Too early to call revival in Latin America manufacturing

September 16, 2013

It may be too early to herald a revival of Latin America’s manufacturing following a recent currency decline, according to a report by London-based research firm Capital Economics.

Increased competitiveness of local factories has been seen as a good side effect of the currency shock triggered by prospects of reduced economic stimulus in the United States. However, the data compiled by Capital Economics suggests there is still a long way to go before investors see any fireworks.

David Rees, emerging markets economist at Capital Economics, wrote in his report:

Most currencies are still around 15 percent stronger in trade-weighted terms than at the start of 2008. Indeed, even the Brazilian real – which has fallen by 20 percent in trade-weighted terms over the past two years – is still far stronger than it was in 2005.

The upshot is that the conditions do not yet seem to be in place for a renaissance in Latin American manufacturing. Instead, one of two things must happen if the region is to experience a period of rapid growth in industry – the authorities need to either kick-start supply-side reforms to boost productivity growth and increase flexibility in the labour market, or exchange rates need to weaken even further.

His conclusions underpin earlier reports by Reuters reporter Alberto Alerigi Jr. showing Brazilian manufacturers were not taking much advantage yet of the recent drop in the real; rather, they were worried about the rise in input costs as the U.S. dollar exchange rate shot up for them.

A closer look at the trade profile of Latin American countries brings up yet another complicating factor. Most countries in the region trade more with each other and with other emerging countries than with the United States and other mature economies, a Santander report showed. That is: even if local currencies weaken further against the U.S. dollar, that would benefit only a smaller part of their trade balance.

Argentina and Uruguay are particularly vulnerable as most of their exports are manufactured goods, which could lead to stricter capital controls in Argentina, said Juan Pablo Cabrera, Latin America head economist at Santander.

Considering that exports are, so far, the only significant inflow of dollars to an economy that is showing mounting FX strains, we believe the expected drop in external sales poses questions about the current BoP sustainability, suggesting that fresh measures to tackle these imbalances may be increasingly likely, or alternatively, that existing controls may need to be toughened significantly.

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