The economy continues to slow down. In his end-of-July testimony before the Senate Finance Committee, Mr. Greenspan lowered the Fed’s GDP forecast for this year to 1.5 percent, from 2.25 percent in May. However, the Fed has a very optimistic view of 2002, with 3.1percent growth. We think the Fed is likely to lower the Funds rate by 25 basis points at its August 21 meeting. Mr. Greenspan is convinced that inflation is completely tamed.
As we have explained in previous briefings, we disagree with the Fed’s view on inflation. Curiously, the Fed and financial market players have become preoccupied with finding the "right" price index. Is it the CPI, or the CPI less food and energy, the so-called core, the personal consumption expenditures deflator, the national income accounts GDP deflator, or some concoction of these indexes? The markets have caught the Brazilian vice, when that country was experiencing hyper-inflation, and as a consequence, local markets developed four to five different consumer price indexes, all of which could be used in indexation contracts. The Fed’s preferred index is the personal consumption expenditures index, which is predicted to reach 2.25 percent this year. We prefer to follow the traditional index, which markets have focused on for years, since what is important is the trend not the level. Based on the CPI, which is currently trending at 3.4 percent, we expect inflation to average 3.3 percent this year.
Second quarter GDP slowed to 0.7 percent growth, from 1.3 percent in the first quarter. Personal consumption expenditures were up 2.1 percent, while investment expenditures fell 8.9 percent. This is in line with our expectations that the economy has slowed, and will not recover strongly, as the Fed and many forecasters anticipate. We think the economy will waffle through a period of stagflation, and possibly slip into a recession next year, depending on what happens to the inflation rate.
Latin American Economies
The economic crisis is far from over and doubts persist about Argentina’s capacity to service its foreign debt. GDP fell 2.1 percent during the first quarter, which underscores the lingering economic weakness. The government’s harsh austerity program is triggering street demonstrations and deep divisions within the government’s coalition. Despite his repeated reassurances about Argentina’s capacity to service its debt, Finance Minister Domingo Cavallo is seeking U.S. financial support for yet another IMF rescue package, this time for $7.0 billion.
Bolivia’s president Hugo Banzer resigned recently, due to deteriorating health. General Banzer’s battle against cancer has turned desperate in the last few weeks. Vice-president Jorge Quiroga, a U.S. trained engineer, was sworn-in as president for the last remaining year of Banzer’s original term. Although very capable, Mr. Quiroga lacks the time needed for turning the economy around.The Brazilian real and the Chilean peso continue taking a beating in the markets, as a consequence of the economic crisis in neighboring Argentina. Brazil recently obtained a US$15.0 billion economic support package from the IMF.
Costa Rica is officially in recession after two consecutive quarters of economic contraction. The monthly index of economic activity started weakening in July of last year and has not recovered in the first five months of this year. The main culprit is the high-tech sector, which has been badly affected by the slowdown in the U.S. economy.
Dominican Republic is also feeling the impact of slow growth in the US, although free zone manufacturing and exports are still churning along. Nevertheless, the first quarter growth of 3.2 percent in the free zones operations represent a slowdown from the strong expansion of previous quarters.
The bruising battle over a VAT increase from 12 percent to 14 percent in Ecuador was finally settled by the Supreme Court. President Noboa issued a decree enacting the increase, after Congress voted down his proposal. At the request of several Congressmen, the Supreme Court reviewed the case and found the presidential decree unconstitutional. An IMF delegation is now in Ecuador to discuss new plans, in view of the ruling.
Central America has been the victim of another natural disaster in the form of a drought that is devastating crops and has caused widespread hunger across the region.
Stormy social and political weather continues to afflict Guatemala. The latest issue is the Congressional approval of a VAT increase from 10 percent to 12 percent. Workers, students and the business community are united in the rejection of tax increases and have vigorously protested. The monthly index of economic activity has been falling in the first five months of the year.
Honduras’ assembly or maquila activity is being affected by the slowdown in the U.S. economy.
In Nicaragua, the Aleman administration will try again to sell six state-owned electricity generating companies. Also on the block is a 40 percent equity in a telecommunications company.
Peruvian president Alejandro Toledo is busy putting together his governing team. All ministers have already been appointed and they are now building their own teams.