of an economy that is out of synch. However, the disputed official Indec figures continue to show singledigit inflation (+9.8%) and extraordinary stability at the margin: Indec has reported headline monthly inflation at either 0.7% or 0.8% for 17 consecutive months (with core bounded between 0.9% and 0.7% during the same period); a remarkable statistical regularity (see Chart 7).
4 -5 3 14 -29 23 32 10 49 30 20 . .
Table 3: Trade Balance, Jan-Jul 2011

% Change from 2010 Value Exports Primary Products Manufacturing (Agricultural) Manufacturing (Industrial) Energy Im ports Capital Goods Intermediate Goods Fuels and Lubricants Components and Parts for Capital Goods Consumer Goods including Autos Consumer Goods ex Autos Automobiles Other 24 26 33 24 -7 37 35 28 102 32 27 26 28 23 2010 Trade Balance (US$bn) Trade Balance (US$bn at constant 2010 prices)
So urce: Indec.
Price 19 32 29 9 31 11 2 16 35 2 5 . .
Quantity
Chart 7: Consumer Price Inflation (Indec; official figures)

12% 10% 8% 6% 0.6% 4% 2% 0% Jan-10
Source: Indec. % mom (rhs) % yoy (lhs)
1.4% 1.2% 1.0% 0.8%
0.4% 0.2% 0.0% Jun-10 Nov-10 Apr-11
2011 % Chge 6.5 3.0 -21% -64%
8.2 8.2
Credible non-government inflation surveys indicate that inflation is currently running at more than double the official rate: i.e., 20%-plus. In fact, even the widely questioned official figures show that five of the nine CPI groups currently have yoy inflation readings in double digits and none of them below 5%. This outcome attests to how generalized inflationary pressures have become. In our assessment, inflation is fundamentally a reflection of the heterodox policy mix in place and monetary policy accommodation. Furthermore, the neglect of inflationary pressures in recent years (in order to maximize short-term growth) has entrenched inflation at a very high level. Therefore,
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disinflating the economy is likely to require a multipronged, multi-year strategy as cementing priceindexation practices is increasing the inertia of the inflationary process, which is worsening the inflationoutput "sacrifice ratio"; i.e., the required output loss to bring inflation down to the average level of Argentinas main trading partners is rising. Given the policy backdrop, we expect consumer price inflation to hover at 20%-plus in 2011, and most likely to remain entrenched in the 20% range during 2012.3 We do not expect the authorities to embrace conventional macro management policies to get a solid grip on inflation, but we have noticed that in recent weeks the government has been expressing the desire to contain wage settlements in 2012 below 20% (from over 30% in 2011). This would be a small step to disinflate the economy, but certainly a step in the right direction.
Chart 8: In Real Terms ARS/USD is Returning to "1:1 Convertibility Level"
(2001=100; eop) 500 400 300 200 100 0 01 02 03 04 05 06 07 08 09 10F 11F
Source: Haver Analytics and Goldman Sachs.
government estimates for headline inflation the bilateral real ARS/USD rate is now approaching the level seen before the 1:1 ARS-USD convertibility regime was abandoned. However, we reckon that in multilateral real terms the degree of real currency appreciation has been milder than when measured against the USD given the observed appreciation in recent years of the currencies of other major trading partners (e.g., Brazil).
President Cristina Kirchner Expected to be Easily Reelected for Another 4-Year Term
President Cristina Kirchner won the mandatory August 14 primary elections by a very large margin and is seen as the overwhelming favorite to win the October 23 presidential elections. The August primaries were in essence a dry run for the October elections as all the main parties and coalitions had already settled on the candidates that will represent them in October. President Kirchner performed well in the primaries, winning a resounding 50.2% of the vote, leaving far behind the Radical Party candidate Ricardo Alfonsin with12.20%, and former president Eduardo Duhalde (dissident Peronist), with 12.12%. The socialist party candidate, Hermes Binner, received 10.2% of the vote, and former president Alberto Rodriguez Saa (dissident Peronist) 8.2%. Based on recent public statements by the main opposition candidates, it is highly unlikely that the opposition camp will close ranks and form any meaningful alliance ahead of the October 23 presidential elections. As such, President Cristina Kirchner is well positioned to win reelection for another 4-year term, very likely in the first round. According to a recent Management & Fit poll (conducted Sept 2-6; error margin 3.1%), President Cristina Kirchner enjoys the preference of 51.9% of voters a month from the October 23 presidential elections, followed at a very large distance by the Socialist Party candidate Hermes Binner with 11.6% and the Radical Party candidate Ricardo Alfonsin with 7.5%. Finally, dissident Peronist former President Alberto Rodriguez Saa polled fourth with 6.0%. These results would guarantee President Kirchner a landslide first-round victory. For a first-round victory the winning candidate must secure at least 40% of the vote and a 10ppt margin over the runner up, or at least 45% of the valid votes irrespective of the margin over the second-most voted candidate. If these conditions are not fulfilled, a runoff will take place November 20.
Nominal ARS/USD rate Real ARS/USD rate
We expect the authorities to continue, until after the October elections, to use the exchange rate as the main nominal anchor in the economy in order to prevent further escalation of inflationary pressures. That is, as was done throughout 2010, and most certainly until the October elections the authorities are likely to allow the ARS to depreciate only gradually; with the upward ARS/USD drift significantly below that of inflation. However, use of the currency rather than rates to tame inflation is leading to significant real exchange rate appreciation (see Chart 8) and concomitant erosion of the trade balance surplus. This will likely prompt the authorities to allow the currency to depreciate at a visibly faster rate after the elections and throughout 2012. In fact, when using the average of non3 The government, labor, and business representatives agreed to increase the minimum wage by 25%, effective August 1. The 25% minimum wage increase is much higher than any reasonable estimate of productivity growth and is therefore likely to contribute to keep consumer price inflation high in 2012.
Government May Regain Control of Congress

President Kirchner may get more than a resounding reelection at the October 23 elections. The government may in fact also regain control of Congress. On October 23, beyond electing a president, voters will also renew one-third of the Senate (24 of 72 seats) and half of the Lower House (130 of 257). The expected strong showing by President Kirchner will likely help the progovernment legislators retain most of their seats and
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eventually capture a few extra ones. This may be enough to secure slight majorities in both chambers of Congress and wrest control of the legislature away from the opposition. The opposition has enjoyed a slight majority in Congress (more pronounced in the Lower House) since the 2009 mid-term elections but has been very ineffective in driving its agenda given the lack of cohesion among the opposition ranks (a reflection of its ideological diversity) and the strong party discipline that has characterized the official camp. Control of Congress would lead to a significant concentration of power and would give the government legislative backing for some of its most interventionist policies.
Conclusion
The economy continues to grow at a very fast pace, and so does inflation. However, voters seem pleased with the short term high-growth high-inflation combination. President Kirchners reelection bid is clearly benefiting from the dividends of an expanding economy and the fact that the opposition camp remains deeply divided in part a reflection of profound ideological and political differences among the political forces that oppose the government. Recent polls show that President Kirchner will be easily reelected in the first round of vote and her political party may even regain control of Congress. President Cristina Kirchner has not presented a wellarticulated governing program for the next four years and has instead advocated in rather general terms deepening the current model during a likely second term. This is in our view a strong indication of broad policy continuity. The Kirchner policy model has been characterized by ad-hoc and unsystematic populist policy moves geared to maximizing domestic growth/consumption.
As such, we expect the administration (after the likely reelection) to react to policy challenges as they emerge rather than embark on the execution of a clear-cut government program for the next four years. In essence, we expect policy to be guided by a small set of objectives: deliver high growth and employment creation even if that entails validating higher inflation, preserve the core of a number of cross-subsidies (energy, transportation) and taxes (agricultural sector), and maintain a trade balance surplus through the pursuit mercantilist and protectionist measures in order to shore up the current account and protect the stock of international reserves. However, we expect policymakers to face significantly deeper macro challenges ahead that those faced currently as the current policy mix is showing increasing signs of distress even under a still favorable external environment. In all, the government may be called to compromise on some of its objectives during a potential second term: e.g., accept slightly lower growth to prevent the inflationary pressures from escalating; validating faster currency depreciation to shore up the current account; target/focus the growing public subsidies in order to protect the budget. Obviously, the policy trade-offs would become more severe if the external backdrop were to turn adverse; a state of the world that has a growing possibility of materializing. Alberto M. Ramos
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September 23, 2011
Focus: Brazil
Potential Effects and Policy Response to the European Crisis
In light of the deterioration of the financial situation in Europe, it is timely to understand how the Brazilian authorities would respond to a new global financial crisis. Brazil is capable of dealing with financial shocks because the fiscal and external accounts are in reasonable shape; the domestic banking system is strong; the stock of reserves is large; and there is ample fiscal and monetary leeway to implement countercyclical macro policies. In addition, the economic team is experienced at crisis management. Strong external financial shocks would shift the BoP to a deficit, weaken the BRL, reduce credit growth, and strain the banking system. This would reduce real GDP growth, open an output gap and probably reduce inflation, opening the scope for lowering interest rates. The Rousseff administration is likely to implement a countercyclical policy response similar to that used in 2008. However, they are likely to be more proactive, easing macroeconomic policies sooner, perhaps attempting more aggressive sector-oriented policies than before. We believe that the authorities should implement ambitious structural reforms aimed at boosting total factor productivity and real GDP growth, making the economy more resilient to global business cycles in the future.
The Effects of the European Crisis in Brazil

The deterioration of the sovereign and financial crisis in Europe begs three questions: (1) How will it affect Brazil? (2) How will the authorities respond to it? and (3) Are there any other measures that the authorities should be considering? To this end, it is useful to understand what the transmission channels from a financial shock from Europe to Brazil would be; how the Lehman crisis affected the economy and how the authorities responded to the crisis in 2008; and how the Rousseff administration would respond to severe global shocks if the financial crisis were to worsen. To be clear, the Goldman Sachs European Economic Team does not envisage a disorderly resolution of the European sovereign and financial crisis. They recently 1 summarized their views as follows: we continue to view scenarios involving a break-up of the Euro area as extreme. The significant costs incurred by those leaving, those remaining and other bystanders in the global economy render such an event highly unlikely. Looking forward, the most likely scenario is a continued transfer of credit risk onto public-sector balance sheets (notably that of the Eurosystem), as a mechanism for avoiding disorderly default by a sovereign or systemically-relevant bank(s). As we have argued in the past, the ECBs capacity to absorb further assets onto its balance sheet (both directly and indirectly) remains significant. The existing situation can therefore persist for some time. In addition, the availability of liquidity facilities and the new swap lines
1 European Economic Analyst: 11/30 Next Steps for the Euro area A primer, by Huw Pill and Adrian Paul.
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from the ECB reduce the likelihood of the reoccurrence of a shock to short-term funding markets as we experienced during the Lehman crisis in 2008. Our forecasts for Brazil and Latin America are consistent with this view about Europe. Therefore, our macroeconomic forecasts assume a further but mild deceleration in global real GDP growth followed by a moderate recovery from mid-2012 onward. In addition, our forecasts assume a slight increase in commodity prices and no disruptions to emerging market financing. On the basis of this global scenario we forecast that in Brazil, real GDP growth will slow to 3.7% in 2011, recovering slightly to 3.8% in 2012. With this in mind, in this focus piece we explore an illustrative scenario just to understand qualitatively what could happen to the Brazilian economy and macro policy response if the European financial crisis and the outlook for the global economy worsened. In this illustrative scenario, we would have a complex combination of contractionary real shocks (reducing global growth, international trade volumes, and commodity prices below our baseline scenario) and sizable financial shocks (raising volatility in financial markets, increasing risk aversion and cutting capital inflows to emerging economies).
Transmission Channels of External Shocks to Brazil

There are two main channels of transmission for a global financial to Brazil: a financial and a trade channel, with both working through the balance of payments. The financial channel would reduce net capital inflows sharply and lead to market dislocations triggered by a
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sharp increase in volatility (for example, the exchange rate). The trade channel would transmit a contractionary real trade shock (lower export volumes as global growth declines) and worsen the terms of trade, resulting from lower commodity prices if the financial shock reduces global growth and trade volumes. We believe that the strongest channel for Brazil is the financial channel, because net capital inflows to Brazil are large and the share of Europe in external financial flows is high. From Chart 1, we can see that FDI flows from Europe to Brazil are large. Equally important but not shown are trade and interbank lines from European to Brazilian banks. From Chart 1 we conclude that in the last two years, about two-thirds of FDI flows came or were registered in Europe. Accordingly, in the last two years, about two-thirds of the remittances of profits and dividends went to Europe (Chart 2).
Chart 1: Two-thirds of Brazil FDI Inflows Come from Europe, 2009-10 avge
(% of total) Asia 9 W.Hem. ex-USA 12 USA 13 Europe 64 Other 2
European parent companies, FDI inflows may decline while remittances of profits and dividends may rise. Another channel of contagion would be the tightening of financial conditions for European banks operating in Brazil. While the presence of foreign banks is important in Brazil, systemically speaking their share in Brazil is small when compared to other countries in Latin America. Specifically, in June 2011, foreign banks accounted for about 20.2% of the total net worth, 33.4% of total loans, and 18.2% of total assets of the Brazilian banking system. The share of European banks is relatively small at 18.5%, 25.7%, and 14.1% of net worth, total loans, and total assets of the banking 2 system, respectively (Chart 3). Therefore, we believe that contained problems in the banking system in Europe would not pose systemic risks for the Brazilian financial system.
Chart 3: The Participation of Foreign and European Banks in the Brazilian Banking System is Small
(% of total) 35 30 25 20 15 10 5 0 Total Assets
Source: Sisbacen.
European banks 7.7
Other foreign banks
1.7 4.1 25.7 14.1 18.5
Loans
Net Worth
Source: BACEN.
Chart 2: Accordingly Remittances of FDI Profits/dividends from Brazil Go Mostly to Europe, 2009-10 avge Other, 1
(% of total) Asia, 4
W.Hem. ex-USA, 9 USA, 17 Europe, 69
Turning to international trade, Europe is an important trading partner of Brazil, because it accounts for 19.4% of the destination of exports and 18.5% of the origin of imports (Chart 4). Therefore, a large hit to growth in Europe will be important for the Brazilian economy. Nonetheless, a large share of exports are commodities, which can go anywhere else, while imports are likely to decline significantly following a large global trade 3 shock. In addition, the trade balance can be surprisingly resilient because large hits to exports are offset by significant import cuts. In all, when considering a global financial and real shock, we believe that the financial channel will be more important than the trade channel.
Source: BACEN.
2
This means that the curtailment of trade and interbank lines could reduce hard-currency funding to local banks, thus reducing the ability of domestic private banks to lend. This tightens trade financing and reduces exports. In addition, as financial conditions tighten for
Issue No: 11/19
The bulk of foreign bank participation is through equity investment in Brazilian banks, with the minority of the exposure consisting of operations of affiliates in Brazil. 3 This was an important difference for the transmission of trade shocks in the 2008 crisis. The hit to trade in Mexico was much larger than for Brazil, in part because the shock to manufacturing exports to the United States was particularly severe, while the hit to commodity exports was milder. 8
September 23, 2011
Chart 4: LatAm Trade Shares w/ Euro Zone, 200510 avge

(% Total) 19.4 19.4 18.5 Exports Imports
inflation, thus creating conditions for COPOM to cut interest rates.
Transmission of the Lehman Shock to Brazil in 2008

Although the global financial shock (or the Lehman shock) of 2008 was one of a kind in terms of its global breadth, speed, intensity, and policy response, it is a useful reference for us to understand how large global financial shocks are transmitted to Brazil and how the authorities are likely to respond to these shocks. As we noted earlier, the financial crisis in Europe is different, because the problems are more concentrated on sovereign issues while the availability of ECB facilities to deal with liquidity issues makes the short-term funding freeze experienced in 2008 unlikely. The Lehman shock shifted the balance of payments from large surpluses to large deficits, particularly during 4Q2008. The financial shock led to a sudden stop in capital inflows, shifting the capital account to a cumulative deficit of US$17.2 billion in 4Q2008 from a cumulative surplus of US$42.8 billion in the year through August 2008. The biggest hits to the capital account were felt by portfolio capital, which shifted to outflows from inflows; the curtailment of medium- and long-term external financing (as the rollover ratio fell to only 22% in November from 167% in January); and the drying up of interbank credit lines and short-term trade financing (leading to net outflows of US$11.4 billion). Moreover, domestic banks were squeezed because interbank lines dropped 11% between August and October 2008, which in turn helped contract domestic credit growth. By contrast, FDI proved to be more resilient than other modalities of capital, slowing to an average of about US$2 billion per month in January and February 2009 from an average of US$3.4 billion 5 before August (Chart 5).
Chart 5: FDI Inflows Slowed, Remittances of Profits Rose During the Crisis, 4Q08-1Q09
(% chge) 50.0 30.0 10.0 -10.0 -30.0 -50.0 -70.0 Jan-Sep 2008
14.8
14.0 11.5 11.711.6 9.6
14.2
9.0
3.9
ARG
BRA
CHI
COL
MEX
PER
With these facts in mind, we explain how the shocks could affect the Brazilian economy. On the external front, the combination of a strong global financial and trade shocks would shift the balance of payments to a deficit from a large surplus currently, weakening the BRL substantially. Being a forward looking asset price, the BRL has already weakened in anticipation of such a shock. The financial shock would reduce net capital inflows, particularly reducing trade financing, lowering the private sectors ability to refinance medium- and longterm debt, leading to portfolio outflows (as foreign investors unwind their positions in local equity and bond markets), and possibly lead of a shift of some liquidity by multinational companies to their parent companies. Currently, we are already observing portfolio outflows (both fixed income and equities) and a more selective access to debt financing. The trade shock would widen the current account deficit through the reduction of net exports (lower export and import volumes combined with deterioration in the terms of trade) and an increase in remittances of profits and dividends by multinationals. On the domestic front, the global financial shock would likely reduce the expansion of credit by private banks. A strong global shock would lower external credit lines to domestic banks and raise unemployment in Brazil, which would likely stress smaller domestic financial intermediaries, likely requiring capitalization and some 4 form of official assistance. In the absence of any countercyclical policy response by the government, these developments would reduce real GDP growth and capacity utilization, increase the rate of unemployment, and lower real wages. In turn, these developments would open an output gap, possibly reduce IPCA
4
FDI Profits/dividends outflow FDI inflow
49.6
11.5
-32.1
4Q08
1Q09
For a comprehensive review of the Brazilian financial system and stress tests to activity shocks, please refer to our article Credit Booms and Financial System Fragilities Demystified, in the Latin America Economic Analyst, August 5, 2011. 9
The figures are distorted by a large disbursement in December, raising the monthly figure to US$8 billion.
September 23, 2011
Issue No: 11/19
The freezing of global liquidity and the plunge in global industrial production led to a sharp drop in export and import volumes (Charts 6 and 7), as well as a cumulative drop of 13.9% in the Brazilian commodity price index IC-Br between September and March 2009. The drop in ACC trade financing and export volumes led to a plunge in net commercial flows in 4Q2008 to US$1.5 billion a month from an average of US$4.8 billion in the year through September 2008. In addition, multinational companies accelerated the outflows of profit and dividend remittances (Chart 5). By 1Q2009, the trade surplus was cut in half from $2.1bn in January-August 2008 to $1.0bn (Chart 8).
Chart 6: Brazil Exports Declided During the Crisis, 4Q08-1Q09...
(% chge) 50 40 30 20 10 0 -10 -20 -30 -40 Jan-Sep 2008
Chart 8: Trade Surplus Cut in Half in 1Q2009 After Crisis

(US$bn, avge) 2.1 2.0
1.0
Jan-Aug-08
Sep-Dec-08
Jan-Mar-09
Volume Price Value
4Q08
1Q09
Chart 7:...And Imports Fell Sharply As Well, 4Q08-1Q09

(% chge) 50 40 30 20 10 0 -10 -20 -30 -40 Jan-Sep 2008
Volume Price Value
The overshooting of the BRL had three causes. The most important was the unwinding of derivatives and structured products through which local corporates were massively short USD if the BRL weakened beyond R$1.70. The second was the freezing of USD liquidity, which dried up trade and interbank lines and medium- and long-term debt financing. The first two factors explain the surge in USD demand, particularly in futures markets and the explosion in vol. The third in order of importance was the real shock, leading to deterioration in the terms of trade and a plunge in export volumes (Charts 6 and 7). The drop in exports was partly offset by lower oil prices and lower import volumes (curtailed by lack of ACC trade finance). As a result, and despite the drastic gyrations in trade volumes and prices, the Lehman shock led to 22.1% drop in the non-oil trade surplus in 4Q2008. On the domestic front, the Lehman shock led to a sharp reduction in financial system credit by private (including foreign) banks to the economy. In addition, the explosion of derivate structures led to severe credit problems for large firms, which in turn became a large problem for the banking system. As activity plunged and unemployment rose, non-performing loan ratios rose to a record high during the credit expansion cycle initiated in 2003; as a result, an increasing number of 6 small intermediaries slipped into severe problems. In turn, this led to a flight to quality of deposits to large from small intermediaries, exacerbating the funding problem for small banks. In all, this exacerbated the contraction of non-official bank credit to the economy and stressed the domestic financial system in 4Q2008. Foreign banks were not the main culprit for the contraction of private bank credit observed in 4Q2008. This is mostly because as noted earlier, they do not have a dominant presence in the overall banking system
6
4Q08
1Q09
In all, the Lehman shock shifted the overall balance of payments to a cumulative deficit of US$23.5 billion between September 2008 and February 2009 versus a cumulative surplus of the same amount in the year through August 2008. In light of these external developments, and despite sizable intervention, the BRL overshot, depreciating 60.3% to R$2.50 in December 2008 versus R$1.56 at the end of July 2008.
The NPL ratio rose to a peak of 4.7% in October 2009 from the lows of 3.2% in September 2008. Since then the NPL ratio has declined to 3.1% in June 2011.
September 23, 2011
Issue No: 11/19
10
(Charts 3 and 9). This contrasts with the situation in Mexico, where the share of foreign banks is much larger than in Brazil and, for this reason, the contraction of credit in Mexico was much larger than in Brazil. The other reason is that the Brazilian government was much more aggressive in expanding credit through its official banks than the Mexican authorities.
Chart 9: European Bank Claims on Brazil Are Small...
(% Assets) 5 4 3 2 1 0 SPA NETH POR UK
Source: Haver Analytics, BIS, IMF IFS, Goldman Sachs.
problems in the banking system; and (3) the resulting drop in domestic demand and real GDP growth. The problems in the FX market resulted from (1) the fact that global credit markets shut down, curtailing trade and interbank financing and closing the access to local firms to debt financing in international capital markets; and (2) the unwinding of derivative products 7 that were triggered by the overshooting of the BRL. BACEN corrected the problems quickly. BACENs strategy aimed at fulfilling the requirements of the FX markets where they had dried up, be it in the spot, forward, or vol market for FX. With this in mind, BACEN: (1) intervened directly in the spot FX market by auctioning a total of US$11.1 billion of reserves; (2) auctioned a total of US$7.3 billion in trade lines; (3) auctioned US$4.7 billion of USD loans with a repurchase agreement; (4) announced a program of US$50 billion of USD swaps, of which BACEN sold US$12 billion; and (5) obtained from the US Federal Reserve a total line of USD swaps totaling US$30 billion. By completing the FX markets in terms of lines, spot, forwards and vols, BACEN limited the extent of the exchange rate overshooting and the damage caused by the structured products. This approach limited the strength of the contagion of the Lehman crisis through the financial channel. An interesting lesson to apply today is that even under a sizable global shock, ex-post the loss of reserves and sale of swaps was small relative to international reserves. The problems in the banking system resulted from (1) the hit to banks balance sheets resulting from the FXrelated losses in structured products made by their large corporate clients; (2) the tightening of external funding and credit availability; and (3) the flight to quality as smaller financial intermediaries lost deposits to larger banks and could not unwind their concentrated loan 9 portfolios. With this in mind, BACEN adopted a three-pronged strategy: (1) to initially focus on the provision of sizable liquidity to the banking system by cutting reserve requirements and adopting unconventional mechanisms to provide funding and liquidity to banks; (2) facilitate the acquisition of smaller by stronger institutions; and at a later stage (3) shift to conventional monetary tools to provide liquidity by implementing large cuts in interest rates.
8
2005-10 avge 2010
3.24 2.35 1.77 0.63 0.49 FRA
In all, the Lehman shock led to a 6.1% cumulative drop in quarterly real GDP growth from 1Q2009 versus 3Q2008. The main hit to growth was experienced by the manufacturing sector, which contracted 17.1% during this period, while commerce declined 10.8%. From the demand side, private consumption declined only 1.0%, with the biggest hits being felt by the foreign balance and gross fixed investment. During this period, the crisis led to a massive involuntary accumulation of stocks.
Policy Response by the Lula Administration to the Lehman Shock

Of the major economies in Latin America, Brazil had the boldest and strongest policy response to the Lehman crisis. In addition, the authorities had at their disposal a powerful arsenal of policy instruments because interest rates and reserve requirements were very high, fiscal policy was sound, and public banks were not expanding credit as aggressively as they are now. The most notable feature of the authorities policy response in 2008 was to properly identify where were the disruptions or problem areas in the economy and use new instruments to address the problems. This approach was the main reason why the effects of the Lehman crisis in Brazil were milder and shorter than elsewhere. There were three main problem areas that required the authorities attention during the crisis: (1) severe dislocations in the FX market; (2) the development of
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According to Mesquita and Tors (see reference 8 below), the total delta of these derivatives positions amounted to US$37 billion. 8 For a comprehensive description of the policy response by the Central Bank of Brazil see Consideraes sobre a Atuao do Banco Central na Crise de 2008, by M. Mesquita and M. Tors, Trabalhos para Discusso No. 202, BACEN, March 2010. 9 Between October 2008 and January 2009, total bank deposits grew 13%, but the deposits in large banks rose 20%, while the deposits in medium- and small-sized banks declined 11% and 23%, respectively. 11
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The effective reduction in reserve requirements amounted to R$116 billion, or 4% of GDP. In addition, the authorities linked the reduction in reserve requirements to measures aimed at improving the distribution of liquidity from the larger and stronger banks to the smaller and weaker institutions. This was achieved by allowing large banks to use their purchase of loan portfolios to reduce their reserve requirements. In addition, BACEN improved the use of rediscount and it strengthened the credit insurance fund (or FGC) to increase funding for smaller institutions that relied excessively on time deposits. The problems resulting from the drop in domestic demand were addressed by using expansionary fiscal, credit, and monetary policies. On the fiscal side, the government reduced the industrialized products tax (IPI) on vehicles and electronics products, which boosted industrial production. On the credit side, the government injected fresh capital in its three main official banks to allow them to boost credit to the private sector, thus partly compensating for the 10 retrenchment of private banks from credit markets. The decisions regarding interest rate policy were not straightforward, because COPOM had to strike a balance between the need for liquidity versus the reality of rising inflation. Initially, COPOM concluded that the best thing to do was to provide liquidity to the banking system through quantities instead of the benchmark interest rate. This is because at the onset of the Lehman crisis inflation was still rising toward the ceiling of the band. Growth was strong, capacity utilization was tight, and expected inflation was rising as investors worried that a weaker BRL would pass through to inflation. For this reason, in September COPOM concluded the ongoing tightening cycle by raising SELIC 75 bp to 13%. In January, the outlook for the global economy had continued to worsen and real GDP growth had plunged in Brazil in 4Q2009. This shifted COPOMs attention to the rising risk of a recession in Brazil. For this reason, only four months after the onset of the crisis that COPOM slashed SELIC by 100 bp in January. This was followed by even larger rate cuts (150 bp in March) leading to a cumulative easing cycle of 500 bp 11 and a SELIC rate of 8%.
USD liquidity for domestic firms, limiting the extent of the exchange rate overshooting and allowing it to recover as global conditions improved. In the domestic credit market, monetary and credit policies provided for a much stronger expansion of credit than in other large economies in the region. The measures implemented by BACEN safeguarded the integrity of the financial system and avoided the development of a banking crisis. In all, the policy response limited the contraction of quarterly real GDP to only 4Q2008 and 1Q2009, with activity rebounding strongly thereafter. As a result, the drop in real GDP growth was capped at -0.6% in 2009. However, while the timing and choice of policy instruments was commendable, perhaps the authorities erred on the side of injecting too much stimulus to domestic demand and taking too long to tighten financial policies as global and domestic economic activity conditions improved from 2H2009 onward. As a result, the extended stay of the countercyclical policy strategy was responsible for the strong expansion in real GDP growth in excess of 10% in 1Q2010 and the strong rebound in inflation which persists until today.
Policy Response to Global Financial Shocks by the Rousseff Administration

We believe that the policy response by the Rousseff administration to global financial shocks will be similar to the crisis management approach used by the Lula administration. The response is likely to be quick, strong, and comprehensive, with the two main priorities being to preserve growth and employment and safeguard the banking system. However, there are important differences: the Rousseff administration is much more focused on stimulating and protecting growth and employment, while the Lula administration was more intransigent about inflation. We also believe that the Rousseff administration will be more proactive and unconventional in its choice of policy instruments than the Lula administration. For example, this means that the Rousseff administration is likely to cut interest rates earlier, easing as soon as it perceives that the risks of a contractionary global shock increased. This is precisely what happened on August 31, when COPOM cut SELIC by 50 bp to 12.00%. At least in its rhetoric, the Rousseff administration sounds more conservative about the use of fiscal policy. The official line is that as this is a global sovereign debt crisis, the government should tighten fiscal policy to differentiate Brazil from the advanced economies and other emerging markets, preserving market access without raising sovereign bond yields. In practice, we believe that if the sovereign/financial crisis abroad intensifies, the government will ease fiscal policy aggressively to stimulate domestic demand. For
12
September 23, 2011
Lessons from the Lehman Shock

The policy response by the Brazilian authorities to the Lehman crisis was strong and effective, mitigating the global shock in the Brazilian economy. In the FX market, the government partly offset the drying out of
10 As a result, the share of official banks in total financial system credit outstanding rose to 34% in June 2009 from 28% in August 2008. 11 In 1Q2009, the yoy IPCA inflation rate was slowly declining, averaging 5.9%; IPCA inflation closed 2009 below the target, at 4.3%.
Issue No: 11/19
example, when it comes down to the forecasts for GDP growth, the draft Budget for 2012 is much more optimistic than COPOM is, perhaps designing a budget that is inconsistent with lower growth in Brazil. The Rousseff administration is more comfortable than its predecessor in experimenting with new economic policies that are more activist and directly intervene in relative prices/ resource allocation. For example, in order to protect the ailing manufacturing industry, last week the government levied an additional import duty on imported automobiles of 30%, reducing the tax on domestic vehicles by 7%. We believe that we should expect more measures of this type in the future. We believe that the Rousseff administration will use the official banks to expand credit if private banks retrench. However, this administrations scope for action will be more limited because the balance sheets of the official banks and of the Treasury (for funding) are more stretched than they were in 2008. Turning to FX policies, the Rousseff administration has two advantages over its predecessor: there is no comparable stock of structured or derivative products that could unravel as the BRL weakens; and, at US$352.2 billion, the stock of net international reserves is 71% higher than it was in September 2008. However, today, Brazils external financing needs are higher because the current account deficit increased and the external debt service is rose. The latter is because the stock of short-term debt and medium-and long-term corporate debt rose about 50% and 100% during this period, to US$49.5 billion and almost US$195 billion, respectively. In all, we believe that FX policy response will be similar: (1) BACEN is likely to auction reserves to complete the spot market; (2) BACEN is likely to sell USD swaps to complete the vol market; and (3) if needed, BACEN could reintroduce the auction of USD liquidity for trade financing and interbank credit or simply for external debt service for a period of less than two years. It is also likely that if capital inflows evaporate and the BRL comes under severe pressure, the government may reduce the IOF tax rate on foreign fixed income investments in local markets, reduce/eliminate the IOF tax on external borrowing by residents, and possibly postpone or even drop the plans to tax net FX positions through derivatives with the IOF tax. The framework for the implementation of monetary policy could be similar but more dovish than in 2008, because COPOM is likely to cut rates faster. Currently, we forecast that COPOM will cut SELIC two more times by 50 bp per meeting, which is in line with the CDI curve. Just to have a general figure (this is not our forecast), we believe that if Brazil is hit by a strong external shock, COPOM may cut SELIC by a total of 400 bp (including the cut of 50 bp implemented in
Issue No: 11/19
August), reducing SELIC to 8%. In addition, each individual rate cut may range between 100 bp and 150 bp. What happens to inflation will depend mainly on the outcome for growth, the output gap, and the extent of the exchange rate overshooting. Monetary policy would also be geared to provide liquidity to banks and to safeguard the integrity of the banking system. Therefore, we believe that COPOM is likely to: (1) cut reserve requirements; (2) allow banks purchasing distressed loan portfolios from weaker intermediaries to partly use these positions as a substitute for reserve requirements; (3) ensure that the guarantee fund (FGC) is well capitalized and able to assist institutions that heavily rely on certificates of time deposits to fund themselves; and (4) proactively seek the expeditious resolution of any liquidity or solvency problems in the banking system. The Rousseff administration is likely to increase government spending or provide temporary sales tax brakes (for consumption of consumer durables or capital goods) to stimulate domestic demand. This means that during a severe crisis, the government would quickly reduce its primary fiscal surplus below the target of about 3.1% of GDP. In addition, the government is likely to encourage official banks to increase lending if credit growth by private banks falters. As noted earlier, we believe that the scale of such programs will be smaller than those implemented during the Lehman crisis.
What Other Measures Should the Authorities be Considering?

Up to this point, the entire discussion of this note has a passive flavor, because it focuses on how the authorities will respond to a large global financial shock. Unfortunately, during these turbulent times we have lost sight of the active approach: what should the authorities be doing to bolster long term growth? How countries respond to global challenges will differentiate them more vis--vis investors than the reactive focus on crisis management. This is because the prolonged and painful deleveraging resulting from financial and sovereign crisis may keep global real GDP growth below the high averages achieved before 2008. Therefore, emerging economies will have to dig deeper to collect those extra basis points of growth that they are currently leaving on the table. From simple development economics and just by observing some of the fast-growing economies in emerging markets, it is clear that Brazil could find more sources of growth at home while the advanced economies conclude their adjustment process. The authorities can achieve this by strengthening economic policies, increasing economic efficiency, investing in human capital and building strong and modern institutions and infrastructure. In turn, this requires
13
September 23, 2011
ambitious fiscal and tax reforms, social security reforms, and labor market reforms, just to quote a few.
Conclusions
Overall, we believe that the Brazilian economy is in reasonably good shape to deal with a strong mix of contractionary financial shocks from the advanced economies. This is because the fiscal and external accounts are in reasonable shape, the domestic banking system strong, the stock of international reserves is large compared to its external financing needs, and there is fiscal and monetary leeway to implement countercyclical macroeconomic policies. In addition, most senior members of the economic team already have significant experience from the 2008 crisis. We believe that the Rousseff administration will follow a similar policy response used in 2008. The main difference is that this administration is likely to be more proactive, easing macroeconomic policies sooner, perhaps attempting more aggressive micro or sectororiented policies than before.
Obviously, the precise macroeconomic outcome will depend on how external unfold in coming weeks and the exact wisdom and sequencing with which the government will use its ample set of macroeconomic tools. More broadly, we believe that the long-term outlook for the Brazilian economy is bright, but it should not be taken for granted. While the authorities have no control over external events, they have full control over their ability to implement ambitious structural reforms aimed at boosting total factor productivity in the future. In this way, the government can raise sustainable real GDP growth while at the same time making the economy more resilient to global business cycles. Paulo Leme
Issue No: 11/19
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September 23, 2011
Country Views and Forecasts Argentina

According to Indec real GDP grew 9.1% yoy during 2Q2011, moderating only slightly from the high 9.9% yoy expansion recorded during 1Q2011. In sequential terms the growth momentum remained high: (+2.5% QoQ sa; 10.2% annualized) moderating from 1Q2010 (3.1% QoQ sa; 13.1% annualized). The economys cyclical expansion has been driven by overly stimulated domestic demand. Investment spending grew a high 23.8% yoy and private consumption expanded +11.5% yoy. Net trade continues to be a drag on growth given the ongoing ARS appreciation in real terms and admittedly above-trend growth. Export growth decelerated sharply to 0.5% yoy during 2Q but import growth remained very high at +24.9% yoy. Hence, the contribution of net exports to growth deepened to -3.1 percentage points of GDP. The economy was exceptionally dynamic in yoy and sequential terms during 1H2011 on the back of very significant fiscal and monetary stimulus, solid external demand and very favorable terms of trade. Furthermore, fiscal and monetary policy remained highly stimulative so far during 3Q2011 given the approaching pivotal October presidential elections.
2010 2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (yoy, e.o.p.) * External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate ($/ARS, e.o.p.) Gross International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) 30-Day CD Rate (e.o.p.) Fiscal Sector Federal Govt Primary Balance (%GDP) Federal Govt Overall Balance (%GDP) Debt Indicators Gross Non-fin. Public Sector Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP)
* Official inflation index. Issue No: 11/19
Solid Real GDP Growth

(% yoy; n.s.a.) 14 12 10 8 6 4 2 0 -2 1Q08 3Q08 -0.8 -0.3 1Q09 3Q09 1Q10 3Q10 1Q11 8.5 7.8 8.6 6.9 4.1 2.0 2.6 6.8 9.2 11.8 9.9 9.1
2011 Q4 9.2 99 10.9 -0.5 2.1 19.5 45.7 3.97 52.2 31.6 14.6 9.63 1.7 0.2 47.7 28.0 19.7 38.0 Q1 9.9 98 9.7 -0.7 2.5 31.1 38.6 4.06 51.3 36.8 14.7 9.48 1.7 0.2 47.7 28.7 19.0 36.7 Q2 9.1 122 9.7 1.5 4.1 20.2 37.3 4.11 51.7 39.6 15.2 9.65 1.5 0.0 43.7 20.4 23.3 36.3 Q3F 9.7 112 9.6 -0.4 2.6 15.0 23.5 4.25 49.6 33.0 14.3 9.60 1.4 0.0 41.8 15.7 26.1 35.0 Q4F 6.9 115 9.8 -1.9 0.7 9.2 19.0 4.35 48.0 28.0 14.8 9.80 1.3 -0.5 40.7 22.0 18.7 34.0
Q1 6.8 79 9.7 -0.6 3.1 9.4 32.7 3.87 47.5 18.6 13.3 9.11 1.4 -0.8 57.3 30.8 26.5 46.5
Q2 11.8 97 11.0 3.3 6.2 23.3 50.5 3.93 49.2 22.3 13.5 9.00 1.7 -0.4 52.2 29.0 23.2 41.7
Q3 8.6 93 11.1 0.9 4.0 35.6 49.3 3.96 51.1 29.7 13.9 9.27 2.2 0.2 49.3 28.2 21.2 39.6
0.9 307 7.7 3.6 6.0 -20.5 -32.0 3.80 48.0 11.5 13.5 9.53 1.5 -0.6 57.9 30.2 27.8 47.9
9.2 368 10.9 0.8 3.9 22.4 45.0 3.97 52.2 31.6 14.6 9.63 1.8 0.2 47.7 28.0 19.7 38.0
8.9 446 9.8 -0.3 2.5 18.1 28.6 4.35 48.0 28.0 14.8 9.80 1.3 -0.5 40.7 22.0 18.7 34.0
3.5 464 13.2 0.5 3.2 5.2 0.7 5.10 49.0 21.0 15.4 9.00 1.8 -0.3 41.0 22.1 18.9 33.7
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September 23, 2011
Brazil
On September 29, FGV will report IGP-M inflation for September. We forecast an increase to 0.65% (mom) from 0.44% in August. On a yoy basis, this implies that IGP-M will decline to 7.47% from 8.00%. On the week of October 3, the National Confederation of Industries will report the capacity utilization index (NUCI-CNI) for August. We forecast that the NUCI-CNI declined further to 81.9% (nsa) from 82.1% in July. On October 4, IBGE will report industrial production for August. We forecast that IP contracted 0.25% (mom, seasonally adjusted) in August from +0.50% in July. In a yoy basis, this translates into a 1.77% increase from -0.3% in July. On October 7, IBGE will report IPCA inflation for September. We forecast that IPCA inflation rose to 0.55% in September from 0.37% in August. On a yoy basis, this translates into an increase to 7.33% from 7.23% in August.
IPCA Inflation (yoy) Likely Peaked in September
(% yoy; eop) 9 8 7 6 5 4 3 2 1 0 04 05 06 07 08 09 10
Source: IBGE; BACEN. Goldman Sachs forecasts.
IPCA
7.3
2010 2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (yoy, e.o.p.) External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate ($/BRL, e.o.p.) Gross International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) Selic Rate (e.o.p.) Fiscal Sector Public Sector Primary Balance (%GDP) Public Sector Overall Balance (%GDP) Debt Indicators Net Public Sector Debt (%GDP) Net Domestic (% GDP) Net External (%GDP) Total External Debt (%GDP) 42.8 52.0 -9.2 10.1 40.2 50.0 -9.8 11.3 39.8 49.8 11.3 39.0 49.2 11.8 42.0 51.4 -9.5 10.9 41.1 50.5 -9.7 11.3 40.3 50.0 -9.7 11.6 40.2 50.0 -9.8 11.3 39.9 50.5 11.7 2.0 -3.3 2.8 -2.6 2.6 -3.0 2.7 -2.9 2.0 -3.4 2.1 -3.3 2.9 -2.3 2.8 -2.6 3.2 -2.3 12.6 42.6 24.6 44.6 14.0 45.6 10.0 46.3 16.0 42.2 8.75 14.7 42.7 20.8 43.5 24.6 44.6 14.8 44.6 -1.5 1.6 -22.7 -26.2 1.74 -2.3 1.0 32.0 42.3 1.67 -2.2 0.8 28.0 30.4 1.62 -2.5 1.0 16.5 15.6 1.78 -2.6 0.2 25.8 36.0 1.78 -2.4 1.4 28.8 54.2 1.80 -2.1 0.9 33.2 47.3 1.69 -2.0 1.3 38.3 33.4 1.67 -2.6 0.6 30.6 25.4 1.63 -0.6 4.3 7.5 5.9 3.7 6.6 3.8 5.6 9.3 468 5.2 9.2 503 4.8 6.7 545 4.7 5.0 587 5.9 4.2 566 6.3 Q1 Q2 Q3 Q4 Q1
2011 Q2 3.1 644 6.7 -1.7 1.5 34.2 33.3 1.56 Q3F 3.5 666 7.3 -2.5 0.6 29.2 33.5 1.60 Q4F 3.9 693 6.6 -2.2 0.6 19.5 28.7 1.62
1625 2099 2567 2635
239.1 288.6 359.6 344.0 244.0 253.1 275.2 288.6 317.2 335.8 346.0 359.6 19.3 45.3 16.0 45.0 14.0 45.6
8.75 10.75 11.00 11.00
10.25 10.75 10.75 11.75 12.25 12.00 11.00 3.5 -2.2 39.7 50.4 11.9 2.5 -3.0 39.6 49.5 -9.9 11.6 2.6 -3.0 39.8 49.8 -10.0 11.3
-10.0 -10.2
-10.6 -10.8
Issue No: 11/19
16
September 23, 2011
Chile
The inflation picture remains benign. The main drivers of inflation during January-August were energy (+10.6%) and fuels (+12.8%). Furthermore, food prices rose by 3.5% during January-August 2011 and are up 6.0% yoy. Hence, ex-food and energy consumer prices are running at a very mild 1.2% yoy. Finally, core inflation pressures also remain well contained: IPCX1 is running at a low and below-target 1.5% yoy. Services inflation is running at an above-target 4.6% but that has been to some extent partially compensated by the low 2.0% yoy increase in goods prices (tradable goods inflation has been anchored by a strong CLP). The constructive inflation picture amidst still solid real sector dynamics should encourage the central bank to remain on hold at a broadly neutral 5.25% over the next few months and to continue to intensely monitor the evolution of the global backdrop. We expect the MPC to act flexibly going forward and to only entertain the possibility of adding monetary stimulus to the economy if the external impulse to growth weakens very significantly, leading domestic activity to downshift to a clearly below-trend pace (under 4.5%).
2010 2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (yoy, e.o.p.) External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate ($/CLP, e.o.p.) Gross International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) Interest Rate 90 Day PDBC (%) Fiscal Sector Public Sector Primary Balance (%GDP) Public Sector Overall Balance (%GDP) Debt Indicators Central Govt Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP) 6.1 1.6 5.3 45.3 7.4 1.3 6.1 42.3 7.3 1.2 6.1 37.1 7.2 1.2 6.0 35.9 -3.9 -4.4 0.1 -0.4 3.4 2.8 2.7 2.0 -1.4 70.2 0.48 11.2 65.8 3.40 14.0 66.7 5.50 12.0 70.0 5.50 4.2 0.50 6.4 1.44 5.4 2.99 11.2 3.40 11.0 4.26 16.8 5.55 13.6 5.35 14.0 5.50 1.6 8.8 -18.5 -30.9 501 25.4 1.9 7.8 31.5 38.3 475 27.9 -1.0 5.2 17.7 28.3 460 38.0 -1.9 3.5 4.5 10.1 480 38.6 4.6 10.4 42.7 31.6 523 25.6 1.1 6.1 27.1 47.3 537 25.2 -0.1 7.1 30.8 43.9 494 26.5 2.1 7.7 27.6 31.6 475 27.9 0.3 7.3 21.0 35.0 480 31.5 0.0 6.3 30.6 31.1 469 34.9 -1.6 4.4 15.0 25.0 460 36.8 -2.4 3.2 7.0 24.0 460 38.0 -1.7 161 -1.5 5.2 203 3.0 6.6 245 3.3 5.4 267 3.0 1.7 46 0.3 6.4 49 1.2 6.9 51 1.9 5.8 57 3.0 10.0 56 3.4 6.8 62 3.4 4.7 62 2.9 5.2 65 3.3 Q1 Q2 Q3 Q4 Q1 2011 Q2 Q3F Q4F
Core Inflation Still Below the 3.0% IT

(%yoy) 9 6 3 0 -3 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11
Source: Central Bank of Chile and Goldman Sachs.
CPI CPI Core Inflation Target
Issue No: 11/19
17
September 23, 2011
Colombia
The central bank bought US$440 million from the market in August. During January-August the central bank bought US$3.3 billion from the market. Although the central bank FX intervention program entails the purchase of at least US$20 million/day, so far the central bank has bought only the minimum amount consistent with the program. Despite the buoyancy of imports, the trade balance posted a US$546 million surplus in July (up from a US$83 million deficit a year ago) as exports posted an even stronger performance anchored in high commodity prices and solid crude oil export volume growth. Year to date the trade balance posted a US$2.75 billion surplus, up from US$1.90 billion during the same period in 2010. The mining sector trade surplus rose to US$17.1 billion during January-July 2011 from US$10.6 billion during January-July 2010, more than offsetting the observed deterioration of the industrial sector deficit to US$14.5 billion from US$9.0 billion during January-July 2010. Well-anchored medium-term inflation expectations, particularly at the core level, are a major source of comfort to the central bank, particularly when there is still no evidence of clear demand-pull pressures on inflation. After all, core inflation is still running below the 3.0% inflation target midpoint.
2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (yoy, e.o.p.) External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate ($/COP, e.o.p.) Gross International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) Interest Rate (e.o.p.) Fiscal Sector Public Sector Primary Balance (%GDP) Public Sector Overall Balance (%GDP) Debt Indicators Gross Non-fin. Public Sector Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP)
Issue No: 11/19
Well Anchored Headline and Core Inflation

(%) 8 7 6 5 4 3 2 1 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Headline; yoy Core; yoy
Source: Banco de la Repblica and Goldman Sachs.
Q1 4.1 68 1.8 -1.9 1.6 20.3 9.2 25.1 10.0 3.99
2010 Q2 Q3 4.7 70 2.3 -2.1 1.8 10.7 8.7 1916 26.0 16.7 3.70 3.6 74 2.3 -4.7 -0.5 14.7 28.0 1800 26.9 11.8 3.50
Q4 4.8 76 3.2 -3.7 0.3 19.6 28.7 1914 28.1 13.5 3.46
Q1 5.1 78 3.2 -2.5 1.5 35.0 38.9 1879 29.5 12.9 3.51
2011 Q2 Q3F 5.0 83 3.2 -2.3 1.4 26.3 30.6 1780 30.8 14.0 3.91 6.2 83 3.5 -2.4 1.4 30.5 14.5 1800 30.5 16.0 4.55
Q4F 5.7 85 3.4 -2.6 1.1 21.4 15.5 1750 30.7 16.0 4.55
1.5 238 2.0 -2.2 1.1 -15.5 -18.8 25.0 6.8 25.8 4.12 0.7 -2.8 42.8 28.3 14.4 23.0
4.3 289 3.2 -3.1 0.7 21.5 22.9 28.1 13.5 27.5 3.50 -0.9 -3.5 43.0 30.0 13.0 22.4
5.5 328 3.4 -2.4 1.3 28.5 24.3 30.7 16.0 28.6 4.55 -0.1 -3.5 44.0 31.2 12.8 21.0
4.9 345 3.0 -2.5 1.2 9.5 11.0 31.5 12.0 29.7 4.50 1.0 -2.5 43.2 30.6 12.6 21.1
2044 1914 1750 1900 1929
18
September 23, 2011
Dominican Republic
The IMF concluded a two-week mission in the context of its seventh review of the Stand-By Arrangement. In a press release, the IMF said that the development of the program remains broadly satisfactory. However, the IMF pointed to delays in the implementation of structural reforms, and said that the country has missed two performance criteria for endJune 2011. These were the target on the transfers to the electricity sector and the target on the consolidated fiscal deficit. This will require further adjustment but, in the view of the IMF, the fiscal measures adopted by the government makes it feasible to reach the fiscal objectives for year-end (i.e., consolidated public sector of 3% of GDP). The IMF lowered its growth forecast for 2011 to 4%-5% (from 5%-5.5% previously) due to the deterioration of the external backdrop. In addition, the IMF said that while inflation is running high (10% yoy), this is due to the effect of higher commodity prices that are likely to wane. We expect the program to remain on track, although this may require the IMF granting waivers for the missed targets, and the government implementing further adjustments. This would enable the disbursement the remaining US$500 million budgeted in the program.
2009 2010 2011F 2012F Activity and Prices Nominal GDP, US$ bn Real GDP, % yoy CPI Inflation, % yoy (e.o.p.) External Sector Current account balance, % of GDP Trade balance, % of GDP Exports of g & s, % yoy Imports of g & s, % yoy Gross international reserves, US$ bn Nominal exchange rate (e.o.p.) Monetary Se ctor Monetary base, % yoy Monetary policy rate, % Fiscal Sector Primary balance, % of GDP Overall balance, % of GDP Debt Indicators Total gross public sector debt, % GDP 28.3 Domestic External 10.8 17.6 28.6 9.4 19.2 31.4 11.4 20.0 34.8 13.8 21.0 -1.6 -3.5 -0.6 -2.5 0.8 -1.6 0.5 -2.0 16.1 4.00 8.1 22.0 5.00 21.0 6.75 20.0 6.75 20.0 20.7 4.00 19.5 20.9 4.00 17.4 21.3 4.00 8.1 22.0 5.00 2.2 21.8 6.00 1.5 21.7 6.75 6.75 6.75 Credit to the private sector, % of GDP 20.6 -5.0 -7.4 -9.8 3.3 36.2 -8.6 11.6 14.4 3.8 37.5 -9.0 7.6 8.6 3.4 39.0 -6.3 12.1 13.1 3.2 41.0 -7.3 8.7 13.5 2.7 36.5 -13.6 5.7 11.8 3.0 36.9 -13.5 15.5 20.6 2.7 37.3 -12.2 16.5 12.0 3.8 37.5 -10.8 6.3 8.4 3.0 37.9 8.0 10.0 2.9 38.0 8.0 8.0 3.2 38.5 8.0 8.0 3.4 39.0 -8.0 -11.7 -12.6 -10.0 46.8 3.5 5.8 51.8 7.8 6.2 54.3 4.2 9.4 58.6 5.2 5.9 11.9 7.5 7.4 12.7 7.5 5.4 12.4 7.7 5.7 14.7 8.3 6.2 12.9 4.3 7.6 13.6 3.7 9.3 13.4 4.5 9.9 15.6 4.4 9.4 Q1 2010 Q2 Q3 Q4 Q1 2011 Q2 Q3F Q4F
Still Constructive Short Term Outlook for Growth

(%, yoy ) 12 10 8 6 4 2 0 06 07 08 09 10 11F 12F
Source: Goldman Sachs; Haver Analytics.
Real GDP growth
So urce: Haver A nalytics; Natio nal So urces; Go ldman Sachs.
Issue No: 11/19
19
September 23, 2011
Ecuador
According to INEC, inflation in August increased 0.49% mom (4.84% yoy), up from 0.18% mom (4.44% yoy ) in July. The August 2011 inflation print is also significantly higher than the July 2010 print (0.11% mom; 3.82% yoy). The main contributor to inflation in July was food and beverages (0.67% mom; 7.28% yoy), followed by goods and services (1.11% mom; 4.79% yoy), and furniture (0.74% mom; 6.01% yoy). Moreover, the contribution from tradable goods (2.76% yoy) was larger than non-tradable goods (1.68% yoy). Inflationary pressures are rising amid higher imported inflation and more significant pressures from domestic factors. While the overall inflation remains moderate, the fact that it is on an ascending path poses a challenge to authorities because in a dollarized economy there is very little that authorities can do to counter the pressures. Against this background, authorities could be tempted to increase subsidies to consumers in order to counter the consequences of inflation. However, this would possibly lead to a further deterioration of the already-challenging fiscal outlook.
Headline CPI Inflation at 4.84 YoY
(%mom) 1.5 MoM 1.0 4.5 0.5 2.0 0.0 -0.5 Jun-09Oct-09 Feb-10Jun-10Oct-10 Feb-11Jun-11
Source: INEC and Goldman Sachs.
(%yoy) 7.0 YoY (rhs)
-0.5
2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (yoy, e.o.p.) External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate (1000 $/ECS, e.o.p.) Gross International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) Interest Rate (e.o.p.) Fiscal Sector Public Sector Primary Balance (%GDP) Public Sector Overall Balance (%GDP) Debt Indicators Central Govt Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP) 19.9 5.5 14.4 26.0 23.4 8.2 15.2 24.2 29.2 13.3 15.9 24.6 33.2 16.9 16.3 25.2 -3.8 -4.3 -1.4 -2.1 -4.8 -6.0 -4.8 -6.0 10.6 26.7 5.24 19.0 29.7 4.28 6.8 31.5 5.00 -2.7 28.1 5.50 -0.2 0.3 -26.0 -20.3 25.0 3.8 -3.1 -2.6 25.9 37.6 25.0 2.6 -3.3 -2.7 17.1 16.9 25.0 3.1 -3.6 -2.9 15.0 15.0 25.0 3.0 0.4 52.0 4.3 3.6 58.1 3.3 4.7 62.9 4.9 3.5 67.4 4.0
Q1 0.4 13.9 3.4 1.1 1.3 53.8 19.8 25.0 4.0 4.87
2010 Q2 Q3 2.5 14.2 3.3 -2.8 -1.8 33.0 47.1 25.0 4.1 4.40 4.5 14.6 3.4 -6.4 -6.5 8.2 47.6 25.0 4.4 4.25
Q4 7.0 15.5 3.3 -4.0 -3.0 18.0 36.1 25.0 2.6 4.28
Q1 8.6 15.6 3.6 1.3 1.3 23.8 24.1 25.0 4.0 4.59
2011 Q2 Q3F 3.5 15.2 4.3 -2.7 -2.0 15.1 15.1 25.0 3.8 4.58 3.5 15.7 4.9 -7.7 -7.0 15.0 15.1 25.0 4.3 5.00
Q4F 3.5 16.6 4.9 -3.9 -3.3 15.0 15.0 25.0 3.1 5.00
Issue No: 11/19
20
September 23, 2011
Mexico
The industrial sector continues to expand at a moderate pace given the still solid performance of the manufacturing sector (anchored in solid exports to the United States) and the gradually recovering construction sector. However, we expect the sector to loose further momentum in the months head given the headwinds coming from the United States. Gross fixed investment grew a solid 11.6% yoy in June (+0.65% mom sa) with investment in machinery and equipment up a high 27.2% yoy. Investment spending picked up pace over the last three months, but we are concerned that the investment recovery will loose momentum in the months ahead given the significant downward revisions of the outlook for real GDP growth in 2011 and 2012 and the deterioration in business sentient given the challenging global backdrop. According to the seasonally adjusted series, investment spending grew 14.1% between the October 2009 cyclical low and June 2011, but is still 6.2% below the July 2008 cyclical high. That is, investment has lagged what has so far been a moderate real business cycle recovery, which is consistent with the view that the economy still exhibits significant spare capacity in terms of resource utilization levels.
2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (yoy, e.o.p.) External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate ($/MXN, e.o.p.) Net International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) Tasa de Fondeo Rate (e.o.p.) Fiscal Sector Public Sector Primary Balance (%GDP) Public Sector Overall Balance (%GDP) Debt Indicators Gross Federal Govt Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP) 22.8 22.7 0.03 22.3 22.1 22.1 0.04 23.8 20.8 20.8 0.00 19.5 19.7 19.7 0.00 19.0 23.4 23.4 0.03 21.9 23.5 23.5 0.03 21.1 23.3 23.3 0.03 22.2 22.1 22.1 0.04 23.8 22.4 22.4 0.04 24.4 22.5 22.5 0.00 -0.1 -2.3 -0.9 -2.8 1.8 -2.5 1.9 -2.3 0.3 -1.8 -0.2 -2.2 -0.6 -2.6 -0.9 -2.8 -0.9 -2.8 -0.9 -2.9 9.4 13.5 4.50 9.7 13.3 4.50 9.0 13.8 4.50 9.0 14.0 4.50 11.9 13.2 4.50 8.7 13.1 4.50 12.3 13.2 4.50 9.7 13.3 4.50 6.3 13.5 4.50 10.0 13.7 4.50 13.9 4.50 13.8 4.50 -0.7 -0.5 -21.2 -24.1 -0.5 -0.3 29.9 28.6 -0.5 -0.3 12.4 12.5 -0.6 -0.7 6.8 8.1 0.2 0.2 34.1 27.5 95.7 -0.3 0.0 38.2 39.5 -0.7 -0.9 29.2 27.0 -1.2 -0.4 21.0 22.4 -0.4 0.7 22.8 20.6 -0.9 0.5 19.9 17.8 -6.1 880 3.6 5.4 4.4 3.9 3.3 3.7 3.3 4.5 242 5.0 7.6 257 3.7 5.1 258 3.7 4.4 279 4.4 4.6 281 3.0 3.3 299 3.3 4.0 307 3.2 3.8 311 3.3 1035 1197 1282 Q1 2010 Q2 Q3 Q4 Q1 2011 Q2 Q3F Q4F
Gross Fixed Capital Formation

(2003=100) 155 150 145 140 135 130 125 120 115 110 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 -15 -20 5 0 -5 -10 YoY % chg (n.s.a.) Index (s.a.; lhs) (%) 15 10
Source: Haver Analytics and INEGI.
13.06 12.36 11.90 11.90 12.46 12.66 12.50 12.36 11.97 11.84 11.85 11.90 90.8 113.6 144.6 169.8 101.4 108.3 113.6 122.7 129.4 137.4 144.6
Issue No: 11/19
21
September 23, 2011
Panama
During 1H2011 the economy grew by 10.3% yoy. Economic activity was propelled by domestic demand growth. In particular, the government is implementing a very ambitious public investment program that includes the expansion of the Panama Canal and other infrastructure projects. On the supply side, the main contributors to growth were construction (+19.2% yoy), retail (+15.2% yoy) and transportation, storage and communication (+15.1% yoy). Leading indicators of economic activity show that economic growth is moderating at the margin, but it remains strong, driven by expansionary fiscal policy. The government has signaled that it is not likely to change the fiscal policy stance. As a result, we updated our growth forecast for 2011 to 8.6% yoy from 7.8% yoy. This assumes that during the second half of 2011 economic growth moderates to 7% yoy from 10% yoy during 1H2011. This is a conservative estimate given the economic performance posted during 1H2011 and the fact that the government is determined to maintain the expansionary bias of fiscal policy. However, these factors are likely to be compensated during 2H2011 by a less supportive global economic outlook and the fact that the base of comparison would be less favorable during 2H211.
Buoyant Real GDP Growth (11.3% yoy in 2Q2011)
(%, YoY) 14 12 10 8 6 4 2 0 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11
Source: Comptroller General.
2010 2009 Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (e.o.p., yoy) External Se ctor Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate (e.o.p.) Gross International Reserves (US$bn) M onetary Sector Credit to the Private Sector (%GDP) Reference interest rate, % p.a.* Fiscal Sector Public Sector Primary Balance (%GDP) Public Sector Overall Balance (%GDP) Debt Indicators Gross Public Sector Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP) 3.2 24.1 1.9 -0.2 5.0 3.4 -11.7 1.0 3.0 89.2 3.5 1.9 -1.0 45.6 3.4 42.2 51.6 2010 7.5 26.8 4.9 -11.0 -4.8 4.6 21.1 1.0 2.7 90.0 2.5 1.2 -1.9 43.4 4.4 39.0 52.3 2011F 2012F 8.6 29.8 7.5 -9.8 -4.0 10.8 9.6 1.0 2.1 90.0 2.4 0.2 -2.4 41.5 4.0 37.5 48.7 7.0 33.1 7.0 -9.2 -3.9 6.2 6.3 1.0 1.3 90.0 2.2 1.2 -1.2 38.6 3.6 35.0 45.4 Q1 6.1 6.4 2.7 -9.0 0.3 9.5 5.5 1.0 3.0 Q2 6.5 6.5 2.8 Q3 8.3 6.7 4.2 Q4 8.7 7.1 4.9 Q1 9.7 7.1 5.5 -12.0 -5.2 25.1 35.3 1.0 -
2011 Q2F 11.3 7.5 6.1 1.0 Q3F 7.0 7.4 6.8 1.0 Q4F 6.5 7.8 7.5 1.0 -
-11.9 -19.1 -4.4 -8.1 -10.3 -1.2 2.6 -9.8 18.5 19.7 26.3 32.0 1.0 1.0 1.0 2.5 2.5 2.7 -
* Rates paid by lo cal banks o n 6-mo nth depo sits (annual averages).
Issue No: 11/19
22
September 23, 2011
Peru
The Central Bank released the inflation report for 3Q2011. In terms of the monetary policy outlook, the picture that emerges from the report is that of a neutral stance, with a greater probability that the next move is monetary policy easing rather than tightening. On the hawkish side, the central bank continues to characterize the current monetary policy stance as preventive pause. This suggest that there is a residual tightening budget that the central bank has decided to forgo for the time-being because the deceleration in global activity is likely to substitute for the need of completing the tightening cycle. On the dovish side, the central bank said that it stands ready to ease monetary policy if the global macroeconomic backdrop continues to deteriorate leading to a larger disinflationary shock to the Peruvian economy. Moreover, the central bank reiterated that it is not concerned about the fact that current inflation (i.e., headline inflation was 3.35% yoy in August) is slightly above the target because this was largely driven by commodity price shocks. The central bank expects inflation to gradually converge back into the target band (1%-3%) aided by a slightly negative output gap that is likely to contain demand-side pressure on prices.
Peru- Central Bank Signals Neutral Monetary Policy Stance
(% ) 7 6 5 4 3 2 1 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
Forecasts
Source: BCRP.
2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (e.o.p., yoy) External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate ($/PEN, e.o.p.) Gross International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) Reference Interest Rate (e.o.p.) Fiscal Sector Public Sector Primary Balance (%GDP) Public Sector Overall Balance (%GDP) Debt Indicators Gross Federal Govt Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP) 27.3 11.0 16.2 28.1 23.5 10.6 12.9 26.4 21.1 9.8 11.3 24.8 19.4 9.3 10.1 23.4 -0.3 -1.6 0.7 -0.5 1.9 0.7 1.6 0.5 5.5 24.7 1.25 45.3 23.4 3.00 -2.3 26.5 4.25 0.5 28.0 4.25 0.2 4.7 -13.1 -26.2 2.89 33.2 -1.5 4.4 31.9 37.2 2.81 44.2 -2.3 4.1 21.8 25.6 2.73 49.2 -3.7 1.5 -1.5 10.0 2.70 50.9 0.9 127 0.2 8.8 154 2.1 6.3 173 3.9 5.9 190 2.7
Q1 6.2 35 0.8 -1.6 4.5 46.5 29.8 2.84 35.3 16.3 24.6 1.25 25.2 9.9 15.3 27.3
2010 Q2 Q3 10.0 39 1.6 -0.9 4.0 32.4 36.9 2.83 35.4 20.9 24.2 1.75 23.7 9.7 14.0 25.5 9.6 39 2.4 -2.3 3.8 29.6 46.7 2.79 42.5 26.5 23.9 3.00 23.2 9.6 13.6 26.6
Q4 9.2 41 2.1 -1.3 5.2 23.9 34.8 2.81 44.2 45.3 23.4 3.00 23.5 10.6 12.9 26.4
Q1 8.7 41 2.7 -1.7 4.7 27.5 29.3 2.80 46.2 32.9 25.4 3.75 22.6 10.0 12.6 26.2
2011 Q2 Q3F 6.7 45 2.9 -2.9 4.4 41.7 45.2 2.75 47.2 37.8 26.4 4.25 21.8 9.7 12.1 25.7 4.6 42 3.6 -1.5 4.5 19.1 17.3 2.73 48.8 18.5 26.2 4.25 20.7 8.9 11.8 25.4
Q4F 5.5 45 3.9 -3.1 2.9 3.8 14.9 2.73 49.2 -2.3 26.5 4.25 21.1 9.8 11.3 24.8
Issue No: 11/19
23
September 23, 2011
Venezuela
Inflationary pressures are now deeply ingrained in the economy as inertia, accommodative macro policies, and eroding macroeconomic efficiency have contributed to broaden/disseminate the inflationary pressures. In the 44 months of data of the new INPC index, monthly inflation has never been below 1.1% mom and monthly core inflation averaged a very high 2.2% between January 2008 and August 2011. Furthermore, the Caracas CPI has now printed above 1.0% mom for 49 consecutive months, and the core yoy measure has averaged 33.3% between January 2008 and August 2011. We expect headline inflation to stay high in 2011 (around 27%-28% for the Caracas CPI) and likely also in 2012 (an election year) on the back of a continuously deteriorating growth-inflation trade-off due to the under-investment in the economy and the expected increase in fiscal and monetary stimulus to the economy ahead of next years election. These price dynamics are likely to lead to significant real currency appreciation. The short-term risk to the inflation outlook is skewed to the upside as the government is expected to boost public spending ahead of next years presidential election, while private investment could remain weak given the backdrop of heightened political and economic uncertainty.
2009 2010 2011F 2012F Activity and Prices Real GDP Grow th (%yoy) Nominal GDP (US$bn) Consumer Prices (e.o.p., yoy) External Sector Current Account (%GDP) Trade Balance (%GDP) Exports (%yoy) Imports (%yoy) Exchange Rate ($/VEF, e.o.p.)* Gross International Reserves (US$bn) Monetary Sector Monetary Base (%yoy) Credit to the Private Sector (%GDP) Interest Rate (e.o.p.) Fiscal Sector Public Sector Primary Balance (%GDP) Central Govt. Nominal Balance Debt Indicators Total Public Sector Debt (%GDP) Domestic (% GDP) External (%GDP) Total External Debt (%GDP) 26.5 7.6 18.9 22.6 41.3 8.8 32.5 35.7 42.5 12.3 30.2 33.0 42.2 13.5 28.6 31.2 -0.9 -5.5 -4.0 -3.3 -1.5 -2.4 -0.5 -2.4 21.2 21.8 21.0 18.0 29.0 17.4 27.0 18.1 20.9 17.7 20.0 21.0 22.0 23.0 25.0 29.0 2.6 5.9 -39.5 -22.3 2.15 35.8 6.1 11.4 14.2 0.4 4.30 31.2 7.6 12.7 32.1 27.4 4.30 27.8 2.9 6.9 -2.9 20.0 4.30 26.0 11.6 17.0 67.8 -33.0 4.30 30.2 3.9 10.3 10.3 -0.4 4.30 29.6 4.0 9.3 -5.6 12.7 4.30 30.3 5.6 10.2 5.6 33.2 4.30 31.2 12.1 17.5 26.0 18.9 4.30 27.6 11.3 17.2 56.4 25.2 4.30 29.2 4.6 9.4 31.0 33.0 4.30 27.0 3.1 7.6 17.0 29.9 4.30 27.8 -3.2 326 26.9 -1.5 238 27.4 3.8 298 27.2 4.2 367 19.0 -4.8 53 28.2 -1.7 59 31.8 -0.2 60 28.5 0.5 64 27.4 4.8 68 28.7 2.5 73 25.1 4.0 76 27.1 4.0 81 27.2 Q1 2010 Q2 Q3 Q4 Q1 2011 Q2 Q3F Q4F
Caracas CPI: Entrenched High Inflation Levels

(% yoy; n.s.a.) 40 35 30 25 20 15 10 5 0 May-06 Jul-07 Sep-08 Nov-09 Jan-11 Headline Core
Source: Central Bank of Venezuela and Goldman Sachs.
12.59 12.60 12.00 12.00 12.60 12.61 12.60 12.40 12.40 12.20 12.20 12.00
* In January 2008, Venezuela redenominated the Bolivar: VEF = VEB/1000.
Issue No: 11/19
24
September 23, 2011
Main Financial Forecasts Forthcoming Data Releases from Latin America

Brazil 27-Sep 29-Sep 30-Sep 3-Oct 4-Oct 6-Oct 7-Oct Chile 29-Sep 30-Sep 5-Oct 7-Oct Forthcoming Data Consumer Confidence IGP-M Inflation Public Debt Primary Budget Balance Trade Balance Capacity Utilization Industrial Production CPI - FIPE Monthly IGP-DI IPCA Inflation Forthcoming Data Retail Sales Industrial Production Unemployment Rate Economic Activity CPI, headline Trade Balance Forthcoming Data Central Bank Meeting Consumer Price Index Forthcoming Data CPI Forthcoming Data Global Economic Indicator IGAE Consumer Prices Consumer Prices Core Forthcoming Data CPI Period Sep Sep Aug Aug Sep Aug Aug Sep Sep Sep Period Aug Aug Aug Aug Sep Sep Period 30-Sep Sep Period Sep Period Jul Sep Sep Period Sep Period Sep Forecast mom/qoq yoy 119.3 0.65% 7.47% 39.2% R$12.0bn 81.9% -0.25% 1.77% 0.30% 0.55% 0.55% 7.33% Forecast mom/qoq yoy 10.4% 0.5% 7.7% 4.6% 0.15% 2.91% Forecast mom/qoq yoy 4.50% 0.10% 3.51% Forecast mom/qoq yoy 0.35% 4.93% Forecast mom/qoq yoy 3.50% 0.30% 3.19% 0.30% 3.15% Forecast mom/qoq yoy 0.20% 3.59% Forecast mom/qoq yoy 2.0% 27.35% Previous mom/qoq yoy 118.7 0.44% 8.00% 39.4% R$13.8bn US$3.9bn 82.1% 0.50% -0.3% 0.39% 0.61% 0.37% 7.23% Previous mom/qoq yoy 9.6% 0.7% 7.5% 4.0% 0.20% 3.20% US$0.49bn Previous mom/qoq yoy 4.50% -0.03% 3.27% Previous mom/qoq yoy 0.49% 4.84% Previous mom/qoq yoy 3.61% 0.16% 3.42% 0.12% 3.22% Previous mom/qoq yoy 0.27% 3.35% Previous mom/qoq yoy 1.7% 26.50%
Colombia 30-Sep 5-Oct Ecuador 6-Oct Mexico 28-Sep 7-Oct Peru 3-Oct
Venezuela Forthcoming Data 3-Oct Caracas CPI
Issue No: 11/19
25
September 23, 2011
Calendar of Economic and Political Events

Argentina Forthcoming Data 23-Oct-11 Presidential Elections Comment The incumbent, President Cristina Kirchner is the overwhelming favorite to win the presidential elections, perhaps in the October 23 first round. Comment We expect COPOM to cut SELIC by 50 bp to 11.50%. Comment The central bank interrupted the policy rate normalization cycle in July and in August set a neutral stance going forward given the worsening external environment. At 5.25%, the policy rate is now in the range of neutrality. The central bank is paying close attention to the evolution of domestic and external conditions in order to properly calibrate the next steps in the rate normalization cycle. A rate cut in the near term cannot be ruled out. Comment At 4.50% the policy rate is still slightly stimulative. We expect the central bank to extend the pause initiated in August given the challenging external backdrop. Comment The two main political parties are the ruling PLD and the opposition PRD. The PRDs candidate is former president Hiplito Meja (20002004). The PLD candidate is party leader Danilo Medina. This is likely to be a contested presidential election. Comment Banxico will likely keep the TdF unchanged at 4.50% with a slight bias to ease going forward to ease given the challenging inflation dynamics. Comment We expect the MPC to leave the policy rate unchanged at 4.25%. The Central Bank has introduced an easing bias to the monetary policy stance, but this is likely to materialize only if there is a sharper deterioration in the global outlook. Comment The umbrella opposition movement (MUD) will hold internal primaries to select the opposition candidate that will face the candidate from the official party (presumably President Chavez) in the presidential elections late in 2012. The opposition, which now controls 40% of the seats in the National Assembly, intends to mount a challenge to President Chavez, who continues to benefit from substantial public financial and logistical resources. The health issues of President Chavez may change the dynamics of the election.
Brazil 19-Oct Chile 13-Oct
Forthcoming Data COPOM Meeting Forthcoming Data Monetary policy committee meeting
Colombia 30-Sep
Forthcoming Data Monetary policy committee meeting
Dom. Forthcoming Data Republic 20-May-12 Presidential elections
Mexico 14-Oct
Forthcoming Data Banxico Meeting
Peru 6-Oct
Forthcoming Data Monetary Policy Committee Meeting
Venezuela Forthcoming Data 12-Feb-12 Opposition internal primary elections
7-Oct-12
Presidential Elections
Issue No: 11/19
26
September 23, 2011
Global Macroeconomic Outlook

Global Macroeconomic Framework
2009 Real GDP Grow th (%, yoy) United States Euroland Japan World Economy CPI Inflation (%, yoy) United States Euroland Japan Interest rates (%, e.o.p) Fed Funds UST 10-Year Exchange Rate s (e.o.p) US$/EUR JPY/US$ -3.5 -4.2 -6.3 -0.8 -0.3 0.3 -1.3 0.12 3.84 1.48 93 2010 2011F 2012F 1Q10 3.0 1.7 4.0 5.1 1.6 1.6 -0.7 0.18 3.31 1.36 88 1.6 1.7 -0.5 3.9 3.2 2.6 0.0 0.10 2.75 1.44 80 2.0 1.3 2.6 4.2 2.3 1.7 0.0 0.10 3.50 1.55 75 2.2 0.9 5.7 5.1 2.4 1.1 -1.2 0.14 3.83 1.38 91 2Q10 3.3 2.0 3.1 5.4 1.8 1.6 -0.9 0.09 2.94 1.27 92 3Q10 3.5 2.0 5.0 5.0 1.2 1.7 -0.8 0.10 2.51 1.29 86 4Q10 3.1 2.0 2.2 4.7 1.2 2.0 0.1 0.18 3.31 1.36 83 1Q11 2.2 2.4 -1.0 4.3 2.2 2.5 0.0 0.14 3.45 1.37 82 2Q11 3Q11F 4Q11F 1.5 1.6 -1.1 3.7 3.3 2.8 0.3 0.09 3.16 1.44 82 1.4 1.5 -1.0 3.7 3.7 2.5 0.0 0.10 2.50 1.36 78 1.2 1.5 0.3 3.6 3.8 2.4 -0.2 0.10 2.75 1.44 77
So urce: Go ldman Sachs Eco no mic Research Gro up.
Consolidated Latin America Aggregate Selected Economic Indicators 2008

I. Econom ic Activity and Prices Nominal GDP (US$bn) Real GDP grow th (% yoy) 1/ CPI Inf lation (% yoy) Domestic Demand (% yoy) II. External Sector Current Account (US$bn) Trade Balance (US$bn) Gross International Reserves (US$bn) Change in Reserves (US$bn) Net Capital Inf low s Direct Foreign Investment III. Public Finance and Indebtness Primary Fiscal Balance (%GDP) Overall Fiscal Balance (%GDP) Total Public Sector Debt (%GDP) Total External Debt (%GDP)
1 Calculated using no minal GDP weights. / So urce: Natio nal A utho rities and Go ldman Sachs estimates and fo recasts.
2009
3,787 -1.8 5.8 -2.7 -15.9 78.5 507.4 38.0 53.8 72.3 0.5 -3.0 35.4 20.5
2010
4,523 6.4 6.6 7.2 -52.3 74.5 594.7 87.4 139.7 106.1 1.1 -2.3 34.5 20.7
2011F
5,401 4.5 6.9 5.3 -66.0 81.1 706.4 111.7 177.6 122.9 1.9 -2.3 33.8 18.8
2012F
5,710 4.0 6.2 4.6 -91.6 66.3 717.2 10.8 102.4 102.6 2.0 -2.2 33.0 19.1
4,011 4.3 8.4 5.1 -21.7 74.6 469.4 57.0 78.7 120.8 2.6 -0.7 31.1 20.9
Issue No: 11/19
27
September 23, 2011
Goldman Sachs Global Economics, Commodities and Strategy Research

Americas Jan Hatzius~ Dominic Wilson~ US Economics Research Andrew Tilton~ Zach Pandl* Alec Phillips* Jari Stehn* Shuyan Wu^ 1(212)902-0394 1(212)902-5924 Asia (cont'd) Japan Portfolio Strategy Research Hiromi Suzuki* 81(3)6437-9955 Tsumugi Akiba* 81(3)6437-9966 Kazunori Tatebe# 81(3)6437-9898 Pan-Asia Strategy Derivatives Research Sam Gellman* 852-2978-1631 Sunil Koul# 852-2978-0924 Jason Lui# 852-2978-6613 Australia & New Zealand Economics Research Tim Toohey~ 613-9679-1079 Andrew Boak* 612-9321-8576 Philip Borkin* 649-362-7306 David Colosimo* 613-9679-1085 Europe, Middle East and Africa Peter Oppenheimer~ European Economics Research Francesco Garzarelli~ Huw Pill~ Ahmet Akarli~ Kevin Daly~ Clemens Grafe~ Dirk Schumacher~ Andrew Benito* Magdalena Polan* Natacha Valla* Lasse Holboell Nielsen# Marek Raczko# Anna Zadornova# Antoine Demongeot^ Michael Hinds^ Adrian Paul^ Global Markets Research Dominic Wilson~ 1(212)902-5924 Francesco Garzarelli~ 44(20)7774-5078 Global Macro Research Kamakshya Trivedi* Jose Ursua# Stacy Carlson^
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Issue No: 11/19
28
September 23, 2011
We, Paulo Leme, Alberto Ramos, Eduardo Cavallo, and Petya Kehayova hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firms business or client relationships. Global product; distributing entities The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs, and pursuant to certain contractual arrangements, on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy. This research is disseminated in Australia by Goldman Sachs & Partners Australia Pty Ltd (ABN 21 006 797 897) on behalf of Goldman Sachs; in Brazil by Goldman Sachs do Brasil Banco Mltiplo S.A.; in Canada by Goldman Sachs & Co. regarding Canadian equities and by Goldman Sachs & Co. 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Issue No: 11/19
29
September 23, 2011
Macroeconomic Country Views
Name Argentina
Present Situation Central Issue President Cristina Kirchner is leading voters' preferences by a wide margin ahead of the October 23 Restoring the credibility of Indec, establishing a functional relationship with the multilateral agencies and dealing with the presidential election. Excessive fiscal stimulus and a lax monetary policy stance are overheating the Paris Club payment arrears are key unresolved issues. Real GDP grew at a strong 9.5%yoy during 1H2011, driven by bouyant domestic demand. We expect real GDP growth to grow at an above-trend 8.9% in 2011 (with risks skewed towards economy and generating strong demand-pull pressures on inflation. a higher print), with inflation remaining at 20%-plus. The surge in imports is likely to push the current account into a small deficit in 2011, down from a 0.8%-of-GDP surplus in 2010.
Brazil
We reduced our forecast for real GDP growth to 3.7% in 2011 and 3.8% in 2012. Therefore, we now expect The main issue is how to prepare the economy against contractionary global shocks and reduce inflation. Real GDP growth the output gap to widen slowly and this should bring IPCA inflation down to 6.6% in 2011 and 5.5% in 2012. is slowing, towards 3.7% this year, but IPCA inflation exceeds the ceiling of the target. In our opinion, the risk of contractionary global real economic and financing shocks will limit the room for manoeuvre. The government should focus on COPOM is likely to cut SELIC two more times, by 50bp per meeting in October and December. structural reforms that could increase total factor productivity and long-term real GDP growth.
Chile
Domestic demand is moderating to trend but is still expanding at a solid pace. The inflation outlook remains Real GDP grew a solid 6.8%yoy (+1.4%qoq sa) in 2Q2011, driven by domestic demand (+9.4%yoy). Inflation is likely to end very comfortable. The Central Bank announced in January a US$12bn reserve accumulation program 2011 at around 3.4%. The current account posted a 1.9%-of-GDP surplus in 2010 and we forecast a moderate defcit (around (US$50mn/day). 1% of GDP) in 2011.
Colombia
The economic expansion is firming, with domestic demand growth accelerating. Inflation, particularly core, Real GDP grew a solid 5.1%yoy (+1.9%qoq sa) in 1Q2011. We expect real GDP to grow 5.5% in 2011. The moderate remains well-behaved. economic recovery does not present an immediate challenge to the inflation outlook as the economy is still operating with slack. We expect inflation to end 2011 slightly above the 3.0% IT midpoint. The Central Bank interrupted the rate hiking cycle in August and we expect the MPC to leave the policy rate unchanged at 4.50% until end-2011. The current account deficit is likely to reach around 2.5% of GDP in 2011 and be fully covered by FDI flows. While we do not foresee external financing problems arising during 2011, the outlook for 2012 is more uncertain. This is because the IMF program expires in February and, with presidential elections scheduled for May, a new program is unlikely to be negotiated until at least 2H2012. As a result, it may prove challenging for the authorities to tap the markets in order to access external financing in 1H2012, particularly if global financial conditions deteriorate.
Dominican Economic performance during 1H2011 was disappointing because real GDP growth decelerated more than Republic expected (4%yoy) and inflation was high (9.3%yoy). Moreover, the external accounts remained weak thanks to the increase in the oil import bill. The government has limited scope to change the stance of macroeconomic policies in order to support economic activity in 2H2012.
Ecuador
Higher oil prices are supporting the smallest OPEC member country on various fronts. Real GDP grew a The heterodox policy mix continues to limit domestic and foreign investment. This makes the economy increasingly more higher than expected 8.6%yoy in 1Q2011. As a result, we upgraded our growth forecast for 2011 to 4.7%yoy dependent on the oil sector and reduces the basis for sustainable long-term growth. from 3.9%yoy.For 2012, we expect the economy to grow by 3.5%yoy.
Mexico
Inflation (headline and core) has been surprising on the downside. The economy continues to recover at a We forecast that real GDP growth will moderate to 3.9% in 2011, after growing 5.4% in 2010. Headline INPC inflation will moderate pace against a backdrop of a still negative output gap and a significant amount of slack in the likely moderate to 3.2% in 2011 from 4.4% in 2010. The external accounts are a source of macro resilience. We forecast a minor 0.5%-of-GDP current account deficit in 2011, which is about a quarter of projected FDI inflows. labour market. The authorities remain firm believers in the benefits of a free-floating currency.
Panama
We forecast real GDP growth of 8.6% in 2011, fuelled by a substantial public investment project: US$20bn A political crisis led to the breakup of the governing coalition. This could result in a relaxation of the already loose fiscal policy over five years to finance the expansion of the Panama Canal and other public works. This project is as the government increases current spending (i.e., subsidies) in order to maintain popular support. While this is not likely to threaten fiscal sustainability, it would increase the countrys vulnerability to an external financial shock. expected to more than double the Canal's capacity on completion (scheduled for 2014).
Peru
Real GDP expanded 6.7%yoy during 2Q2011, down from 8.7%yoy in 1Q2011. The economy is decelerating We expect inflation to increase to above the 3% upper end of the Central Bank's target band due to supply-side shocks and towards trend-like growth rates, as expected. For the second half of the year, we expect the growth a less favourable base. For 2012, we see inflation gradually declining back towards the target. The current account deficit is deceleration process to consolidate, leading the economy to expand 6.3%yoy, with more subdued private likely to hover around 2.5% of GDP in 2011, and should be easily financed by solid FDI inflows. investment growth.
Venezuela The policy mix remains heterodox and market-unfriendly. President Chavez was diagnosed with cancer in We forecast a moderate 3.8% real GDP expansion in 2011 (up from -1.5% in 2010) on the back of policy stimulus, higher oil June and has undergone four rounds of chemotherapy treatment. The medical prognosis remains unknown. prices and a favourable statistical base. Inflation is high and endemic: low investment in the economy, together with loose monetary and fiscal policy, have entrenched inflation at above 25%yoy. As expected, the authorities devalued the VEF early Presidential elections will be held on October 7, 2012. in 2011. The external accounts remain solid: higher oil prices are likely to secure a current account surplus of 7%-plus in 2011.
Issue No: 11/19
September 23, 2011

Goldman On Brazil

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Latin America Economic Analyst

Issue No: 11/19 September 23, 2011

High Growth in Argentina and Crisis Management Experiences in Brazil

HP Output gap 1: 93Q1-11Q2 HP Output gap 2: 93Q1-08Q2

Important disclosures appear at the back of this document.

Issue No: 11/19

September 23, 2011

Goldman Sachs Economic Research

Latin America Economic Analyst

The Real Economy Performed Strongly During 1H2011

Actual GDP SA HP trend 1: 93Q1-11Q2 HP trend 2: 93Q1-08Q2

Issue No: 11/19

September 23, 2011

Goldman Sachs Economic Research

Latin America Economic Analyst

Chart 2: Output Gap in Positive Territory

HP Output gap 2: 93Q1-08Q2

Source: Haver Analytics.

Source: Haver Analytics.

Issue No: 11/19

Goldman Sachs Economic Research

Latin America Economic Analyst

Table 1: Argentina - Real GDP

Table 2: Argentina - Contribution to YoY Real GDP

Real GDP Growth in 2011 to Rival the Expansion Recorded in 2010

Goldman Sachs Economic Research

Latin America Economic Analyst

Chart 6: Buoyancy of Imports Eroding Trade Surplus

Inflation Remains the Most Visible Macro Imbalance

Table 3: Trade Balance, Jan-Jul 2011

Chart 7: Consumer Price Inflation (Indec; official figures)

1.4% 1.2% 1.0% 0.8%

0.4% 0.2% 0.0% Jun-10 Nov-10 Apr-11

2011 % Chge 6.5 3.0 -21% -64%

Issue No: 11/19

Goldman Sachs Economic Research

Latin America Economic Analyst

Nominal ARS/USD rate Real ARS/USD rate

Government May Regain Control of Congress

Issue No: 11/19

Goldman Sachs Economic Research

Latin America Economic Analyst

Issue No: 11/19

September 23, 2011

Goldman Sachs Economic Research

Latin America Economic Analyst

The Effects of the European Crisis in Brazil

Transmission Channels of External Shocks to Brazil

Goldman Sachs Economic Research

Latin America Economic Analyst

European banks 7.7

Other foreign banks

1.7 4.1 25.7 14.1 18.5

W.Hem. ex-USA, 9 USA, 17 Europe, 69

Goldman Sachs Economic Research

Latin America Economic Analyst

Chart 4: LatAm Trade Shares w/ Euro Zone, 200510 avge

inflation, thus creating conditions for COPOM to cut interest rates.

Transmission of the Lehman Shock to Brazil in 2008

14.0 11.5 11.711.6 9.6

Source: Haver Analytics.

FDI Profits/dividends outflow FDI inflow