Now that the recessions in Argentina and Brazil have ended, the major economies of Latin America are looking forward to sustainable – if modest – growth rates in 2018. Yet significant domestic and international uncertainty clouds the longer-term outlook, according to experts from Wharton and elsewhere.

“Domestic demand in the region is recovering gradually….,” notes a recent report by the International Monetary Fund (IMF). And despite the “full-blown economic, humanitarian and political crisis” of Venezuela — where real GDP plummeted about 35% from 2014 through 2017 – the regional economy is expected to have grown by 1.2% in 2017, rising modestly to 1.9% in 2018, notes the IMF’s latest regional outlook. Moreover, inflation in Latin America likely declined to 4.2% in 2017 from its peak of 6.2% in 2015, and is projected to stabilize at about 3.5%.

Longer term — three to five years — Latin America looks set to grow steadily at about 1.7% annually, which is slightly above the average rate for the last 25 years, notes the IMF’s Country Focus report. That rate is “only marginally better than those in advanced economies, raising concerns that the region is not catching up to income levels in advanced countries.”

Still, that modest growth is a welcome improvement. A key reason for the turnaround in Latin America is an uptick in commodity prices, notably for soy beans, metals and oil, which play a vital export role. “Commodity prices are higher than a year ago, and they are growing faster than the consensus forecasts,” notes Walter Kemmsies, chief strategist for JLL’s Global Infrastructure Group. “That is helping Latin America. Brazil is past its bottom, as are Chile, Peru and Colombia.”

For the region’s largest economy, “the good news is that 2017 marked the end of the most severe economic recession Brazil has had” and most economists say the recession is over, notes Felipe Monteiro, senior fellow at Wharton’s Mack Institute for Innovation Management and an affiliate professor of strategy at INSEAD. “Also, the unemployment rate, which had been growing and growing, is starting to decrease.”

In 2016, both Brazil and Argentina were in recession, and in 2017 Brazil grew by just 1%. But in 2018, Argentina is projected to grow by about 3%, while Brazil will grow 2%-2.5%. In the rest of South America – including Colombia and Chile — expectations are for higher growth than in 2017. “With the exception of Venezuela, which is doing very poorly, the region will be in a better place; it will grow more,” adds Monteiro.

“The good news is that 2017 marked the end of the most severe economic recession Brazil has had.” –Felipe Monteiro

In Brazil, the most significant positive to emerge from 2017, adds Monteiro, was the importance of the government’s ongoing reforms, especially labor reforms, which took effect in November. “The major remaining question mark is pension reforms.” Both Argentina and Brazil are moving towards more pro-business governments, Monteiro said. “In general, this is good for the region. However, Brazil is still in the process of recovering what it lost over the last few years – eleven [consecutive] quarters of recession.”

In Mexico, the GDP advanced only 1.5% year-on-year in the third quarter of 2017 (according to the latest figures), slowing from the 1.9% rate reported in the previous quarter. According to Trading Economics, this was Mexico’s weakest growth rate since the fourth quarter of 2013, as services and agriculture slowed down while industry shrank. The trend appears to reflect a gradual slowing from the 2.6% GDP rate of 2015 to a projected 1.9% in 2018, notes the IMF.

For all that, not a single country in Latin America is really growing at a “robust” rate, notes Wharton management professor Mauro Guillen. Unemployment is very high in countries such as Brazil and Argentina, while inflation is high in Argentine and Venezuela, which has the highest rate in the world. Guillen identifies two broad categories of uncertainty that continue to hamper Latin America’s performance: politics and relationships outside the region, such as with the United States and China.

Elections in Brazil, Colombia and Mexico

Political instability within the region has been an issue a few years, Guillen says. In 2018, more instability could follow national elections set in Brazil (October), Colombia (March), Mexico (July), as well as in Paraguay and Venezuela.

In Brazil, notes Monteiro, “the political drama continues, and the corruption probes continue to grow as more and more people are implicated – and more politicians and businessmen are going to jail. In that sense, there is no end. It takes a lot of energy and is very painful. But on the other hand, Brazil’s democracy continues to move forward with very strong institutions, and with the judiciary doing what they have to do. I think this is good.”

Kemmsies thinks “Brazil is setting itself for a much better future. We knew there was a lot of corruption in Brazil, but what is surprising is that [although] it created a lot of political upheaval, we don’t see the tanks of the military rolling through the streets. Democratic processes are working, and that makes me very hopeful about the economy” – and the prospects for attracting further foreign investment to Brazil.

Brazil’s election is “very important,” notes Guillen, but “there are so many parties competing — too much fracturing — so many candidates. Brazil has always been very difficult to predict.” Meanwhile, he is not very optimistic about the country overcoming its corruption issues. “There is an enormous problem with corruption, and I’m not even sure that electing a new president will help overcome that problem.”

“I’m not even sure that electing a new president will help overcome” the corruption problem in Brazil. –Mauro Guillen

Monteiro agrees that there are a lot of possible scenarios. One is that the election will be very polarized between former president Luiz Inacio Lula da Silva on the left, and nationalist congressman Jair Bolsonaro on the right. Bolsonaro, a congressman running second in opinion polls, is anti-gay, pro-gun, and warns that China is taking over Brazil. “Lula’s supporters want him to return, despite the fact that he is under investigation and has been sentenced in a number of courts [legal judgments] but which are currently under appeal to higher courts. Lula is definitely more leftist and protectionist, and more focused on protecting labor rights,” notes Monteiro. “People may [also] have concerns about the ability of a government like Lula’s to approve measures such as pension reform.”

A contrasting scenario would involve less polarization of the Brazilian electorate. Here the situation would resemble that of France during its most recent presidential elections (in 2017), when two extremists — Marine LePen, from the right-wing, and Jean-Luc Melenchon, from the left — were major candidates.  Notes Monteiro, “There is the hope that someone in the middle will be able to mobilize all the forces that are not on the extremes” as did Emmanuel Macron in France. Potential candidates for that role include Joao Doria, current mayor of Sao Paulo, and Luciano Hulk, a TV anchor with no political experience.

Despite such uncertainties, Monteiro expects Brazil will continue to attract significant foreign investment in 2018, especially in the oil and gas sector. In October, Brazil awarded six of the eight blocks on offer in the auction for the rights to pump oil from Brazil’s highly prized offshore “pre-salt” region, where billions of barrels of oil are trapped below thousands of feet of salt in the country’s Atlantic waters. Royal Dutch Shell won half the blocks, while rival BP took two blocks and Exxon Mobil Corp took one. President Michel Temer announced that development of the blocks would lead to 100 billion reais ($30.2 billion) in investment from the winning companies, and 130 billion reais ($39.3 billion) in royalties and other revenues for the Brazilian government.

Throughout much of the region, the uncertainty of energy prices – a major source of foreign exchange – is also important. According to Guillen, how oil prices move over the coming year “will have a large impact on Venezuela and Mexico, a little bit on Colombia and Argentina, and to a lesser extent on Ecuador…. Who knows where the price of oil is going to go? Right now, it seems to be fairly stable – at levels that are not historically high.”

NAFTA’s Impact

Mexico’s economic dependence on the United States has helped generate significant economic growth in recent years, but continued uncertainty about the future of the North American Free Trade Agreement (NAFTA) – which plays a key role in that relationship – makes it difficult to predict Mexico’s economic prospects. Despite months of heated negotiations with the United States and Canada, it remains unclear whether NAFTA will survive largely intact, see significant changes or be scrapped entirely by the Trump administration.

Notes Guillen, “Americans [and other] companies have been making investments, assuming that NAFTA was in place. If there is a significant change to the agreement — or even worse, if the agreement comes to an end — obviously, this is going to be an earthquake. It will also affect in a negative way many parts of the United States, not just Mexico and Central America.” Given the stakes, Guillen advises, “The only contingency plans that make sense now are to put further investments on hold. You cannot take action until you get a little more clarity.”

For several years, Mexico’s government has been attempting to diversify trade from its over-dependence on U.S. markets. Some 80% of Mexico’s exports go to the U.S. and about 47% of Mexico’s imports come from the U.S. Mexico has 11 free trade agreements involving 46 countries and also signed on to the Trans-Pacific Partnership (TPP), a proposed free trade agreement signed by 12 Asia-Pacific countries, in 2016. Last January, the U.S. announced it would not be part of the pact. How much will those pacts help Mexico over the long term?

“The only contingency plans that make sense now [in Mexico] are to put further investments on hold” –Mauro Guillen

Guillen says it’s is hard for Mexico to diversify its trade away from its dependence on the U.S. for two reasons: First, the mutual border — neighbors tend to trade more with one another. Second, most company decisions over the past 20 years involve value chains dependent on shipping materials and components between the U.S. and Mexico. If it were just a case of shipping final goods to the American consumer, Guillen adds, diversification would be easier.

China’s Massive Infrastructure Projects

Another key economic driver for the region is the ongoing scale of China’s growth plans, which will impact Latin American commodity export volumes and prices. Despite some mixed signals, China is planning huge investments, most notably its “One Belt, One Road” initiative, a grand scheme for creating a network of roads, ports, railways and other links from East China through Southeast, South and Central Asia all the way to Europe. China expects to lend as much as $8 trillion for infrastructure in 68 countries – which would affect up to 65% of the global population and a third of global GDP, notes a McKinsey report.

China’s ambitions could spur quite strong demand for commodities produced in Chile, Peru, Argentina and Brazil, says Guillen. “That would be great because we would be going back to the situation of six or seven years ago – when there was a commodities boom that helped the countries in the region.” Already, China and other major countries in Asia are the biggest trading partners for Peru, Brazil and Argentina. “The relationship between Latin America and Asia will be even more important because the economies of that region are growing even faster – and they will need some commodities from Latin America to produce that growth,” notes Guillen.

As for Brazil, Kevin Gallagher, professor of global development policy at Boston University, notes that China’s commercial relationship with South America’s largest economy has taken on a new character. While commodities continue to underpin the region, “the boom is over … but there is now a shift toward infrastructure, banking and some manufacturing.” Over the first four months of 2017, Chinese investors invested $5.7 billion in Brazilian mergers and acquisitions, about 37.5% of total investments in Brazil, according to Dealogic.

Economists note that China has been diversifying investments in Latin America away from Venezuela and Ecuador into more financially stable economies such as Brazil. Last year, notes Monteiro, Chinese companies pulled off 17 acquisitions in Brazil, involving electricity companies and those involved in oil, ports and other infrastructure. Chinese investors even invested in 99 Taxi, a Sao Paulo company that competes with Uber.

Brazil and the U.S.

Monteiro predicts that China’s ascension as the major trading partner of Brazil will continue in 2018. While the U.S. is not “pushing against” Brazil, “there is nothing in the agenda” of the Trump administration that is specifically focused on boosting U.S. business with South America and Brazil.

Meanwhile, Colombia, Peru and Chile each have bilateral trade agreements with the U.S., which operate on the same or similar principles as those of NAFTA. For those three countries, the Trump administration’s trade policy also represents “potential threats or uncertainties” to Latin America that could become big challenges, notes Guillen.

“A crazy government in Venezuela started breaking everything, and now it has become a really poor country.” –Gilles Duranton

When it comes to Mexico’s upcoming presidential election, Guillen says that all of the major parties favor continued membership in NAFTA. As for their areas of disagreement, PRI, the traditional ruling party “is less inclined to engage in privatizations. The most important disagreement between the two key candidates [for the Mexican presidency] will be about what to do about the presence of the state in the economy – and to what extent privatization should be pursued.” Nevertheless, “It is hard to know [such details] until the campaign really starts.”

As for the challenges facing Colombia, Wharton real estate professor Gilles Duranton, who studies urban development in that country, says that while much of that country has modernized, “in terms of income distribution, it is a highly unequal country and not much has changed. In terms of its geography, the Caribbean region [of northern Colombia], which had been in decline for many years, seems to be coming back because this region has the best access to the U.S.”

Colombia is something of a poster child representing a country that has manged a fairly spectacular economic turnaround over a number of years. Still, the gains have been uneven with some parts of the country lagging significantly far behind others. For example, even in the southern areas of Bogota, the country’s capital, “the land is being used horribly inefficiently. Eighty percent to 90% of the land is being covered by low-quality, low-rise residential buildings, and there is no space for utilities or schools or roadways.” While some cities are addressing these challenges, “there is no impetus at the highest level [of government] because all of their time and energy is being devoted to the peace process,” which culminated in a controversial 2016 peace agreement with the FARC rebels.

For many in northern Colombia, notes Duranton, “the biggest worry is the collapse of Venezuela” – especially in places like Bucaramanga, 200 kilometers from the Venezuelan border. There are already tens of thousands of immigrants from Venezuela in that part of Colombia. “The irony is that historically, Colombia was a poor country and Venezuela was really rich – so there was mass immigration of Colombians looking for work in Venezuela. But then you had a crazy government in Venezuela that started breaking everything, and now it has become a really poor country.” Now, immigration runs in the opposite direction.