JP Morgan Latam Outlook

Completed 12 Dec 2017 06:13 PM EST
Disseminated 12 Dec 2017 06:13 PM EST

Economic Research
December 12, 2017
Latin America 2018 Outlook: Contents

Overview 2
Surfing the election tsunami Top trades for 2018
Argentina
19
20
Brazil 24
Latin America is poised in 2018 to grow above potential for the Chile 28
first time since 2013 Colombia 32
Ecuador 36
The 2018 regional growth forecast is 2.8% (versus potential of
Mexico 38
2.4%), up from 1.8% in 2017
Paraguay 41
Brazils cyclical recovery remains the backbone of the regional Peru 43
rebound, but 2018 growth is also expected to outpace potential in Uruguay 45
Argentina, Peru, and Uruguay Venezuela 46
Cyclical recoveries have been supported by lower policy rates,

Ben Ramsey
slowing inflation, improved terms of trade, and better demand (1-212) 834-4308
conditions, both domestic and external benjamin.h.ramsey@jpmorgan.com
But fallout from the heavy electoral cycle is a downside risk, as Cassiana Fernandez
Latin America will see its busiest election calendar in a dozen years (55-11) 4950-3369
cassiana.fernandez@jpmorgan.com
Elections in the biggest two economies, Mexico in July and Brazil
in October, present the biggest uncertainties Gabriel Lozano
(52-55) 5540-9558
Our modal forecasts assume neither election will deliver a market gabriel.lozano@jpmorgan.com
destabilizing result, but jitters may prevail amid lack of certainty Diego W. Pereira
(1-212) 834-4321
Our tenuous base-case for NAFTA 2.0 is a forward-looking agree- diego.w.pereira@jpmorgan.com
ment that takes advantage of technological change and structural
reforms in Mexico, but frictions and political hurdles could delay Cristiano Souza
(55-11) 4950-3913
the agreement or result in an abrupt exit by any of the countries cristiano.souza@jpmorgan.com
Banco J.P. Morgan S.A.
External accounts are healed, and a generally rebalanced Latin
region now seems poised to move into healthier territory as com- Lucila Barbeito
(54-11) 4348-7229
modities continue to gradually reflate lucila.barbeito@jpmorgan.com
JPMorgan Chase Bank Sucursal Buenos
Latin Americas recovery will drive the increase in EM vs DM Aires
growth differentials, which we see as a determining factor for on- Vinicius Moreira
going capital flows (1-212) 834-4144
vinicius.moreira@jpmorgan.com
Depending on perceptions of the election landscape, spillover of J.P. Morgan Securities LLC
regional inflows could benefit the Andes and the Southern Cone Steven Palacio
(52 55) 5382-9651
The surplus of FDI over the CAD at the regional level remains an steven.palacio@jpmorgan.com
encouraging signal for resilience to any shocks emanating from less Banco J.P.Morgan, S.A., Institucin de
Banca Mltiple, J.P.Morgan Grupo Finan-
loose DM monetary policy ciero
With some exceptions, fiscal consolidation remains a work in pro- Katherine Marney
(1-212) 834-2285
gress, but paramount to securing higher sustainable growth over katherine.v.marney@jpmorgan.com
the longer term J.P. Morgan Securities LLC
Inflation should stay close to targets in 2018, but move gradually

higher, outside of Mexico and Argentina, where it is poised to slow
Monetary policy remains in easing mode in the short term, though
not for long given closing output gaps and risk management www.jpmorganmarkets.com
This document is being provided for the exclusive use of john.philip.murray@jpmorgan.com & clients of J.P. Morgan.
J.P. Morgan Securities LLC Economic Research
Ben Ramsey(1-212) 834-4308 Latin America 2018 Outlook
benjamin.h.ramsey@jpmorgan.com December 12, 2017
Picking up steam, looking to avoidmainly Figure 2: ...as Brazil and Argentina recoveries consolidate
politicalpitfalls Real GDP, %3m/3m oya Argentina
While fallout from the heavy electoral cycle is a downside 15 Brazil
risk, Latin America is poised in 2018 to grow above potential Mexico
10 Chile, Colombia and Peru*
for the first time since 2013. The regional growth forecast for
next year now stands at 2.8%, versus potential of 2.4%. The 5
2018 forecast is 0.5%-pt higher now than it was six months 0
ago, largely on the back of continuous growth upgrades in
Brazil. But next years growth is also expected to outpace -5
potential in Argentina, Peru, and Uruguay. Mexicos base- -10
case forecast is benign, but there are significant uncertainties 08 10 12 14 16 18
related to elections and NAFTA renegotiations (see page 17). Source: J.P. Morgan *Simple average
Elsewhere, cyclical recoveries have been supported by lower
policy rates, slowing inflation, improved terms of trade, and Table 2: Real GDP growth forecasts
better demand conditions, both domestic and external. Politi-
%oya
cal and trade policy uncertainty suggest some modest down-
side to our calls, particularly in Mexico. However, Brazils 2016 2017 2018 Potential
momentum from the cyclical recovery should be strong, even Latin America* -0.6 1.8 2.8 2.4
if a less market friendly election scenario ends up causing Argentina -2.2 2.9 3.3 2.5
any significant turbulence (not our base case). Brazil -3.5 1.1 2.8 2.0
Chile 1.6 1.5 2.9 2.8
Table 1: Emerging Markets: Growth forecasts Colombia 2.0 1.6 3.0 3.3
% contribution to regional GDP Ecuador -1.6 2.4 1.0 2.3
Consumption Investment Net Exports Mexico 2.9 2.1 2.2 2.5
2017 2018 2017 2018 2017 2018 Peru 4.0 2.6 4.4 3.5
Uruguay 1.8 3.2 3.3 2.5
Emerging markets Venezuela -12.0 -10.0 -10.0 1.5

3.3 3.3 1.8 1.7 -0.1 -0.1
EM Asia 3.9 3.8 2.2 2.1 0.0 0.0 Source: J.P. Morgan *excludes Venezuela
EMEA EM 2.8 2.1 1.0 0.8 -0.3 -0.3
Latin America 1.4 2.1 0.5 1.0 -0.1 -0.3
Source: J.P. Morgan. Aggregates exclude: Venezuela, Croatia, Egypt, GCC, Kazakhstan, 2017 in review: An uneven comeback
Nigeria, Serbia and Ukraine.
Growth at the regional level posted a solid recovery in 2017,
as expected, led by Brazil and Argentina, which both exited
Figure 1: Latin American growth is catching back up to the other EMs deep recessions. Brazils recovery had even more momentum
%oya than we expected. Meanwhile, Mexicos economy exhibited
10
resilience in the face of the lingering uncertainty from the US
election result. With the regions two heavyweights outper-
8 EM Asia forming our initial expectations, regional growth is poised to
6 deliver an expected 1.8% in 2017up from -0.8% in 2016
4 EMEA EM and better than our original expectation of 1.5%. This strong-
2 er-than-expected regional recovery comes despite sluggish-
ness in the Andes, which (apart from Ecuador) underper-
0
Latin America formed our initial growth forecasts at the start of the year.
-2
11 12 13 14 15 16 17 18 19
Source: J.P. Morgan Brazil: When we wrote the 2017 Outlook last year, we ex-
pected Brazils GDP to expand 0.6%, recovering from the
2015-16 depression. Our view was of a recovery driven by
both private consumption and investments. Thus far, it ap-
pears that growth recovered even more than we anticipated.
We are now working with a 1.1% growth estimate for 2017,
notably boosted by a record agricultural harvest in the first initially seen a touch stronger in 2017 than in 2016, and in
half of the year. The main difference versus our original the end both will slow this year vis--vis the prior. We now
forecast lies in the composition of the GDP demand drivers. forecast Colombia to finish the year at 1.6% (versus 2.2%
Most of this years growth came from private consumption, initially), as investment has been depressed for the second
while investments, with the exception of 3Q, remained weak, straight year, and consumption has faced headwinds from
underperforming our expectations amid the lingering political early-year VAT hikes. Chiles growth has disappointed again
uncertainty, in particular the turbulence of May. Private con- this year: we see 1.5% versus our 2.3% initial forecast. Be-
sumption, in turn, is delivering better-than-expected results, yond the supply shock on growth inflicted by the Escondida
helped by the governments decision to inject cash into mining strike, poor domestic confidence kept Chilean in-
households worth about 0.9% of GDP via the early with- vestment and consumption subdued. Finally, the smaller
drawal of various workers compensation funds this year. countries outperformed in 2017: both Ecuador and Uruguay
will grow 2%-pts more than we initially forecast at the start
In Mexico, going into this year multiple factors supported of the year, with Ecuador helped by election year (debt-
our call for GDP to grow at a subdued 1.8% pace in 2017. financed) spending and Uruguay leveraged to recoveries in
Uncertainty following the US election and the possibility of Brazil and Argentina.
the US withdrawing from NAFTA, rising inflation on cur-
rency pass-through and higher energy prices, and the ensuing Figure 3: 2017 growth forecasts: initial versus current
policy tightening and hit to disposable income were among Real GDP, %oya
the chief factors. These factors largely unfolded as expected, 5.0
though their impact on activity has proven to be smaller. US- 4.5 Original Latest
4.0
related uncertainty sent sentiment spiraling, and investment 3.5
has remained a meaningful drag. But despite inflation bal- 3.0
looning to above 6%-levels, consumption proved to be much 2.5
more resilient than expected on the back of a tightening labor 2.0
1.5
market, resilient credit growth and the solid links of the ser- 1.0
vices sector to the external sector. Notwithstanding its 0.5
strength earlier this year, private consumption is now more 0.0
LatAm Bz Mex Arg Col Cl Pe Ec Uy
clearly decelerating. The headwinds to domestic demand
Source: J.P. Morgan
associated with lingering uncertainty will be partially offset
by solid external demand, which continues to benefit from a
competitive currency and healthy growth abroad. We expect 2018 growth above potentialfinally
growth to stand at 2.1% this year, followed by 2.2% in 2018.
In Brazil, the ongoing recovery should continue next year,
and we expect a solid 2.8% rate of GDP growth in 2018.
Argentinas growth expectations for 2017 are not that far off
Private consumption should lead the recovery, supported by
from our December 2016 estimates. We forecast a 2.9%
improving fundamentals, namely credit (looser monetary
expansion now, 40bp below the level back then. The econo-
policy) and labor market conditions. However, there are
my failed to gain steam in the first quarter of the year, as
important risks to our scenario. The main one we see is do-
consumption took time to manifest after higher regulated
mestic: next years election promises to be one of the most
prices shaved down real disposable income in 2H16. In any
uncertain of Brazils democratic period, and a negative out-
case, the investment bounce-back suggests growth has further
look in the elections could undermine our scenario of eco-
legs going into 2018. The other larger economies of the re-
nomic activity strengthening throughout the year. The exter-
gionnamely the Andean members of the Pacific Alli-
nal environment could harm next years GDP performance as
anceall struggled to generate growth in 2017. To be sure,
well. In the case of a change in the current external condi-
only in Peru were we expecting to exceed potential: our
tions, which have effectively facilitated the recent positive
initial forecast was 4.5% on optimism from better copper
cyclical combination (low inflation, low rates, USDBRL
mining output and improved confidence after the election of
stable), a few headwinds for growth could arise in the future.
a market friendly president. However, a double shock (Ode-
brecht corruption scandal and El Nio Costero) left growth at
just 2.6%--in part as countercyclical measures intended to
boost growth after 2Q17 got stuck by intransigent politics
curtailing their full impact. Chile and Colombia were both
Figure 4: Domestic demand recovery leads Brazil rebound weigh negatively, as imports will likely continue to outpace
%-point contribution to real GDP growth exports for a second consecutive year.
8
6 Consumption Investment Net exports In Chile, following the elections, our base case scenario is
4
for upbeat business and consumer expectations to consoli-
2
date. Accentuated by better terms of trade, the better tone
0
should push activity growth to 2.9%y/y next year. The main
-2
risk to our constructive 2018 forecast spans from the election
-4
outcome actually curbing enthusiasm of constructive expec-
-6
tations, thus delaying investment decisions and the economic
08 09 10 11 12 13 14 15 16 17 18 19 recovery. This could trigger downward revisions to consump-
Source: J.P. Morgan tion and investment for next year. In Peru, the growth story
is about expansionary monetary and fiscal policies crowding-
in private investment. We are currently projecting an above-
Figure 5: Investment coming back in Latin America ex -Brazil
consensus 4.4% GDP growth for 2018 (above both the cen-
%-point contribution to real GDP growth
tral bank and Treasury estimates), incorporating an accelera-
8
Net exports Investment Consumption tion of public investment by 17.5%y/y on reconstruction
6
efforts and other infrastructure works. The main risk for the
4 economic recovery remains political gridlock that would
2 impede either smooth execution of public spending or the
0 crowding effect of private investment by public investment.
-2 We see Colombian growth at an above-consensus 3% in
-4 2018 as oil and mining continue to rebound, helped by new
-6 Capex, and better prices and construction has improved pro-
08 09 10 11 12 13 14 15 16 17 18 19
spects (finally) underpinned by 4G, which together should
Source: J.P. Morgan
boost investment. Consumption should be supported by low-
In Mexico, we expect the uncertainty surrounding NAFTA, er interest rates and disinflation. We dont expect noise from
coupled with that arising from the outcome of general elec- 1H18 elections to impact our growth outlook significantly.
tions in July, to keep investment subdued in 2018. Consump-
tion is also likely to muddle through in 1H18, as softer em-
Figure 6: 2018 GDP led by firm domestic demand
ployment gains and modestly high inflation weigh down
%-point contribution to real GDP growth
purchasing power. Ongoing fiscal consolidation efforts 6 Domestic demand Net exports
should also lean on domestic demand. In contrast, external
demand should remain a tailwind, as US demand proves 4
robust. The domestic demand outlook should improve in
2H18, when sources of uncertainty could abate and inflation 2
should be markedly lower. The risks to this scenario include
any negative fallout from NAFTA negotiations or the uncer- 0
tainty that could follow an AMLO victory in presidential
-2
elections. All told, we think growth will be nearly unchanged
Arg Bz Cl Col Ec Mex Pe Uy
at 2.2%oya next year, but acknowledge that risks are skewed
Source: J.P. Morgan
slightly to the downside.
Among some of the smaller countries in the region, we high-
We expect upbeat activity momentum to consolidate in Ar- light a few noteworthy growth stories: both Uruguay and
gentina and project 3.3% GDP growth in 2018. We assume a Paraguay should again be supported by growth in neighbor-
fiscal correction will be frontloaded in 1H18, with quarterly ing Brazil and Argentina. Uruguayan growth at 3.3% should
average GDP growth at 2.4%q/q saar in 1H18 and 3.5% in remain above potential in 2018, helped also by the resump-
2H18. In terms of growth sources from the demand side, we tion of the refinery (which technical stoppage subtracted
expect private consumption to add 3.0%-pt to GDP (com- 0.4%-pt to 2017 growth) and the start of infrastructure works
pared to 3.4%-pt in 2017), while investment should add by the end of the year. For Paraguay, the base of growth
2.5%-pt (versus 2.3% in 2017). Net trade should continue to drivers has improved, as reliance on primary sectors has
diminished, with a higher contribution of industry and con-
struction sectors. 2018 GDP is expected to be 4.2%y/y, a tad in Brazil, failing to give a correct direction on the risks for
above 2017s 4.0%. the quarter.
The Central America and Caribbean (CAC) region has favor- Figure 7: Latin America nowcaster
able tailwinds from US demand, even if higher oil prices and %q/q saar, both scales
US interest rates present some drag. The Dominican Repub- 12 Nowcaster
lic cooled on the margin in 2017 on moderating credit and (97% of the sample)
8
slowing investment, but remittances and tourism remain
healthy, and we project 4.2% growth in 2018, down slightly 4
from 4.5% in 2017. Structural efforts to increase tax revenue 0
could be a wise preemptive move but remains politically -4 Latin America GDP
uncertain. Necessary fiscal consolidation is also on the agen- -8 R-sq=0.95,StdErr=0.94
da in Costa Rica, and puts some downside risk to our 4.1%
-12
growth call in 2018 (from 3.8% this year), but spending mo- 06 08 10 12 14 16 18
mentum should remain growth supportive, at least ahead of Source: J.P. Morgan
the February 2018 presidential election. Following relatively
low growth by Panama standards in 2016, the economy is
Figure 8: Latin America nowcasting 2Q17 GDP growth
expected to regain momentum, accelerating toward 5.5%
%q/q saar
both this year and next on robust global growth and trade,
3.5 JPM 2Q Forecast Nowcaster
alongside the expanded Canal and other infrastructure works. 3.0
2.5 1.9 2.0 2.2 2.1 2.0
El Salvador should grow 2.4% this year and next, as remit- 1.7
2.0 1.5 1.5
tances and trade remain important tailwinds. Such growth 1.3 1.2 1.4 1.3 1.1 1.1
1.5
would be fairly above potential (1.6%) but still low by re- 1.0
gional standards. Jamaica could accelerate from 1.4% in 0.5
0.0
2017 to 1.9% in 2018, yet structural constraints may limit the -0.5 Result
uplift. -1.0
Week 1
Week 2
Week 3
Week 4
Week 5
Week 6
Week 7
Week 8
Week 9
Week 10
Week 11
Week 12
Week 13
Week 14
Week 15
Week 16
Week 17
Week 18
LatAm nowcaster: A real-time tracker Source: J.P. Morgan
The J.P. Morgan nowcaster incorporates both hard data
Looking ahead, 4Q data (as of week 6) is the first instance
(including spending and output) and soft data (including
this year in which the nowcaster is implying downside risks
surveys and sentiment measures) and employs a statistical
to most Latin American economies. Brazil is the only country
model to filter the information from a wide range of indica-
for which the nowcaster is indicating an upside of 1.3%-pt on
tors. The factor recovered from the movements in the ob-
our 4Q 1.4%q/q saar GDP forecastalthough this tool has
served data is then compared with real GDP growth as it
been overestimating GDP for a while now. In Chile, the
captures the underlying common movement in a broad range
nowcaster is in line with our 1.4%q/q saar GDP estimate for
of indicators (for full methodology, see Introducing J.P.
this quarter. In Peru, Mexico, Colombia and Argentina, the
Morgan's EM nowcasters). The usefulness of the nowcaster
tool indicates even more meaningful downside risks of 2.3%,
also owes to its timeliness, as hard data are published with
3.6%, 4.5% and 8.2%-pts, respectively (Figure 9).
significant lags. In practice, the real value of the nowcaster
lies in its ability to provide a reliable signal of the direction Figure 9: Deviation of 4Q17 JPM forecasts and the nowcaster
and magnitude of risks around the J.P. Morgan official fore- %-points, q/q saar
casts. Our LatAm nowcaster, introduced this past year, is 6

Upside risks
built from the aggregation of six country-level tools, includ- 3 1.3
ing Brazil, Mexico, Argentina, Colombia, Peru and Chile
0
(Figure 7). -0.1
-3
-2.3
As we showed in the real-time tracking of the Latin America -6 -3.6
Downside risks -4.5
nowcaster in 2Q, the tool accurately signaled upside/ -9 -8.2
downside risks before we started moving our official GDP Brazil Chile Peru Mexico Colombia Argentina
forecasts (Figure 8). However, we note that the nowcaster
Source: J.P. Morgan
has overestimated 3Q Latin America GDP so far, particularly
External accounts: Healed, mostly healthy Table 4: Commodities prices on the rise in J.P. Morgan forecasts
2016 2017* 2018f
It goes without saying that Latin America, especially South
Brent ($/bbl, avg) 45 54 60
America, is dependent on commodities prices. More than half Copper ($/ton, avg) 4870 6155 6150
of the regions exports are commodities, though different Soybeans (Usc/bu, avg) 989 977 1010
countries have different exposures (Table 3). The end of the Source: Bloomberg and J.P.Morgan estimates *2017 reflect ytd average
commodities super-cycle took its toll on the current account
balances, and subsequently growth (Figure 10). But the
Figure 11: On aggregate, FDI to the region is fully financing CAD
slowdown allowed external accounts to heal, and a generally
as % of GDP
rebalanced Latin region now seems poised to move into
6
healthier territory as commodities continue to gradually re-
flate in 2018 (Table 4). Moreover, the growth recovery FDI
4
should be supportive of capital inflows (notwithstanding
risks). Indeed, the surplus of FDI over the CAD (Figure 11) 2
at the regional level remains an encouraging signal for resili- CAD
ence to any shocks emanating from less loose DM monetary 0
policy.
-2
Table 3: Latin American countries exports 95 00 05 10 15
Source: J.P. Morgan
as % of GDP, 2016
Total* Commodities Manufacturing
Brazil appears healed and healthy, at least in terms of exter-
Total Agricultural Oil Metals nal accounts. In 2017, external accounts in Brazil benefited
Latin America 16.0 7.3 4.1 1.5 1.6 8.8 from a combination of factors that kept imports down while
Argentina 8.7 6.4 5.8 0.2 0.3 2.3 pushing exports up. The slow economic recovery tamed
Brazil 10.0 6.1 4.3 0.6 1.1 3.9 imports growth, while a record harvest, high commodity
Chile 24.4 20.9 8.4 0.2 12.3 3.4 prices and the solid global growth boosted exports, leading to
Colombia a record trade balance estimated at US$64bn this year. The
10.1 7.6 2.4 5.1 0.1 2.5
Ecuador
trade balance was the main component behind the current
16.5 15.3 9.6 5.5 0.2 1.2
account deficits (CAD) continuous retraction in 2017, reach-
Mexico 31.7 5.0 2.6 1.6 0.8 26.6 ing 0.5% of GDP from the peak of 4.4% in April 2015. How-
Peru 15.4 13.4 4.3 1.2 7.9 2.0 ever, when looking ahead, the acceleration of economic
Uruguay 12.9 10.2 10.2 0.0 0.0 2.7 growth on the back of household consumption and a 4-6%
Venezuela 7.7 6.4 0.2 6.0 0.1 1.3 estimated reduction in grains production may reverse the fall
Source: UNCTAD and J.P. Morgan *Does not include gold and precious stones in the CAD, pushing it to 1.7% of GDP in 2018. Meanwhile,
Figure 10: Growth still seems to be lagging ToT improvement foreign direct investment (FDI) has remained steady
%oya both axes throughout the period, slightly above 4.3% of GDP, and we
10 30
GDP growth expect these solid inflows to continue; we estimate total FDI
8 20 at 3.8% of GDP by the end of next year. With FDI inflows
6 continuing to largely compensate the current account deficit,
10
4 we think external accounts will remain healthy next year.
0
2
-10
0
-2 Terms of trade -20
-4 -30
06 07 08 09 10 11 12 13 14 15 16 17
Source: J.P. Morgan
Figure 12: Single-country current account balances behind the current account deterioration to 4.0% of GDP this
as % of GDP, 12-month average year, widening 1.2%-pt in just 12 months. We see further
6 Brazil Chile Colombia
CAD widening into 2018 and call for the external deficit to
4 Mexico Peru
reach 4.6% of GDP.
2
0 Table 5: Current account balance
-2 as % of GDP
-4
2016 2017 2018 2019
-6
Latin America -1.9 -1.5 -2.2 -2.4
-8
08 10 12 14 16 18 Argentina -2.8 -4.0 -4.6 -4.8
Source: J.P. Morgan
Brazil -1.3 -0.5 -1.7 -2.0
In Mexico, the improvement in current account dynamics has Chile -1.4 -1.2 -1.4 -1.8
been twofold. First, the non-oil trade balance is now at multi- Colombia -4.3 -3.5 -3.6 -3.6
year highs on the back of solid demand for vehicles and elec-
Ecuador 1.5 -0.4 -0.4 -0.2
tronics in the context of a competitive currency and healthy
Mexico -2.1 -1.8 -2.0 -1.8
external demand; second, remittances and tourism have also
improved, which have contributed meaningfully to stop the Peru -2.7 -1.9 -2.2 -2.4
deterioration in the CAD. Accordingly, we now project the Uruguay -0.9 2.2 1.5 0.4
CAD to stabilize around 2.0% of GDP this year and next, and Venezuela -0.1 2.1 1.2
if the oil trade balance deficit stabilizes ahead, we could start Source: J.P. Morgan
talking about 1.5% deficits in the medium term. From a Fi-
nancial Account (FA) perspective, we are now less concerned Table 6: Foreign Direct Investment
about risks of a dramatic reduction in FDI related to NAFTA US$ Billions
uncertainty, and we are maintaining our call for gross FDI 2016 2017 2018 2019
reaching US$28bn this year and US$31bn next year. With Latin America 157.6 150.1 170.7 196.0
the CAD well financed, there should not be pressing con-
Argentina 1.5 8.5 17.0 22.0
cerns on the external accounts front.
Brazil 78.9 80.0 85.0 95.0
The Andean countries have benefited from higher commodi- Chile 17.0 8.5 16.0 24.0
ties export pricescopper in the south and oil in the north Colombia 12.0 10.5 10.0 11.5
(see next section). However, Chiles net profit remittance has Ecuador 0.8 0.5 0.5 0.5
proved more of a drag than in Peru. Thus, the current ac- Mexico 33.9 28.0 28.0 34.0
count deficit in Chile has remained rather stable at 1.2% of
Peru 5.1 5.6 5.7 6.0
GDP, from 1.4% last year. Meanwhile, in Peru the current
Uruguay 2.4 0.0 2.5 3.0
account deficit it will narrow by 0.9%-pt to 1.9% of GDP.
Next year, under the assumption of stable metals prices, we Venezuela 3.0 3.0 3.0
expect a bit of deterioration spurred by a stronger growth Source: J.P. Morgan
momentum underpinned by investment. Colombias current Oil prices supportive but no game changer
account deficit narrowed from a high of 6.4% of GDP in
2015 to 3.5% projected for 2017 helped also by significant The regions most exposed country to oil is far and away
import compression as domestic demand has slowed. But the Venezuela, but the better tone and outlook for prices seems
CAD remains somewhat wide, and incremental narrowing too little too late to revert economic collapse there. Cash flow
will be harder-won notwithstanding better external demand constraints mean large arrears have been built up with oil
and higher oil prices, since we see imports and profit remit- service providers and international partners, which
tances gradually picking back up. combined with the indirect impact of sanctionshas acceler-
ated the decline in output, in turn offsetting higher prices. Oil
Argentina is a noticeable exception when it comes to exter- is quite relevant for external accounts in Ecuador and Co-
nal accounts deterioration. Constructive growth expectations, lombia, and higher prices should also provide a better tone
a cyclical and structural investment recovery (weighing via for investment, helping to recover output. However, neither
imports), and a hefty fiscal deficit financed by foreigners country is expected to see much fiscal windfall yet with these
(weighing on the real exchange rate) are the main factors level of prices. On the flip side, Argentina, Peru and partic-
ularly Chile are net oil importers, so ceteris paribus higher to 2.5% next year. That said, the CAD remains a far cry from
oil prices translate into lower national disposable income via the 6.5% shortfall seen a few years back.
both terms of trade and real consumer income. Mexico, de-
spite being a small net importer, does get fiscal relief from
higher prices, and may also perceive momentum to invest-
ment in the sector post energy reform.
In regards to inflation pressures, prices associated directly

and indirectly to oil have contributed strongly to headline
CPI this year (though not enough to slow the overall disinfla- Latin relative growth recovery should sup-
tion trend in South America; Mexico is a separate case). The port capital flows
fact that nominal exchange rate appreciation has not offset
the 20% jump in oil prices explains oil-related CPI running in Figure 13: EM (ex CN) vs DM growth differential and capital flows
between 6.2%oya and 8.3%oya (Mexicos +16.6%oya was %-pt % GDP
exacerbated by tax-related changes). For 2018, we now ex- 6.0 1.5
Growth diff Capital flows
pect Brent prices to go another 11% higher (year average) 5.0
1
and exchange rates rather stable, so likely upward inflation 4.0
pressures will linger in 2018 for most of the countries. 3.0 0.5
2.0
1.0 0
Table 7: Latin America oil price exposure 0.0
-0.5
Net Fiscal -1.0
Exports CPI exposure
Trade revenue -2.0 -1
% % % 02 05 08 11 14 17
Weight %oya % total
GDP GDP total Source: J.P. Morgan
Venezuela 12.6 16.4 91 11.3 n/a 45.7
Ecuador 2.9 5.6 32.5 9.6 n/a 10 EM GDP growth is set to pick up in 2018. Despite a slow-
Colombia 2.2 3.6 32.6 10.6 8.3 2.0 down in China, EM growth is forecast to reach 4.8% in 2018,
Mexico -1.6 2 5.5 10.4 16.6 16.3 slightly higher than in 2017. EM ex-China should see growth
Peru -1 1.4 7.1 12.5 -2.1 2.3 rise to 3.6% from 3.3% in 2017, while growth in EMEA EM
Brazil 0 0.7 7.3 11.2 6.2 4.1 should remain broadly stable. The largest pickup in growth,
Argentina -0.5 0.4 3.5 9.3 n/a 3.7 in terms of the delta, is in LatAm, from 1.8% to 2.8%.
Chile -3.3 - - 10.3 6.2 3.9
Source: National central banks, J.P. Morgan. CPI weight based on broad in-
Our longstanding thesis has been that the dominant driver of
cludes gasoline and other subcomponents, Venezuela based on 2014/15 esti- aggregate capital flows into EM is its growth differential
mates, while Ecuador and Colombia are based on 2018 estimates with DM (see EM: Its all about growth, May 2016). While a
narrowing EM-DM interest rate differential would appear to
The oil-importing CAC countries would tend toward deterio- present a countervailing headwind, our empirical analysis is
rating external accounts in the face of higher energy prices. inconclusive on this front (see Emerging Markets Outlook
But Panama is seeing other forces at work, too. Services- and Strategy 2018, November 2017).
related trade is firming while infrastructure projects, specifi-
cally the expansion of the Canal, are unwinding, diminishing Obviously there are large variations depending on country-
capital import needs. Since part of the adjustment in oil pric- specific policies and politics that are not captured by the
es is already behind, we expect these latter forces to domi- growth differentials. For example, election uncertainty in
nate, allowing the current account deficit to shrink on the Mexico and Brazil alongside NAFTA uncertainty could con-
margin to just below 5% of GDP next year. ceivably push inflows toward smaller countries such as
Chile, Colombia and Peru, with less perceived volatility
The rising oil bill should have a more noticeable impact on around their growth prospects. In the following section, we
El Salvador, where we forecast the current account deficit to look more closely at the country-specific drivers relevant for
widen to 2.4% of GDP from about 2% last year. Remittances capital flows.
have helped offset the impact of higher oil prices, which has
been mostly digested by the economy, but a rising interest
bill should contribute to a mild uptick in the countrys CAD
8
Figure 14: LatAm growth differential and capital flow forecast capital flows should continue to weigh on overall capital
%-pt % GDP inflows. Portfolio flows have slowed markedly from their
6.0 2 recent years peak and are likely to be negative this year. We
5.0 Growth diff Capital flows expect improvement in 2H18 that allows for portfolio flows
4.0 1.5
to be modestly positive in 2018, though. Acting in the oppo-
3.0 1 site direction, resident deposits abroad are likely to remain
2.0
high and perhaps rise, as locals appear more risk averse than
1.0 0.5
0.0 non-residents to a potential policy shift. But, overall, under
-1.0 0 our base case scenario we expect capital inflows as a whole
-2.0 -0.5 to rise in 2018 as key risks dissipate.
-3.0 02 05 08 11 14 17
-4.0 -1 In Argentina, 2018 should mark another year of strong port-
Source: J.P. Morgan
folio inflows, as the Treasury and Provinces will continue to
Table 8: Latin America capital flows, $bn rely heavily on external markets to finance their fiscal gaps,
2014 2015 2016 2017e 2018f while the private sector should increase external financing as
Latin America 204.4 111.4 94.3 102.0 146.5 economic activity and investment growth consolidates. We
Argentina 8.3 12.8 29.4 41.9 53.5 project portfolio inflows of US$42bn, fairly in line with 2017
Brazil 122.0 54.1 27.0 21.2 43.0 levels. On the real side, we expect the reform push and up-
Chile 2.7 3.0 2.2 2.2 5.3 beat expectations to drive inward FDI up to US$18bn in
Colombia 23.8 18.8 12.2 10.8 11.1 2018, from the US$10bn expected for 2017. In all, we esti-
Ecuador 0.1 1.7 -1.4 0.4 0.4 mate continued portfolio inflows and higher FDI to drive
Mexico 38.9 11.2 20.4 19.1 25.8 international reserves up US$22.5bn to US$79.2bn (or 12%
Peru 4.7 9.7 6.5 6.1 7.2 of GDP).
Uruguay 4.0 0.2 -1.9 0.5 0.2
Source: JP Morgan, KA= -CA-RA (where -RA = Increase)
In Chile and Peru we expect capital inflows to accelerate,
though more markedly in Chile. The rationale is that higher
In Brazil, we expect foreign direct investment to remain commodity prices and the new government will incentivize
solid in 2018, totaling US$80bn, while portfolio investment foreign investment following years of declining interest in
could recover and add about US$15bn to the external inflows the country. In Peru we may be too cautious in regards to
under the assumption that the newly elected government will inflows, in particular if the government comes to be success-
maintain the reformist agenda and signal sound economic ful in accelerating PPP projects.
policies ahead, more than counterbalancing the current ac-
count deficit, which we expect to rise on the back of the Colombia should see its relatively wide current account
stronger economic growth. Nevertheless, there are two risks deficit financed by a slowly increasing FDI, with the oil
to this scenario. One relates to the external scenario: surprises sector and 4G-related investments poised to take the lead,
with monetary policy decisions abroad, especially in devel- while a better tone for domestic demand after several years of
oped countries, could affect the expected flows. Domestical- adjustment could encourage more broad-based flows. 1H17
ly, the eventual election of a government seen as less com- elections should be less of an event compared to those in
mitted to maintaining economic stability and fixing the econ- neighboring countries given the low ceiling for any anti-
omys problems ahead may weigh on investors confidence system candidate at the national level. That said, the narrow-
and willingness to invest in Brazil. ing interest rate differential could prove more risky to Co-
lombia given reliance on portfolio flows to cover the still-
Mexicos FDI has been robust in the past few years, but we wide CAD, and some lingering risks to credit ratings.
expect it to lose momentum this year and next, as uncertainty
related to NAFTA and elections, rather than shifting growth
dynamics, weigh on investor sentiment. As these hurdles are
cleared, we would expect FDI to accelerate in 2H18, allow-
ing FDI to remain stable vis--vis 2017 at US$28bn. Need-
less to say, our forecast calls for NAFTA being successfully
renegotiated and the countrys macro framework to remain
largely unchanged regardless of the election outcome. Other
Disinflation has room to tango with tequila, mental perspective, economic activity should remain below
but last call elsewhere trend, keeping the output gap negative. This, in turn, should
help cool the labor market and prevent wage pressures to
Inflation will likely move gradually higher in 2018, outside arise. Were inflation to drop as rapidly as we expect, we
of Mexico and Argentina, where we think it is poised to slow
believe wage growth would shift back toward 4%, particular-
sharply and steadily, respectively. Disinflation was the story
ly as employment gains moderate. That said, we think inertial
for most of South America in 2017, but for the more estab-
inflationthrough high wage growthand renewed curren-
lished inflation targeters, we expect CPI to trough between
4Q17 and 1Q18 and head gradually higher thereafter. This is cy weakness are the main sources of upside risk to our infla-
the case in Brazil, Chile, Colombia and Peru, though in the tion call, which remains that inflation will end the year at
former two recovering inflation will still likely stay below 3.6%, within the central banks target range.
target midpoints in 2018, while in the latter two inflation
should rise back to the upper end of target ranges. Note that Inflation in Brazil went from double digits a couple of years
our forecasts include modest upward impact from higher oil ago to the record low of 2.5% in August, the lowest level in
prices. Argentinas disinflation process will likely be a multi- the past 20 years. In fact, if our forecast is on the mark, 2017
year endeavor, and, despite steady progress, getting inflation will be the first year since the inflation target regime was
into target range and eventually single digits remains elusive. implemented that Brazil will breach the lower bound of infla-
The 2017 South America story should play out next year in tion target range. Next year, inflation should remain below
Mexico, as FX pass-through and supply shocks should come the target, particularly given the high level of slack in the
off sharply in 2018, as the base effect kicks in. economy, which should tame underlying pressures to prices.
Table 9: Inflation forecasts We expect the IPCA to average 4.1% in 2018. This means an
CPI %Dec/Dec, except where noted
acceleration from this years 2.8%, but mainly due to a rever-
sal of some one-off effects. In particular, we expect food
2018 (%oya)
price inflation to revert from south of -5% to 3%, with the
2017 1Q18 2Q18 3Q18 4Q18 2018 2019 phase-out of the effects of favorable weather, appreciated
Inflation targets 6.4 5.8 5.4 4.9 5.3 5.3 4.7 USDBRL and a record crop this year.
Argentina 23.5 22.8 20.1 14.5 16.3 15.2 10.6
Brazil 2.8 2.8 3.1 3.8 4.0 4.1 4.3 For Chile and Peru, following a year of economic decelera-
Chile 2.2 1.7 2.2 2.8 2.9 2.7 2.9 tion and stronger currencies, inflation decelerated strongly
Colombia 3.9 3.4 3.4 3.6 3.8 3.8 3.5 and is expected to close the year at 2.2% in Chile and 1.4%
Ecuador 0.0 1.6 1.6 1.6 1.6 1.4 1.6 in Peru. In 2018, headline inflation is likely to drop further in
1Q18 on base effects, to recover lately in the year if our con-
Mexico 6.2 4.5 3.6 3.3 3.3 3.6 3.6
structive growth scenario materializes. We expect inflation to
Peru 1.4 1.0 1.7 1.8 2.8 2.7 2.0
end the year inside the central banks respective targets,
Uruguay 6.3 6.1 6.5 6.8 6.8 6.7 6.7 reaching 2.7% in Chile and Peru. In Colombia, the end of
Venezuela 2000 2830 4455 5229 3545 3000 transitory shocksFX pass-through, el-Nio related and a
Source: J.P. Morgan 1Q VAT hikesaw inflation drop from 5.8% in 2016 to
Note: Inflation targeters include Brazil, Chile, Colombia, Mexico, Peru, and Uruguay. skim below the 4% target ceiling in 2017. A favorable base
In Mexico, consumer price inflation has by and large over- effect from 1Q17s VAT hike should carry inflation deeper
shot early year expectations. We looked for a weak currency into the target range by 1Q18 before sticky core inflation and
and ensuing pass-through pressures to bring inflation toward normalizing food prices take inflation toward the upper end
the upper bound of the central banks target range (4%), but of the target range by year-end.
unexpected, severe one-off shocks sent inflation spiraling
higher. A 20% increase in gasoline prices early in the year, Uruguay is likely to see headline inflation trending a bit
along with continued increases in liquefied gas and agricul- higher in 2018 than in 2H17, scraping the ceiling of BCU
tural prices, was a driving force, as were the indirect effect of target range (52) by 4Q18. Yet, we see 2018 inflation in
such increases on other CPI components. However, shocks to range at 6.7%oya. The recent announcements regarding high-
inflation this year should prove transitory. We expect infla- er tariffs to finance infrastructure projects, together with the
tion to drop sharply in January, as gasoline price increases above-potential activity momentum we penciled in, suggest
drop off the annual calculation. Additionally, significant some upward risk to this forecast. In Paraguay, the marginal
pass-through pressures present during the first half of the headline inflation acceleration observed in October prompts
year should generate a benign base effect and help pull infla- an upward revision of end-2017 inflation to 4.2% from 4.0%
tion lower through the first quarters of 2018. From a funda-
10
previously. We expect inflation to print at 4.0%oya by year- ing recovery in activity, the negative output gap remains
end 2018, in line with the centrals bank target. wide, inflation expectations are anchored, and the exchange
rate has remained stable for a while, supporting our monetary
Finally, we are constructive on Argentina in regards to see- policy view. In addition, fiscal policy should remain tight for
ing inertial pressures more tamed next year, yet convergence longer, and the government has successfully implemented
to target remains unlikely. Inflation should close 2017 well institutional changes such as the new BNDES benchmark
above target (we estimate 23.5% vs 17% target ceiling for interest rate (TLP), favoring lower structural rates ahead.
this year), with tariff adjustments (electricity, gas and trans- However, there is a significant risk over the rest of the reform
portation) contributing with more than 6.5%-pt to headline agenda, mainly on the fiscal front and the global economy,
inflation on the year. Going into 2018, the December 2017 which could have negative impacts on the USD/BRL. Less
tariffs hike will likely keep inflation high in 1Q18. But under global liquidity derived from higher interest rates in DM
the working assumption that nominal wages average 15-17% economies and/or loss of investor confidence in the govern-
higher next year, we see inflation starting to yield in 2Q18, ments ability to keep fiscal accounts under control could
so to converge to 15.2% by December 2018 (which is still eventually necessitate a tighter policy rate again.
320bp above the target ceiling).
With inflation expected to recede rather quick early next year
Monetary policy accommodation reaching in Mexico, the real policy rate is expected to increase sharp-
limits? ly, paving the way for Banxico to adopt a dovish (or less
hawkish) stance that should shift into an outright cutting
With disinflation still in play in the short term, monetary cycle until the end of the year. However, with important
policy should remain in easing mode, though not for long.
domestic and external risks looming around during 1H18
We continue to see room for Brazil to keep cutting the
(elections, NAFTA, Fed hiking), we believe Banxico will opt
SELIC, as a large negative output gap should keep inflation
to wait and see before taking any action. In recent weeks, a
under wraps. External and political risks loom large, as the
combination of tighter monetary policy abroad and uncertain- more hawkish board has made it clear that it is keeping its
ties with reforms and/or deterioration in the domestic politi- options open given external and domestic risks that should
cal scenario could weigh on the USD/BRL. If depreciation keep the pressure on the MXN and the fact that inflation
pressures intensify, then the COPOM could turn more cau- remains stubbornly high (6.6% in November) in the context
tious. For the Andean IT central banks (Chile, Colombia, and of a tight labor market. For the time being, we do not expect
Peru), monetary policy has room to ease on softer-than- changes to the policy rate in the near future. While we be-
expected inflation amid economic slack. However, all three lieve Banxico will not hesitate to increase the policy rate to
could start shifting to tightening stance in 2H18 if the ongo- anchor inflation expectations and if we continue to witness
ing cyclical recovery progresses as we expect. inflation surprises that evidence second-round effects, the big
question is what could happen if the board opts to hike again
Table 10: Latin America policy rate forecasts and the currency resumes its weakness in the context of elec-
% tions and NAFTA risks, or if the Fed adopts a more hawkish
Current 4Q17 1Q18 2Q18 3Q18 4Q18 stance.
Latin America 9.30 9.28 9.12 8.72 8.49 8.18
Argentina 28.75 28.75 28.75 25.75 23.75 21.75
Argentinas BCRA, like Banxico, is at crossroads in the
Brazil 7.00 7.00 6.75 6.75 6.75 6.75
Chile 2.50 2.50 2.25 2.25 2.25 2.75 near term. The 2017 CPI target (17% ceiling) will be missed,
Colombia 4.75 4.75 4.25 4.25 4.50 5.00 and headline and core CPI stickiness has become more evi-
Mexico 7.00 7.00 7.00 7.00 7.00 6.50 dent in recent months, which we also see as endangering next
Peru 3.25 3.25 3.25 3.25 3.50 4.00 years target (10% 2%). Refreshed by positive electoral
Source: J.P. Morgan estimates. outcome in the October mid-term legislative elections, and
ahead of the 2018 wage negotiations, the monetary authority
The recovery in the global commodity cycle, the marginal surprised markets with 250bp of hikes in the last month to
improvement in external competitiveness and the sharp de- 28.75%, a bold bid to bridge the prevailing credibility gap
cline in inflation have allowed an outsized easing of financial defined by 2018 inflation expectations that are hovering
conditions by Brazils COPOM. Under these conditions, we around 400bp above the 2018 target ceiling. However, the
see policy rates reaching the bottom at 6.75% by February tightening has been unable to meaningfully impact expecta-
next year, from 13.75% at the end of 2016, and remaining at tions, which have proven to be resilient to an already high
that level up to the end of 1Q19, when we expect the start of nominal and real ex-ante policy rate. Thats why BCRA also
a gradual normalization cycle up to 8.25%. Despite the ongo-
11
hinted at a slower pace of reserve accumulation as a way of the year. As such, we see BanRep on hold at 4.25% for most
lowering depreciation expectations over the coming months of near year before hiking the policy rate to 5%.
as a temporary nominal anchor. At the current juncture, we
see BCRA on hold through 1Q18, resuming easing by May In Uruguay, we believe conditions are aligned for BCU to
with a 150bp cut as core disinflation trend materializes. But finally consolidate inflation expectations inside the band for
we believe the risk is currently skewed to the upside if De- years to come if the authority holds to a mild contractionary
cember core inflation accelerates. Thus, we do not rule out monetary bias. Also, we believe policy measures such as
another 75bp hike in early January. We expect inflation to lowering the midpoint of the inflation target range and/or
ease in 2H18, ending the year at 15.2%. Monetary policy narrowing the tolerance band would be perceived by the
should follow the downward inflation trend, yet maintain and market as credibility enhancers, in particular amid exchange
rate stability.
ex-ante real policy rate close to 10%.
In Paraguay, the CB decided to adjust lower the inflation
We believe Chiles BCCh will cut once more, with 25bps in
target to 4.0% from 4.5% in February 2017, keeping a 2%-
February, and commence a tightening cycle by 4Q18. In our tolerance range. More recently, the central bank eased mone-
baseline scenario, we see disinflation pressures becoming tary conditions, cutting the policy rate by 25bp in July to
more evident via tradable prices if the CLP gains consolidate 5.25%, a level currently deemed as consistent with the infla-
following the second round of the Presidential election. Lack tion target. In the eyes of the central bank, the different infla-
of underlying healing in the labor market, together with sub- tion trend measures suggest a downward trajectory, although
target realized inflation, is likely to limit nominal wage gains they are consistent with the convergence of inflation to the
and, thus, non-tradable prices increases, despite improved target over the projection horizon (4%). Furthermore, the
activity momentum. The central bank is still weighting risk inflation expectations of economic agents have remained
for disinflation pressures, jeopardizing the activity recovery anchored to the target. We believe the central bank will hold
strength in 2018. A 25bp cut in February 2018 should dissi- the policy rate stable at 5.25% for the foreseeable future.
pate concerns about the speed of inflation convergence with
the target. By the end of 2Q18, if our constructive activity Figure 15: 1-year ahead inflation minus target
scenario transpires, we expect to see inflation returning to the %oya, difference
band to close 2018 at 2.7%. Later in the year, and once the Brazil Chile
3
Colombia Mexico
output gap starts to narrow, BCCh should commence to nor-
Peru
malize real policy rates hiking 50bp by 4Q18 and driving the 2
policy rate to 2.75%.
1
The narrative is similar for Perus BCRP. The central bank
cut the policy rate 100bp in 2017 to 3.25%, and our base case 0
scenario is for BCRP to stay put until 3Q18. Admittedly, in
-1
the near term any deviation from our current constructive 08 10 12 14 16
view for activity growth could prompt further easing, as we Source: J.P. Morgan
do not except upside inflation pressures until 2H18. In our
Figure 16: Latin America cumulative output gaps
base case scenario, we expect BCRP to start tightening the %-pt Brazil Chile
policy rate by 3Q18 with a projected 25bp increase in the 8 Colombia Mexico
policy rate, followed by another 50bp in 4Q18 driving the 6 Peru
policy rate to 4.0% by December 2017. We assume inflation 4
would print 2.3% in 2019, leaving the ex-ante real policy rate 2
0
at around 1.7%, roughly in line with the policy rate level
-2
deemed as the equilibrium by the monetary authority (1.8%). -4
-6
Colombias BanRep has cut the policy rate deeper into ex- -8
pansionary territory in an attempt to boost growth amid -10
steady disinflation, with 300bp in cuts since initiating an 07 08 09 10 11 12 13 14 15 16 17 18
Source: J.P. Morgan
easing cycle in December 2016. While we expect the board
to cut the policy rate to 4.25% by 1Q18, higher inflation in
2H18, a stubborn CAD and external risks with the Fed tight-
ening may still compel BanRep to hike again by the end of
12
Real exchange rates are close to historically neutral levels Figure 19: Primary fiscal balance forecasts for 2018
in much of the region and should not pose meaningful as % of GDP 0.9
constraints to monetary policy in the short term. REER 1 0.1
and NEER levels are well below long-term averages in 0
Mexico and Colombia, but in the former the looming poten- -1 -0.1
tial permanent shock of the NAFTA outcome could validate -2 -1.3
-3 -2.1 -2.1
the weaker level. Colombia, meanwhile, has stubborn twin -2.7
-4 -3.4
deficits and may well be the country where the desire of the
-5
Central Bank to deliver some modest monetary stimulus
-6
would run up against external constraintsespecially in a
disruptive scenario of dollar strength and higher DM rates.
Source: J.P. Morgan
Figure 17: Real Effective Exchange Rate
z-score, sample from 1990-2017 ARS BRL
CLP COP Opposite from external accounts, the fiscal performance is
2
MXN Brazils Achilles heel. We forecast the federal primary
1 deficit to reach BRL158bn in 2018, or 2.2% of GDP, as the
central government continues to struggle to keep a lid on
0 expenditures even in a scenario of stronger GDP growth
pushing up tax revenues. Our estimate of the fiscal thrust
-1 shows that the difficulties in tackling the high primary defi-
Depreciation
cits will lead to a gradual change in the fiscal thrust to slight-
-2
ly tight in 2018 after two years of mildly expansionary poli-
08 10 12 14 16 18
Source: J.P. Morgan cy. Part of the difficulty lies in the fact that the government
will continue to depend on non-recurring revenues while
cutting expenditures remains hard given the rigidity in the
Searching for fiscal consolidation budget. Our estimate of the fiscal thrust still points to a mild
0.3%-point of GDP tightening in 2018. Meanwhile, lower
Fiscal consolidation remains a work in progress in much of
interest rates and the BRL130bn early payment of BNDES to
Latin America, and in some countries where financing needs
the Treasury shall help containing the rise in gross debt,
are higher, it still represents an impending constraint on
which we expect to reach 75.4% of GDP next year.
growthparticularly if market conditions become less sup-
portive. With some exceptions, fiscal consolidation remains a
Mexico has shown its intent to proceed with its fiscal consol-
headwind to the current cyclical upturn, but paramount to
idation process, notwithstanding next years election. In fact,
securing higher sustainable growth over the longer term.
not only should the country achieve its first primary surplus
in almost a decade in 2017(even after subtracting non-
Figure 18: Public debt to sovereign rating recurrent revenues), but we expect it to double it to near 1%
80 % of GDP 0 2014 0 2017 of GDP in 2018. Thereafter, long-term fiscal plans point to a
70 Brazil
stable fiscal balancesomething that will, of course, depend
60 on the outcome of next years election. The envisioned path
50 would put debt-to-GDP on a downward trend following a
Colombia Mexico
40 rapid rise in past years, allowing a convergence toward 46%
30 of GDP by 2018 from a record-high 49% in 2016. The flip-
Peru
20 side of improving fiscal accounts, however, is it is expected
Chile
10 to remain a drag on activity. Public infrastructure spending
has been coming down sharply in past years and should con-
0
4 B+
B+ 6
BB BBB-
8 BBB+
10 A
12 AA-
14 AA+
16 tinue to trim a few tenths from GDP growth this year and
Source: J.P.Morgan, National Ministries of Finance, S&P, Fitch and Moody's next.
In Argentina, the government has shown commitment to

pursue a more decided fiscal effort next year to tackle the
current hefty imbalance, weaning itself from the prevailing
13
stance of fiscal gradualism. The 2018 budget projects a 1%

of GDP primary fiscal deficit reduction, driving it to 3.2% of Table 11: Fiscal breakdown
GDP, with the bulk of the adjustment arising from cuts in % of GDP
subsidies and to a lesser extent in government consumption. Accounts Brazil1,2 Chile Colombia1 Mexico3 Peru
We see primary deficit 0.2% above the governments target, 2010-2013
but flag downside risk of a quicker-than-expected regulated Revenues 22.6 21.5 15.5 22.7 22.0
price adjustments. Moreover, the government has unveiled a o/w commodity related 1.1 3.2 2.2 8.1 2.9
Primary spending 17.3 20.6 16.0 23.4 19.8
reform package, which we believe is paramount to secure the
Primary balance 1.9 0.9 -0.4 -0.6 2.3
fiscal consolidation ahead and a sustainable growth path. Headline balance -2.5 0.4 -2.9 -2.5 1.2
Fiscal consolidation is, in turn, critical to prevent a more 2015-2017
worrisome external imbalance in the coming years. Revenues 20.8 21.4 15.5 23.6 19.3
o/w commodity related 0.9 0.8 0.1 4.2 0.8
We are less constructive on the structural balance correction Primary spending 19.6 22.7 16.1 23.5 20.6
ahead in the case of Chile. While we should have more clari- Primary balance -2.3 -1.3 -0.7 0.1 -1.2
ty on the fiscal program once the presidential election tran- Headline balance -9.2 -2.0 -3.6 -2.5 -2.2
Source: J.P. Morgan. 1: Central government; 2: Gross revenues, prior to regional transfers;
spires, it is important to highlight that both presidential can- balances are net; 3: Mexicos primary deficit bottomed at -1.2% in 2015
didates are entertaining higher fiscal spending. The question
is whether budgets will pencil-in real spending growth above,
or below, real GDP growth. That will determine whether Table 12: Fiscal thrust
Chile will find a fiscal compass ahead, or whether the cycli- %-pt impact on real GDP growth
cal-adjusted deficit will remain elevated in years to come. Countries 2014 2015 2016 2017 2018
Aggregate1 1.6 -1.0 0.2 -0.1 -0.4
In Peru, we expect a more accommodative fiscal stance as
the government continues to step up capital spending with Brazil 2.3 -1.5 0.9 0.2 -0.3
the reconstruction program and fiscal stimulus underway Mexico 1.4 -1.6 -0.8 -0.5 -0.9
through 2020. Worth noting, the government has enacted this Colombia 0.3 0.6 0.1 -0.5 -0.6
year a 1.3% of GDP fiscal package targeted at reconstruction
Chile 0.4 0.2 0.1 0.5 0.2
needs and public investments. The fiscal deficit is, thus, ex-
pected to widen further to 3.5% in 2018, from 3.0% expected Peru 0.9 1.4 0.9 0.7 1.0
by the end of this year amid public capital spending execu- Source: J.P. Morgan estimates. 1: PPP weighted.
tion. The political gridlock has delayed public works execu-
tion this year, and the risk is for perennial political gridlock
to impede a smooth execution of public spending ahead, The sustainability of fiscal finances is crit-
preventing the crowding in of private investment. ical to the outlook for NEXGEM countries
Colombia is also going through its share of belt-tightening. Structurally high fiscal deficits have resulted in significant
2018s deficit is seen declining to 3.1% of GDP from an financing needs in Ecuador. Fiscal deficits have remained
estimated 3.6% in 2017, with the expected downward path of wide in Ecuador, as the outgoing Correa government spent
the 2018 deficit dependent on cuts to capital expenditure. The heavily to arrest a decline in growth ahead of 2017s elec-
authorities have not yet provided full guidance into how a tions, in spite of a significant revenue shock sustained with
US$1.5bn arbitration claim against two telecom companies the decline in global oil prices. The new Moreno government
will be incorporated into its 2017/18 fiscal planning, but it has expressed a more pragmatic stance, including towards a
should help the government meet its targets. Longer term the gradual fiscal consolidation. The 2018 budget targets a 4.1%
crux of the challenge for Colombias fiscal policy is how of GDP deficit from about 6% in the prior two years. These
spending will be adjusted consistent with the deficit re- efforts may, in turn, contain financing needs from 16% of
duction path that envisioned a deficit at 1% of GDP by 2022, GDP in 2017 to a still-high 13% of GDP in 2018.
while also incorporating post-conflict expenditures.
This year political parties agreed on reforming El Salvadors
pension system, a hitherto meaningful drag on fiscal ac-
counts. We estimate the reform could reduce annual pension
payments by around 0.8%-pts of GDP, which, alongside
ongoing improvement in the primary balance, suggests fiscal
14
accounts may have reached a tipping point. We look for the Hoping to successfully navigate a poten-
public sectors headline deficit to drop 0.6%-pts of GDP to tially turbulent year for politics
2.5% in 2018, rendering a 0.8% primary surplus and allowing
for a downtick in debt-to-GDPthe first in a decade. Latin America will see its busiest election calendar in a doz-
en years in 2018. No incumbents are standing in the major
Costa Ricas current debt-to-GDP ratio is likely not sustain- countries, raising the chances for significant turnoverand
able given expectations of revenues to remain below 15% of hence policy uncertainty. The most watched races are in
GDP and expenditures to reach 20% in the next couple of Mexico and Brazil, and well deal with those first. But there
years. While the economy is expected to expand close to are a host of other elections and political stories that could
potential this year and next, the lack of progress in fiscal bring surprises and dictate shifts in sentiment.
consolidation is adding pressure to the sovereign, risking
another credit rating downgrade. Back in February, Moodys Next years July federal elections (for President and both
downgraded the sovereign by one notch to Ba2. The risk of chambers, in addition to State-level elections) in Mexico will
lack of progress on the fiscal agenda could result in another be closely watched given the ascent from left-of-center Mo-
downgrade from either Moodys or S&P, which currently rena party, led by long-standing presidential candidate An-
hold a negative outlook on the country. The government has dres M. Lopez Obrador (AMLO). Last Junes State of Mexi-
co election was closely watched and perceived as a thermom-
struggled to reach broad agreements in Congress, as it only
eter of the real strength of Morena. In the end, incumbent
holds 22% of the seats. However, one of the pressing con-
centrist PRI kept power in the most populous state in the
cerns is that a comprehensive fiscal reform has been kept on
country, sending a strong message of its political muscle in
the sidelines, and higher debt-service receipts are limiting a the country. We do expect Morena to continue exerting pres-
faster-than-expected shrinkage of the primary fiscal deficit sure on the PRI given corruption scandals in which several
(projected at around -1.9% for 2017 after -2.3% last year). PRI governors have been involved recently and the declining
The big risk for the implementation of a new fiscal plan that approval rate of president Enrique Pena (EPN). While a Mo-
pushes in favor of tax-diversification efforts is a gridlock in rena victory could spark investor concerns regarding the
Congress. Back in August, the Ministry of Finance an- strength of the reform agenda approved since 2013, we be-
nounced fiscal contingency measures given fragile current lieve institutions are strong enough to prevent a sudden
fiscal dynamics and the risk for harsher borrowing condi- change in the countrys leadership. Last month Jose Antonio
tions. It seems increasingly likely that only the new govern- Meade, former Minister of Finance, registered as pre-
ment will address the pressing concerns on the fiscal front. candidate for the presidential election of July 1, 2018. This
means he is the facto candidate of the incumbent govern-
In Jamaica, steady implementation of the IMF agreements ment, and while he will have to catch up fast with AMLO in
has anchored fiscal policy and significantly lowered debt terms of name recognition, we expect this to be a two-horse
levels since 2013. The new Holness government made pro- race. Preliminary polls still show AMLO leading the race,
gress on structural and public sector reforms, including a but with high level on no answers and a fragile right-left
pension reform bill in 2017. The focus in 2018, aside from coalition still in the picture.
ongoing reforms on the FX and inflation targeting regimes,
will be the ability of the government to bring a long-awaited Figure 20: AMLO leads, but center-right combined are majority
public sector wage freeze across the finish line. Political % voting preference
fatigue with the fiscal adjustment is the main risk, in our 35 31
view, yet commitment to the program on both sides of the 30
25
23
aisle remains strong.
20 16
15 10
10
4
5
0
AMLO (Morena- Anaya (PAN- Meade (PRI- Zavala Rodrguez "El
PT) PRD-MC) PVEM) (Independent) Bronco"
(Independent)
Source: El Universal 1-4 Dic '17
In Brazil, the cast of leading politicians could be significant-

ly reshuffled in 2018, as the population will elect a president,
all 513 members of the Lower House, the governors and state
15
assembly members, and 54 out of 81 members of the Senate. Figure 22: Fajardo leads the favorability ratings in Colombia
The composition of the next Congress is key, as we expect 60 % voting preference
Unfavorable Favorable
the new representatives to vote on the pension reform in
40
2019. Given what is at stake for the future of the reforms and,
therefore, the country, we foresee an increase in volatility 20
next year. A market-friendly outcome requires the next gov- 0
ernment to demonstrate the willingness and ability to move -20
forward with the reform agenda, which is key to Brazils
-40
future. Our baseline scenario is that the improvement in the
economic scenario, with falling unemployment and low infla- -60
S Fajardo ML H de la G Petro G Vargas I Duque
tion, will favor a candidate that would represent the continui- Ramirez Calle Lleras
ty of the current economic policy framework. However, we Source: Invamer, December 2017
recognize that the risk around this scenario is high, as polls In Chile, the second round of the presidential election will
do not support this view, showing leftist candidate Lula as a decide the model the country will pursue in the coming years,
frontrunner, followed by right-wing nationalist Jair Bolso- facing two welfare strategies: increasing welfare via higher
naro as runner up. Still, past elections show that it is too early growth and investment or by redistribution aiming to address
to trust the polls, and elections tend to be defined no earlier negative externalities. Paramount to our baseline scenario is
than 60 days before the vote. that forward-looking upbeat sentiment consolidates into
Figure 21: Vote intention stronger investment expectations following the second round
% of vote intention on December 17th. We have penciled in this effect for next
Lula (PT) year and expect strengthening domestic demand to drive
40 Marina Silva (Rede) 2018 GDP growth to 2.9%, leaving behind four years of a
35 Jair Bolsonaro (PEN) 34
Geraldo Alckmin (PSDB) lackluster 1.7% average GDP growth. The risk to our con-
30
structive 2018 forecast is that a less growth-friendly policy
25
framework following the second round of the presidential
20
17 election could take a toll on constructive business and con-
15
sumer expectations, delaying investment decisions and the
10 9 economic recovery. This could trigger downward revisions to
5 6
investment and consumption, and thus GDP for next year. In
Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17
Source: Datafolha all, this election may cast light on whether Chile may be able
to avoid falling in the middle income trap.
Colombia will hold congressional elections in March and
In Paraguay, the general election is scheduled for April
presidential elections in May (with a June second round) to
2018. While there is still uncertainty surrounding the polls, it
define the successor to President Santos. Early polls indicate
seems that today the Colorado Party candidates are likely to
that centrist ex-governor Sergio Fajardo has superseded cen-
win the Presidential election in April. We do not expect ma-
ter-right ex-Vice President German Vargas Lleras in the lead,
jor changes with respect to the macroeconomic framework,
suggesting the two will compete against Senator Ivan Duque
despite the debate on the fast external indebtedness pace the
representing former President Uribes party and possibly
economy has experienced under President Cartes. until after
Humberto de la Calle for spots in the second round. Leftist
the vote.
Gustavo Petro could also make noise, and FARC participa-
tion will be a novelty, but we see slim prospects in a run-off
The Costa Rican presidential election will take place on
for an anti-system candidate who could depart from the
February 4 next year, after four years of government by the
pro-market framework. While the peace process will be a
center-left Partido Accion Ciudadana (PAC, in Spanish), who
campaign theme, the fast track implementation and favora-
was unable to secure majority in the Legislative Assembly.
ble court decisions should allow much of the deal to take
The lack of consensus in Congress resulted in an important
root. The fiscal rule may also be debated as the next govern-
stalemate that prevented badly needed fiscal reform and re-
ment would, in theory, inherit a significant fiscal consolida-
sulted in an important debt crisis and the downgrade from
tion effort.
major rating agencies. With corruption scandals and fiscal
concerns at the forefront, this election is expected to be par-
ticularly complex. The centrist PUSC (currently holding 11%
16
of the preferences according to recent polls) and the PLN (the holdout was barred by the ANC from assuming office).
most popular party and the one that has the stronger political Chavismo predictably swept December 10 municipal elec-
apparatus, which has 20% of the preferences) are expected to tions after the opposition MUD coalition this time formally
lead the race, probably reaching the second round, which abstained. Meanwhile, a formal dialogue process tenuously
would take place in April 1st. The candidate of the PAC, the perseveres. The MUD, backed by international support, con-
incumbent party is lagging behind, with 6.3% of vote inten- tinues to try to win concessions to ensure competitive elec-
tions. tions going forward, while the government is interested in
seeing sanctions eased. Economic conditions are worsening,
While there is no election on the calendar in Peru, politics and a unity opposition candidate for still-to-be-defined 2018
may still have a saying in regards to our constructive view, as presidential elections could in theory be competitive, but the
risks associated with political gridlock have abated, but not oppositions two most attractive candidates, Lopez and
vanished. The tension between the government and the Con- Capriles, are out of the race, and the government seems de-
gress (led by the opposition) has abated following the Con- termined to stay in power.
gress approval of the new cabinet in October, and business
confidence has indeed recovered with forward looking expec- Finally, in Bolivia, elections are due to be held only in 2019,
tations (next 3 months) back at last 4-year time highs. How- yet the preparations have already begun. President Morales
ever, risks remain in place, as ongoing corruption investiga- won a long fought battle that would allow him to run for his
tions may prompt renewed tensions. Returning to a scenario fourth term, which, if he won, would keep him in office until
of political logjam would impede either smooth execution of at least 2025. Nonetheless, the issue has proven quite divi-
public spending or the crowding in effect of private invest- sive, and Moraless own popularity has sagged. With few
ment by public investment. clear successors for Morales within his MAS party and a
divided opposition, it seems likely that Morales will remain a
In Ecuador, a pivotal vote in a consulta popular (referen- dominant force. Large twin deficits to the tune of 14% of
dum) schedule for February 4 should set the tone in GDP have helped Bolivia cushion growth amid a significant
2018. President Moreno has so far defied expectations that terms-of-trade shock. Fiscal adjustment remains on the back-
he would be a compliant placeholder for his predecessor. burner, and spending pressures may mount in the run up to
Morenos moves to politically separate himself from ex- elections as Morales seeks to persuade voters of the resili-
President Correa have earned him strong approval ratings and ence of his state-heavy, pro-growth model for a fourth time.
ample political capital. Among the two most far-reaching
issues contemplated in the referendum are re-imposing term Table 13: 2017-18 Election Calendar
limits and restructuring a key institutional body (CPCCS), Location Date Type
both of which seek to sideline ex-President Correa and his Paraguay Dec 17 General
loyalists who are still scattered throughout the government, Chile Dec 17 Presidential runoff
and appear critical to realign the political forces in Morenos Ecuador Feb 4 Referendum
El Salvador Mar 4 Legislative
favor.
Colombia Mar 11 Legislative
Colombia May 27 Presidential, Rd 1
In Venezuela, the international community continues to Mexico Jun 3 General
apply pressure via incremental sanctions and efforts to ex- Brazil Oct 7 General, Rd 1
pose human rights abuses, but opposition divisions have Venezuela TBD Presidential
deepened after an enormously frustrating result in October Source: National electoral commissions
regional elections. The parties of the MUD coalition fiercely
debated even going to the election in the wake of Maduros
installation of an all-powerful National Constituent Assembly Still a long road ahead for NAFTA 2.0
(ANC), and opposition abstention was somewhat high, even Despite five rounds of negotiations, both the timing and the
as the government used its institutional advantages to compel content of NAFTA 2.0 remain shrouded in considerable
votes. In the end, despite a massive deficit in private opinion uncertainty. Thus far, five rounds of negotiations have been
polls, the official count gave a 55% majority and 18 of 23 completed, with only two chapters having been closed (on
governorships to the PSUV. Driving divisions even further, 4 competition and small and medium enterprises). Gaps among
of the 5 elected opposition governors (all from the AD party) the positions of the three countries on e-commerce, services,
decided to swear in before the ANC, effectively lending intellectual property, anticorruption, telecom, energy and
legitimacy to that internationally questioned body (the lone textiles remain substantial. The last round did not feature
17
Minister-level meetings, and the more contentious issues like also given the negative implications for the other two
dispute-resolution mechanisms and national content were not NAFTA economies. We expect potential growth falling from
taken up. Moreover, some of the more contentious issues around 2.5% to 2.1% in the adverse scenario and to 1.8%
raised by the US regarding automotive content, dispute pan- under the severely adverse case. .
els, government procurement, and the sunset clause requiring
periodic revisions of the agreement have all been rejected by
both Canada and Mexico. In addition, general elections in
Mexico and US Congress and state elections in 2018 compli-
cate matters further. The earliest that a new NAFTA could be
approved is March 22 given that the US government notified
Congress on September 22 of its intention to modify
NAFTA, and this has to be done 180 days ahead of its sign-
ing. We believe there is room to achieve positive results, as
suggested by the November 15 comments from the Ministry
of the Economy of Mexico, who indicated openness to evalu-
ate NAFTA every five years, something that was a no-go
during Round 4.
Our baseline is that there is reasonable clarity on the key

components of the new arrangement sometime in mid-2018
and that NAFTA 2.0 is a forward-looking agreement that
takes advantage of technological change and structural re-
forms in Mexico. However, frictions and political hurdles
could delay the agreement or result in an abrupt exit by any
of the countries. A delay in the agreement or a significantly
watered-down renegotiation until after elections in US and
Mexico are completed, which we label the adverse scenar-
io, could hamper investment across the region and possibly
even derail the renegotiation if opposition parties gain signif-
icant leverage in the elections. The severely adverse sce-
nario contemplates the six-month notice to exit NAFTA by
the US, but we do not entertain the idea of a sharp recession-
ary shock given that the terms-of-trade shock would be buff-
ered by the exchange rate adjustment. Furthermore, only
half of Mexico trade takes place within NAFTA, and the
remaining is subject to World Trade Organization (WTO)
rules and most-favored-nation benefits, which should smooth
an otherwise significant increment in tariffs. While a NAFTA
exit is not retroactive to existing investments, new invest-
ments could be held back by legal ambiguities. Of note, it
remains unclear what would be the reaction of the US Con-
gress to the six-month notice, and potential legal actions.
We expect the currency to depreciate to 20.5-21.9 in the

adverse scenarios in the first year following the end of the
trade negotiation, with a shock on inflation of around 40bps
under the adverse scenario and 70bps under the severely
adverse case. Of note, the mid-term effect on inflation from
higher tariffs (even if tariffs remain at single-digit levels due
to the MFN status) could shift inflation expectations to above
4% levels. Potential growth would be affected given the
structural (negative) shock to investment, productivity and
18
J.P.
J.P. Morgan
Morgan Securities
Securities LLC
LLC Banco J.P. Morgan S.A. Economic Research
BenNguyen
Trang Ramsey(1-212) 834-4308
(1-212) 834-2475 Emy Shayo Cherman (55-11) 4950-6684 Latin America 2018 Outlook
benjamin.h.ramsey@jpmorgan.com emy.shayo@jpmorgan.com
trang.m.nguyen@jpmorgan.com December 12, 2017
J.P. Morgan Securities LLC
Carlos Carranza (1-212) 834-7139
carlos.j.carranza@jpmorgan.com
Top trade recommendations for 2018 We hold an OW in Brazil as a recovery trade, despite
uncertainties around the pension reforms and 2018 Pres-
idential elections. We also hold an RV trade to be long
FX:
Brazil versus short South Africa in 5y CDS.
Stay OW BRL in the GBI-EM Model Portfolio: High
Volatility will likely remain high in Mexico on NAFTA
real rates despite policy cuts, low inflation and growth
and election noise, but we remain long risk by way of
recovery should offset political volatility, in our view,
Pemex, where higher carry offers more attractive risk-
and we are bullish BRL heading into 2018.
reward to compensate for the mix of risks.
UW MXN in the GBI-EM Model Portfolio: Volatility
We balance our OWs by staying UW Bolivia, where the
around NAFTA negotiations and presidential elections,
twin deficits remain and where political uncertainties
and heavy MXN positions with tight valuations warrant
could overshadow any economic adjustments. We stay
an UW peso stance, in our view, which also serves as a
UW Peru, where the political gridlock puts further pres-
hedge for OW Mbono positions and OW ARS and BRL.
sure on already-tight spreads.
Sell 1Y USD/ARS NDF: We believe the 1Y USD/ARS
NDF is over-pricing the devaluation of the peso, particu-
larly in a context of a market-friendly government apply- Equity
ing orthodox policies, with an independent central bank
that should keeping real rates high. OW Brazil on GDP recovery lifting earnings. Interest
rates should stay low for longer, leading to a rotation
from fixed income to equities.
Rates:
OW Peru: Premium GDP rebounds on reconstruction,
infrastructure and greater mining capex. Rising earnings
OW Brazil local (NTNF) bonds: Foreign positions
growth, better politics.
dont appear heavy despite recent international demand
for local bonds. The BCB is forecast to continue easing,
OW Off-Index Argentina, as the renewed political
and inflation is set to remain within CB target range.
capital of President Macri fosters reforms. Lower infla-
This context bodes well for carry trades in Brazil nomi-
tion leads to higher growth. MSCI inclusion.
nal bonds, in our view.
N Chile on high valuations and asymmetric risks. Re-
Receive 5y1y TIIE FRA: Inflation forecast to fall
forms still essential to justified valuations.
meaningfully next year should help premium to come off
in the front-end of Mexico rates. Additionally, this trade
UW Colombia: Growth led by lower rates but fiscal still
has positive carry and roll, which makes it a preferred
challenging. Oil depletion and low ADTV. Challenging
one to hold over time.
stock selection.
UW Mexico: Lack of acceleration in the growth rate:

Credit: GDP is LatAms lowest. NAFTA and election are risk-
off events in 1H, leading to MXN volatility. Disinflation
We expect EMBIGD spread compression in 2018, as the
brings lower rates in 2H. Moderate valuations and realis-
positive EM fundamentals and attractive relative valua- tic earnings forecasts.
tions means EM credit can digest the gradual repricing in
core rates. We are currently MW the EMBIGD overall,
but we would be biased to add on dips, with spreads seen
tightening to 250bp (from 290bp currently).
We hold our OW in Argentina despite consensus posi-

tioning, as we believe the results of the mid-term elec-
tions reinforce positive reform momentum and valua-
tions remain attractive relative to the EMBIGD universe.
19
Diego W. Pereira (1-212) 834-4321 Latin America 2018 Outlook
diego.w.pereira@jpmorgan.com December 12, 2017
JPMorgan Chase Bank Sucursal Buenos Aires
Lucila Barbeito (54-11) 4348-7229
lucila.barbeito@jpmorgan.com
Argentina: Steering the ship Inflation to decelerate in 2H18, yet conver-

gence to target remains unlikely
Economic growth to firm up in 2018 at 3.3%y/y
Inflation has eased considerably, from 39.3% in December
Reform agenda unveiled and moving swiftly 2016 to 22.9%oya through October (19.4% YTD), still 2.4%-
pt above the 17% central bank (BCRA)s target ceiling for
BCRA to maintain a tight stance through 1Q18
2017. In the near term, upcoming regulated price adjustments
are expected to put upside pressure to headline and core CPI
Economic growth to firm up in 2018 by year-end. Indeed, electricity and gas prices, as well as sea-
Activity has strengthened in the last quarters, as evi- sonal price adjustments, are expected to add close to 2%-pt to
denced by the economic activity indicator running at a December inflation.
5.3%q/q, saar growth pace in September (4.3%oya). On Figure 2: CPI
the supply side, the robust activity momentum is evidenced by %-, cumulated YTD
widespread growth across sectors, with 13 out of 15 sectors
25.0 Seasonal
expanding on an over-year-ago basis in 3Q17. On the demand
side, it is worth emphasizing that the growth source in 2017 20.0 Regulated
has been very different from recent cycles. In particular, 15.0 Core
through 2Q17, investment has been the main driver of growth
momentum, rather than consumption. 10.0
5.0
Figure 1: Monthly economic indicator 0.0
% %oya, 3mma Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17
20 %3m/3m saar Source: Indec and JPMorgan
15
10
5 Beyond regulated prices, wage negotiations will be in the
0 spotlight in 1Q18. Real wages were up 4.4%oya by August,
-5 which could give the government leverage to negotiate nomi-
-10
nal increases more in line with BCRA inflation targets next
-15
-20 year, a necessary condition for disinflation process to acceler-
05 07 09 11 13 15 17 ate. The first negotiations that will likely set the bar are the
Source INDEC and J.P. Morgan banking sector and the teachers of the province of Buenos
Aires. We expect nominal increases for around 15% (with
Going forward, in terms of the quarterly GDP growth profile, trigger clauses in case inflation outperforms adjustments).
we expect 4Q17 growth to decelerate to 4.0%q/q, saar from
5.3% in 3Q17. In such a scenario, annual GDP growth would Figure 3: Real private and public wages
still reach 2.9%y/y, just below the threshold that triggers the %oya,3mma, real terms
payment of GDP warrants (3.0%y/y). Indeed, our models cur-
10
rently suggest around a 20% probability for 2017 GDP
5 Formal private
growth to print above 3%. wages
0
In 2018, we expect upbeat activity momentum to consolidate -5
and project a 3.3%y/y GDP growth. We assume that fiscal
correction will be frontloaded in 1H18, with quarterly average -10
GDP growth at 2.4%q/q saar in 1H18 and 3.5% in 2H18. In -15 Public wages
terms of growth sources from the demand side, we expect 2009 2010 2011 2012 2013 2014 2015 2016 2017
private consumption to add 3.0%-pt to GDP (compared to Source: INDEC
3.4%-pt in 2017), while investment should add 2.5%-pt (ver-
BCRA endorses tight money, but flirts with the exchange rate
sus 2.3% in 2017). Net trade will continue to weight negative-
as a nominal anchor. The BCRA has been increasingly con-
ly as imports should continue to outpace exports for a second
cerned about stubborn inflation expectations. The 2017 CPI
consecutive year.
target (17% ceiling) will be missed and headline and core CPI
stickiness has become more evident in recent months, which
we also see as endangering next years target (10%+/- 2%).
20
Refreshed by positive electoral outcome in the October mid- Reforms: The road to walk
term legislative elections, and ahead of the 2018 wage negoti-
Following the favorable outcome in the October midterm
ations, the monetary authority surprised markets with 250bp
election, the government has been moving swiftly with the
of hikes in the last month to 28.75%, a bold bid to bridge the
reform agenda aiming to consolidate upbeat growth mo-
prevailing credibility gapdefined by 2018 inflation expecta-
mentum going forward. The reform package is comprehen-
tions that are hovering around 400bp above the 2018 target
sive, encompassing capital market, labor market, fiscal-pact
ceiling.
with provinces, and tax reforms with a gradual 5-year imple-
mentation period. All of these reforms have already reached
However, the tightening has been unable to meaningfully im-
the Congress and are evolving at different speeds (Table 1).
pact expectations, which have proven to be resilient to an al-
ready high nominal and real ex-ante policy rate (Figure 4). A
From a fiscal standpoint, in the near term the most relevant
host of structural frictions prevent prices from providing clear
reform in terms savings is the one that changes the way pen-
signals to the markets, while the shallowness of the banking
sions are adjusted every year, with savings estimated at
credit market and the hefty fiscal imbalance hamper the effec-
around 0.6% of GDP in 2018. The reform is aimed at contain-
tiveness of the credit channel. Hence, with the exchange rate
ing rampant social security spending growth, a necessary
as the one viable policy channel, we believe the BCRAs
condition to consolidate the fiscal accounts. Social security
monetarist approach is focusing on lowering depreciation
spending has shown a sustained increase over the past years,
expectations over the coming months, as the BCRA has
reaching 9.7% of GDP in 2017, increasing from 7.9% back in
acknowledged a rethinking the pace of reserve accumula-
2014. We have flagged that any efforts to consolidate the fis-
tiona more explicit nod to using the exchange rate as a
cal deficit without addressing social spending would eventual-
temporary anchor.
ly hit the wall in light of the structural issues arising from
high (and indexed) social spending in the context of disinfla-
We expect inflation to ease in 2018 to 15.2% and monetary
tion. Worth noting, this bill does not solve the structural issue,
policy to accompany the downward inflation trend, but main-
but provides more time to address it.
taining ex-ante real policy rate close to 10%. In the short term,
we expect upcoming tariff adjustments (electricity, gas and
Table 1: Reform package
transportation) to put upside pressure on headline and core
Reforms Progress Expected approval Estimated impact
inflation. Thus, we see BCRAs policy rate on hold at 28.75%
Sent to Con- 0.3% cost next
through 1Q18. Tax gress, pending 1Q18 year (neutral in 5-
discussion year period)
Yet, we expect disinflation trend to materialize in 2Q18, un-
Approved in the 0.5% cost (central
der the working assumption that nominal wages average 15% Fiscal pact Senate, pend- government
Dec-17
higher next year. In this scenario, we see BCRA resuming with provinces ing Lower 0.3%; provinces
easing by May with a 150bps cut. As inflation deceleration House approval 0.2%)
consolidates, we expect BCRA to drive the policy rate down Approved in the
to a terminal rate of 21.75% by end of 2018, which would still Capital Lower House,
Dec-17 n.a.
Markets pending Senate
be consistent with a 10% real rate (when deflating by 2019 approval
expected inflation).
Sent to Con-
Too early to as-
Labor Market gress, pending 1Q18
sess
Figure 4: Real ex-ante policy rate and 2018 inflation expectations discussion
% Approved in the
Real ex ante policy rate Senate, pend- 0.6% of GDP in
12 17 Pensions 1Q18
ing Lower estimated savings
2018 inflation expectations 16.5 House approval
10
16
8 15.5 Source: EcoGo and J.P. Morgan
15
6 At a provincial level, the fiscal agreement with the provinces
14.5
4 14 is also paramount to maintain the overall public sector prima-
13.5 ry spending flat in real terms, as well as to advance in gradu-
2
13
0 12.5 ally reducing the share of personnel in provincial spending
May 16 Aug 16 Nov 16 Feb 17 May 17 Aug 17 Nov 17 (bear in mind that 80% of total public employment is at a pro-
Source: BCRA vincial level).
21
But the consolidation of the fiscal accounts also requires fos- Figure 5: Central Government
tering competitiveness and investment to improve tax collec- % GDP
tion and achieve sustainable growth, making the tax and labor 10 Personnel
market reforms the utmost importance in our view. The tax Social security
8 Transfers to private sector
reform proposal reduces tax pressure by 1.5%-pt over a five-
Capital spending
year periodwith corporate income taxes dropping from 35% 6 Interests
to 25%. In its first year, the fiscal reform is expected to have a
4
0.3% fiscal cost. But the fiscal impact over that 5-year period
is projected to be almost neutral, offset by the expected GDP 2
gain resulting from efficiencies and growth spurred by the
0
reform. Meanwhile, the labor reform seeks to reduce high 2003 2004 2005 2006 2007 20082009 2010 2011 2012 2013 2014 20152016
informality prevailing in the Argentine economy (estimated at Source: IARAF and JPMorgan
around 35% of total labor workforce) through a labor amnesty
and reducing labor costs to foster productivity and employment.
Reliance on external markets to finance the
Lower fiscal spending to drive the primary fiscal gap remains the main risk
deficit 1%-pt of GDP lower The reliance on foreign savings to bridge the fiscal gap to-
gether with the scarcity of domestic savings continue to make
Argentinas 2018 budget proposal shows the governments
Argentina vulnerable to a less benign external backdrop,
commitment to wean itself from the prevailing stance of fiscal
which remains a risk to our baseline scenario.
gradualism, and advance in a more decided effort to tackle the
current hefty fiscal imbalance in a non-electoral year. The
We estimate gross financing needs with the market at
budget projects a 1%-pt of GDP reduction in the primary fis-
US$32.6bn in 2018, slightly below US$35.7bn this year. Due
cal deficit, driving it to 3.2% of GDP in 2018.
to the reasons outlined above, we expect the government to
continue sourcing a relevant portion of its financing needs
In the first year of implementation, we expect the aggregate
from the external markets. In terms of currency breakdown,
reforms impact to be neutral at a central government level
we expect US$10bn issuance in the external markets, com-
with the savings from pension reform almost offsetting tax
pared with US$13.3bn performed in 2017. In the local mar-
reduction. But the medium term benefits are expected to sur-
kets, we expect the government to issue US$9.4bn in local
pass the costs, if and only if overall fiscal spending consoli-
currency debt issuance (compared to US$11bn issued YTD
dates at lower levels. Thus, expenditure trimming will drive
2017), US$5bn in Bonar bonds (US$3.6bn issued YTD 2017)
the 1%-pt of GDP fiscal consolidation in 2018, with the bulk
and US$8bn in Letes (net). We will reassess our forecasts
arising from cuts in economic subsidies (0.6%-pt) and to a
once the government announces its 2018 financial program in
lesser extent, government consumption.
January next year.
We expect primary deficit to print at 3.4% of GDP in 2018, a
In our models, gross public debt should reach around 55% of
tad above governments target of 3.2% of GDP, but flag
GDP by December 2018. When netting out intra-public sector
downside risk if subsidies reduction is stronger than expected.
debt (e.g., Treasury debt in hands of the pension fund ANSeS,
Still, we expect central government headline deficit at 5.7% of
or IOUs in the asset balance sheet of BCRA), net debt goes
GDP in 2018, 0.7%-pt higher than the level observed in 2015
lower to 30% of GDP. This stock (debt in hands of the private
when the Macri administration took office. Moreover, adding
sector, bilateral and multilateral institutions) is expected to
up provinces, we estimate consolidated public sector deficit to
continuing moving north, as the Treasury financial require-
close at 5.9% in 2018, from 7.1% in 2017.
ments remain elevated when compared to EM peers. Moreo-
ver, the elevated front end financial costs in local currency,
emanating from the very tight monetary policy rate, still tilt
the government to finance the fiscal gap with a relevant por-
tion of hard currency debt.
22
Table 2: 2018 Fiscal Uses and sources The logical outcome spanning from REER stability amid
2018 strengthening activity is a wider trade deficit. Argentinas
ARS USD Total % of trade deficit has widened markedly in 2017, with the last 12-
(bn) (bn) (USDbn) GDP
month deficit reaching US$6.1bn by October, compared to a
A. Uses 674.0 12.4 48.6 7.3
US$1.8bn surplus for same period last year. The bulk of the
Primary Fiscal Deficit 422.0 22.7 3.4
merchandise trade flow deterioration continues to be ex-
Debt Amortization 112.0 4.4 10.4 1.6
Interests 140.0 8.0 15.5 2.3 plained by the non-energy balance, on upbeat imports mo-
B. Sources 205.0 5.0 16.0 2.4 mentum driven by the cyclical activity upturn, and we expect
Rents BCRA 140.0 7.5 1.1 this trend to linger in 2018. A wider trade deficit prompts us
New multilateral credit lines 5.0 5.0 0.8 to revise the 2017 current account deficit higher, to
Intra-public sector financing 45.0 2.4 1.4 US$24.6bn or 4.0% of GDP, compared to 2.8% on 2016. In a
C. Financial req. (A-B) 469.0 7.4 32.6 4.9 similar fashion than in 2017, next year the juxtaposition of
Hard ccy debt issuance 178.0 23.0 32.6 3.5 both cyclical activity upturn together with a structural open-
In external markets 10.0 10.0 1.5
ness of the economy should be the main forces behind the
In local markets (Letes) 8.0 8.0 1.2
further widening current account behavior. We expect the
In local markets (Bonar) 5.0 5.0 0.8
Local ccy debt issuance 178.0 9.6 1.4 current account deficit to climb up to 4.6% of GDP (or
Source: 2018 Budget and J.P. Morgan
US$30.2bn).
Notes: Excludes intra-public debt
Figure 7: Current account balance
%GDP, 4q sum
A fine line to walk: Real exchange rate ap-
9
preciation and growing external imbalances
7
The policy mix of tight monetary policy (with real ex-ante 5
rates around 10%) amid a still hefty fiscal imbalance financed 3
with foreign savings will continue to put upside pressure on
1
the real exchange rate, unless inflation eases enough for
BCRA to adopt a more accommodative monetary policy -1
stance. In the meantime, BCRA is likely to continue purchas- -3
ing the bulk of the hard currency the Treasury sells next year. -5
Otherwise, the multilateral real exchange rate could pierce the 94 96 98 00 02 04 06 08 10 12 14 16
Source: Indec and J.P. Morgan
last six quarters max level. Currently, the REER is around
17% weaker than the pre-2015 devaluation level, yet just
4.7% below the last six quarters max. It is worth noting that On the financing side, for 2018 we pencil in US$42bn in port-
BCRA intervened in the exchange rate market buying dollars folio inflows as the private sector should increase external
when it reached that level. In all, we expect the multilateral financing, while the Treasury will continue to rely heavily on
exchange rate to move sideways in 2018, and we may see a external markets. On the real side, we expect the reform push
much stronger ARS REER vis vis BRL. and upbeat expectations to drive inward FDI up to US$15bn
Figure 6: Real exchange rate in 2018, from the US$10bn expected for 2017. In all, contin-
Index, Dec 16 2015 =100 Multilateral ued portfolio inflows and higher FDI will drive international
165 BRL reserves up US$22.5bn to US$79.2bn (12% of GDP).
155
145
From the net savings point of view, in the coming years, fiscal
consolidation appears as a necessary condition to prevent un-
135
sustainable external imbalances. It is of the utmost importance
125
that, with increased political capital, the government advances
115 swiftly with the fiscal adjustment in order to provide private
105 sector with more room to finance rising investment with exter-
95 nal savings. If not, any deviation from the 2018 and 2019 pri-
15 16 17 mary deficit targets would translate into a much wider CAD.
Source: BCRA and JPMorgan
23
Banco J.P. Morgan S.A. J.P. Morgan Securities LLC Economic Research
Cassiana Fernandez (55-11) 4950-3369 Vinicius Moreira (1-212) 834-4144 Latin America 2018 Outlook
cassiana.fernandez@jpmorgan.com vinicius.moreira@jpmorgan.com December 12, 2017
Cristiano Souza (55-11) 4950-3913
cristiano.souza@jpmorgan.com
Brazil: Staring at a fork in the financial conditions, should continue to support the capital
inflows and the ongoing recovery despite the likely rise in
road electoral uncertainties. Despite the recovery, the still large
output gap, with the expectation of a roughly stable FX,
2018 general elections likely to dominate market should contain inflationary pressures. Next year, inflation
attention should also be curbed by the indexation mechanisms that
increase the persistence of low inflation levels today. And we
Fundamentals are solid, with strong growth, low infla-
expect 2018 to be the second year in a row of IPCA below the
tion and sound external accounts
Central Bank target, at 4.1% (from 2.8% this year).
Fiscal accounts remains the weak spot, and sustainability
of the recovery depends on reforms 2018 Elections: the rubber is yet to hit the
road
Over the last 18 months or so, the Brazilian economy has
been recovering and repairing. Activity went into a tailspin Next year, political actors positions can be significantly
in 2014-15 as domestic business confidence plummeted in the reshuffled as the population will elect a president, all 513
face of intense political instability while global commodity members of the Lower House, the governors and state as-
prices collapsed. The banking system was able to absorb the sembly members, and 54 out of 81 members of the Senate.
impact of the economic crisis and the adjustment within The composition of the next Congress is key, as we expect the
overleveraged corporates mired in corruption-related investi- new representatives to vote on the pension reform in 2019.
gations without threatening bank solvency. And now, the Given what is at stake for the future of the reforms and, there-
balance sheet of households seems to be adjusted to support a fore, the country, we foresee an increase in volatility next year.
mild credit expansion. Since end-2016, a recovery has slowly
taken hold and in the last few quarters it has both widened and A market friendly outcome requires the next government to
picked up pace. demonstrate the willingness and ability to move forward with
the reform agenda, which we believe is key to Brazils future.
Much of the ongoing recovery reflects a restoration of busi- Our baseline scenario is that an improvement in the economy,
ness and household confidence after changes to the economic with falling unemployment and low inflation, will favor a
policy framework. Importantly, there is a more widespread candidate that would represent the continuity of the current
acceptance of the need for reforms, albeit there is still no economic policy framework. However, we recognize that the
consensus in the society on the nature and form of these re- risk around this is high, as current polls do not support this
forms. The current government, at least up to now, approved view. A recent poll from Datafolha, showed that former presi-
several reforms aiming to improve fiscal solvency and in- dent Lula is ahead with 35% voter support (Figure 1). Of
crease productivity, but has so far has failed to approve the note, Lula was already convicted on charges of corruption,
pension reform, which is key to improve fiscal sustainability which does not bar him from running next year, as he ap-
ahead. Fiscal adjustment will need to be done in the future to pealed, but creates uncertainty about his participation. Jair
reduce medium-term risks, which have in part been better Bolsonaro has been improving in the polls, and he now has
straitjacketed by the recent reforms, but further fiscal adjust- 17% of the vote intention. Marina Silva, a candidate in the
ment is needed to secure a sustainable debt-to-GDP path last two elections, follows with 13%. At last, Geraldo Alck-
ahead. A credible long-term adjustment could also help to min (or Joo Dria) appears with 8%. Still, past elections
improve the low level of savings seen. Other reforms, aiming show that it is too early to trust election polls.
to increase productivity and reducing business costs, should
also increase potential GDP. Figure 1: Vote intention
% of vote intention
Lula (PT)
But most concerning, there is little visibility on who will be 40
leading the Presidential race at this stage, and next years 35 Marina Silva (Rede) 34
economic performance will depend on the ability of the can- 30
didates to forge a compromise on the key structural reforms 25
that is sufficiently balanced to also win popular support. We 20
believe that the economic cycle should favor the candidates 17
15
that support the continuation of current economic policy 10 9
framework. The recovery in the global commodity cycle, the 6
5
marginal improvement in external competitiveness, the sharp Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17
decline in inflation that has allowed an outsized easing of Source: Datafolha
24
2018 GDP to grow 2.8%, driven by con- case growth momentum fails to improve abroad, or a disrup-
sumption tive tightening in developed economics become the base case
for market participants, the external conditions that allowed
The recovery in the global cycle and the sharp decline in the current positive cyclical combinationlow inflation, low
inflation that has allowed an outsized easing of financial rates, USDBRL stablecould prove to be a headwind to our
conditions should continue to support capital inflows and forecasts for growth and the SELIC rate.
the ongoing economic recovery despite electoral uncer-
tainties. We expect a solid GDP performance next year,
Inflation to rise somewhat mostly on the
growing 2.8% (Table 1). This recovery should be led by pri-
vate consumption, with the lagged effects of the monetary back of food inflation
policy easing kicking in, improving credit conditions. Also, After a year in which inflation bottomed in the lowest level
the recovery in the labor market is expected to continue and to in the past 20 years, we expect the IPCA to return to 4.1%
support growth. Another important factor underpinning our next year. The usual suspects will play a key role in defining
more optimistic view is the sustained recovery in business headline inflation in 2018. Food prices are expected to go
confidence. The missing piece here remains to be invest- back to the positive camp, reaching almost 3.5%. We under-
ments, given the high corporate sector leverage and levels of stand that this years food inflation was unusual, helped by
spare capacity. favorable weather, appreciated USD/BRL and a record crop
on the top of the worst recession ever in the country. Our
Table 1: Annual GDP forecasts expectation is that part of these factors, especially on the food
%oya supply side, will normalize, pushing food CPI up.
Items Weight (%) 2015 2016 2017 2018 2019
While we see a deceleration of administered prices from 8.1%
GDP 100 -3.5 -3.5 1.1 2.8 2.5
this year to around 6.1% in the next, controlled prices in 2018
Demand components:
should still run above the last 10 years average. The main
Private Consumption 63 -3.2 -4.3 1.1 4.0 3.3
reason for this underlying trend is, at this point, electricity
Government Consumption 20 -1.4 -0.1 -0.6 -0.8 -0.8
prices as the costs of electricity production have risen given
Investment 18 -13.9 -10.3 -1.9 4.0 5.0 the low levels of hydroelectric power reservoirs. This should
Exports 13 6.8 1.9 5.4 3.2 2.4 be reflected in the annual price readjustment on consumer
Imports -14 -14.2 -10.2 5.4 5.0 5.5 prices. Of note, our forecasts embed the hypothesis of green
Source: IBGE and J.P. Morgan forecasts flag by February, with a subsequent upgrade to red flag 1 by
mid-2017. This system of flags changes prices automatically
Figure 2: Quarterly GDP growth according to wholesale electricity costs (which ultimately
% change depends on rainfall and level of water reservoirs).
10 %oya
Table 2: Consumer prices (IPCA)
5 %oya, data and forecasts
Components Weights (%) 2014 2015 2016 2017 2018
0 IPCA headline 100.0 6.4 10.7 6.3 2.8 4.1
IPCA core - 6.3 9.0 6.6 3.6 4.2
-5
Administered 24.9 5.3 18.1 5.5 8.1 6.1
%q/q saar Market driven prices 75.1 6.7 8.5 6.5 1.1 3.5
-10
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Goods 39.2 5.4 8.9 6.6 -1.7 2.7
Source: IBGE and J.P. Morgan forecasts Non-durable 23.6 6.9 12.3 9.3 -3.2 3.3
Semi-durable 7.7 3.9 5.3 4.1 2.3 3.8
While we are relatively more constructive on the GDP story Durable 7.9 3.0 3.3 1.4 -1.0 -0.3
next year, there are important risks to our scenario. The main Services 35.8 8.3 8.1 6.5 4.4 4.4
one, in our view, is domestic: next years election promises to Cyclical services 27.7 9.1 8.3 6.6 3.8 4.3
be one of the most uncertain during the democratic period. Trend services 8.2 5.8 7.6 6.1 6.5 4.5
With the known need of reforms, a negative outlook in the Source: IBGE and J.P. Morgan forecasts.
elections could create an inhospitable environment for in-

vestments and even consumption, undermining a more con-
sistent recovery throughout the year. The external environ-
ment could harm next years GDP performance as well. In
25
Rates should be lower for longer Table 3: Fiscal scenario

When it comes to monetary policy, we see rates reaching as % of GDP, except when noted
the bottom at 6.75% by February next year (Figure 3), and Variables 2015 2016 2017 2018 2019
remaining at that level up to the end of 1Q19, when we should Central govt. primary balance (BRLbn) -115 -161 -159 -158 -130
see a gradual normalization cycle up to 8.25%. We see the
Consolidated govt. primary balance -1.9 -2.5 -2.1 -2.1 -1.6
Central Bank less concerned about the possible inflationary
pressures coming from the domestic economy, since the lev- Nominal balance -10.2 -9.0 -8.2 -7.7 -7.4
els of idle capacity remain high. And, in fact, we think there Source: BCB and J.P. Morgan forecasts.
are reasons for the monetary policy authorities to think that
way: the negative output gap remains wide, inflation expecta- Figure 4: Fiscal thrust
tions are anchored and the exchange rate has remained stable %-points of GDP
for a while. 2.4
However, there is a significant risk over the reforms and glob- 1.6
al economy, which could have negative impacts on the
USD/BRL. Less global liquidity derived from higher interest 0.8
rates in central economies and/or loss of investors confidence
in the government ability to keep fiscal accounts under con- 0.0
trol could lead to rate hikes or the end the cycle before ex-
-0.8
pected. These facts are not in our baseline scenario and, im- 10 11 12 13 14 15 16 17 18
portantly, appear unlikely to materialize before February. Source: J.P. Morgan estimates
Figure 3: Selic rate This scenario still underpins a further increase in gross debt,
%p.a. which we forecast at 75.4% of GDP next year. The rise in
20 debt may be smoothed by the BRL130bn early payment of
BNDES to the Treasury, with an impact of 1.8%-point of
GDP on the debt level. For 2019, we see debt-to-GDP climb-
15
ing further and reaching 78.3%, evidencing the situation of
the Brazilian public accounts (Figure 5).
10
6.75 Figure 5: Gross debt Forecasts
5 as % of GDP
04 07 10 13 16 78.3
80 75.4
Source: BCB and J.P. Morgan forecasts
75
70
A mild reduction in the primary deficit 65
60
The stronger GDP growth and some specific measures 55
next year should contribute to push tax revenues up, while 50
a 6.5% nominal rise in social security spending should 45
keep pressuring expenditures. Even as the government tries 40
to control some expenditure, we expect a central government 06 07 08 09 10 11 12 13 14 15 16 17 18 19
Source: J.P. Morgan
primary deficit of BRL158bn, or 2.2% of GDP. Conversely,
we expect regional governments to post a mild surplus and the
general governments primary deficit to amount to 2.1% of Adjusted external accounts should be a
GDP. The lower interest rates should help contain the rise in buffer in case of shocks
interest expenditures, thus contributing to reduce the fiscal
The slump in economic activity between 2014 weighed on
deficit to 7.7% of GDP from 8.2% in 2017 (Table 3). In terms
the volume of imports of goods and services, while resili-
of the fiscal stance, the tightening will be slow, leading to a
ent export prices led to a strong adjustment in the current
gradual change in the fiscal thrust towards a mild 0.3%-pt of
accounts. As a result, the current account deficit (CAD) has
GDP tightening in 2018 (Figure 4, see also Latin America:
retracted consistently from the recent peak of 4.4% registered
Searching for fiscal consolidation).
in April 2015 and we expect it to reach 0.5% by the end of
26
2017 (Figure 6). The recovery of the economy is likely to lar short-term measures, the spending cap could be breached
push imports, as it has already been happening for some ser- in 2019.
vices, and increase the CAD to 1.7% of GDP in 2018.
Continuing with the sets of reforms and important measures
Meanwhile, foreign direct investment (FDI) has remained adopted by 2016, the Agenda BC+ and the Governance rule
steady throughout the period, slightly above 4.3% of GDP, 13.303/2016 were both approved in December 2016. The
mostly directed at equity capital participation, rendering them Agenda BC+ consists in guidelines for structural issues from
less prone to any sudden reversal. Also, international reserves the Central Bank and for the Nacional Financial System. The
have been hovering around US$380bn, which is enough to central objective is improving efficiency of financial system
support about 21 months of imports of goods and services. (see Os 4 pilares de medidas estruturais do BC anunciados
Thus, even with some increase in the CAD in 2018, we deem por Ilan Goldfajn, Infomoney, December 20, 2016). The
that the external adjustment has been completed and will not governance rule is based on principles of governance of pub-
be reversed soon. lic companies as independence, professionalization and rank-
ing of the administrators, making the administration act more
Figure 6: Current account deficit and FDI inflows efficient (for more detail see Decreto do governo federal
in US$ Billion regulamenta Lei das Estatais, Governo do Brasil, December
150
28, 2016).
100 FDI In September this year the Congress approved the creation of
80 new benchmark interest rate for Brazil National Development
50 Bank (BNDES). The new law states that, over the next five
38
CAD years, the TJLP rate, a benchmark rate historically below the
0 Central Banks policy rate will be gradually replaced by the
TLP, a market-based rate defined by a pre-fixed 5-year real
-50 government bond yield (5-year NTN-B) plus accrued inflation
05 08 11 14 17
Source: BCB and J.P. Morgan over time for BNDES lending. This law is important because
it helps the economy in three fronts: fiscal, monetary policy
and capital allocation. The implementation of the TLP rate
Reforms: A summary of the last 12 months should reduce the implied subsidy from the earmarked rate
The last couple of years were important for Brazil. Not that benchmark over BRL500 billion only from BNDES. Ac-
only because it marked the end of the worst recession in its cording to government estimations (as presented in the TLP
history, but also because the country successfully dealt with bill draft here), the implied subsidies from the TJLP from
several challenges and was able to move forward with a tough 2007 to 2016 amounted up to BRL284.7 billion, or almost 6%
and necessary economic agenda. The reforms implemented of the current gross public debt. Besides the fiscal costs, the
should favor the sustainability of economic recovery going TLP rate shall also improve the efficiency of the monetary
forward, improve business environment and reduce con- policy, as well as promoting a better allocation of capital by
straints to productivity gains ahead. But challenges remain. impacting the earmarked (or regulated) credit market.
Brazil still needs to secure fiscal sustainability with a broad
and deep pension reform. Another objective is to increase To improve productivity and the legal framework, the Labor
efficiency and reduce barriers to growth with a tax reform Reform was approved in Congress in July, revising a few
aiming mainly at reducing the complexity of the system, re- aspects of the current labor rules, aiming at making them
flected in the time spent to deal with taxes. more flexible and lowering costs, mainly regarding labor
justice (for more details see Brazil: Labor reform was ap-
In December 2016, President Temers government approved proved in the Lower House with an eye on pension reform
an important measure based on a spending ceiling for public negotiations. One of the main aspects of the reform to in-
expenses in which the government should cap the budget crease labor flexibility was to allow negotiations between
using previous years expenditures and a reset factor (for employers and employees to prevail over the labor laws.
more details see Brazil: Spending cap is good, but not
enough). Nevertheless, given the rigidity of the budget (man- Finally, the government has also announced an ambitious
datory expenditures accounts for roughly 90% of the total), it privatization schedule. The agenda comprehends a set of
will be difficult to contain the rise in expenditures without airports, energy power plants and transmission lines and
additional measures. With the expected delay of the pension ground transportation lines.
reform presented to the Congress this year, and other unpopu-
27
Chile: December election to by postponing investment decisions and keeping precau-

tionary savings high enough for consumption to underper-
prove pivotal form versus our current baseline. From a medium term point
of view, the policy mix set in place by the coming administra-
December presidential elections could prove a galvaniz- tion will likely determine whether productivity growth will
er for a sustained economic recovery ahead return to positive terrain, or consolidate the downward trend
in place in the last few years (Figure 2).
We are constructive on 2018 GDP growth at 2.9%y/y
BCCh to cut once more, 25bp in 1Q18, and commence a Figure 2: Productivity growth
tightening cycle by 4Q18
CLAPES TFP index,growth, 5-yr average
Former President Piera and incumbent Senator Guillier

will compete for the first office in a second round. The first 3%
round of the Presidential that transpired on November 19 sug-
gests the ballotage (to take place on December 17) will be
more contested than what we had previously expected. The 1%
few polls released so far suggest a tight result in the second
round. While the presidential second round outcome is open,
we already know the composition of the Congress. The Par- -1%
96 98 00 02 04 06 08 10 12 14 16
liament will have three clear poles, and neither Piera nor Source: CLAPES UC and JP. Morgan
Guillier will have the necessary votes to pass complex laws.
Thus, due to the new electoral system and the good perfor-
Activity has been recovering at a decent pace over the past
mance of leftist party Frente Amplio, the government will be
few months and we expect the recovery to linger. Activity
forced to negotiate with the other political blocks to pass al-
logged a decent 6.1%q/q saar pace in 3Q17, leaving behind a
most any project. This clearly limits both the bullish and bear-
mediocre 1H17 (GDP expanded q, saar in 2Q17 and 0.3% in
ish reform scenarios.
1Q17). On the demand side, net exports explained the 3Q17
GDP sequential acceleration, followed by consumption, most-
Figure 1: First round of Presidential and Congress elections
ly explained by private consumption. The good news is that
%
fixed investment also accelerated on the quarter, while inven-
40
35
tories proved a drag after three consecutive quarters of expan-
30 sive behavior. On the supply side, mining explained half of
25 the sequential GDP acceleration on the quarter.
20
15
Figure 3: Chile monthly activity index (IMACEC)
10
10
5
0 8 %3m/3m saar
Piera Guillier Sanchez Kast Goic
6
Source: CADEM and Servel
4
%oya, 3mma
2
Despite the Congress composition, we still believe there is
scope to improve the institutional design, helping private 0
investment to recover. Indeed, a pro-growth political agenda -2
aimed to unleash productivity gains would consolidate upbeat -4
consumer and business expectations, driving investment to 11 12 13 14 15 16 17
spearhead the growth recovery. We had thought of this elec- Source: INE, BCCh and JP. Morgan
tion as an inflection point, a galvanizer for Chile to leave be-
hind a cycle characterized by subdued business and consumer Improved terms of trade and upbeat expectations make us
expectations that have weighed on domestic demand since constructive on 2018 growth, and we forecast GDP to ex-
2014. Yet, as discussed before, the Congress distribution like- pand 2.9%y/y. Following the elections, our base case scenar-
ly limits the governments degrees of freedom to pursue a io is for the upbeat expectation regime to consolidate, driving
deep pro-growth agenda. On the other side, a less growth- activity growth to levels close to 3%y/y next year. Our mod-
friendly policy framework could delay the economic recovery els still show subdued investment expectations levels versus
28
what activity confidence indicators suggest. We have penciled

Figure 5: Business confidence: Current situation vs expectations
in this effect for next year and expect strengthening domestic Zscore
demand to drive 2018 GDP growth close to 3.0%, leaving
1.5
behind four years of a lackluster 1.7% average GDP growth.
1.0 Current
Economy expectations
Confidence indicators showed upbeat expectations ahead, 0.5
which makes us constructive, yet also entails risks. Busi- 0.0
ness confidence has recovered markedly in the last months.
-0.5
Yet, confidence improvement masks a telling development:
the pure forward-looking components have explained the -1.0
bounce back, while current economic conditions are deemed -1.5
as still subdued (see Figure 5). The drivers for improved ac- 10 12 14 16
Source: IMCE and J.P.Morgan
tivity prospects ahead are deemed a combination of higher
commodity prices and its spillovers to manufacturing, com-
merce, and construction sectors via direct impacts, or through Figure 6: Consumer confidence
Index, IPEC
terms of trade, which are upgrading national income. But also Next 12m- current conditions
expectations of a political change have been deemed respon- 15
sible for better economic conditions. 13
11
9
Figure 4: Contribution of consumption to GDP 7
%-pts, q/q sa 5
Net exports Inventories 3
3.5 1
Fixed investment Public consumption
-1
2.5 Private consumption -3
1.5 02 04 06 08 10 12 14 16
Source: BCCh and J.P.Morgan
0.5
-0.5
Near-term, the main risk to our forecast is a sudden con-
-1.5 solidation lower of upbeat expectations in light of height-
-2.5 ened political uncertainty. The risk to our constructive 2018
2Q16 3Q16 4Q16 1Q17 2Q17 3Q17
Source: BCCh and JPMorgan forecast is that a less growth-friendly policy framework fol-
lowing the second round presidential elections could take a
toll on constructive business and consumer expectations, de-
Similarly, the consumer confidence series show the optimist
laying investment decisions and the economic recovery. This
gap close to historical highs. In the same vein as for business
could trigger downward revisions to consumption, invest-
confidence, it is the pure expectation component that has
ment, and thus GDP for next year.
pushed headline confidence higher. Optimism in regards to
future consumption behavior has recovered a lot quicker than
the sentiment on current consumption levels. To illustrate the Figure 7: Unemployment rate
%
point more directly, in Figure 6 we plot the difference be-
8.0
tween the pure forward looking component (next 12month
expectations) and the current conditions level. The optimism 7.5
has reached levels not seen since 2009 (recovery from the
7.0
global financial crisis).
6.5
6.0
5.5
10 12 14 16
Source INE and J.P. Morgan
Loose labor market conditions and still feeble investment.

We continue to categorize the current cyclical labor mar-
ket conditions as loose, with job creation tilted to self-
29
employment. Despite the green shoots evidenced in employ- We believe BCCh will cut once more, 25bp in 1Q18, and
ment growth, the sources of new jobs have been related to commence a tightening cycle by 4Q18. In our view, disinfla-
public sector and services, which cannot deliver sustained tion pressures will become more evident via tradable prices if
improvement, and own account jobs are running close to the CLP gains consolidate following the election. Also, lack
highs as a share of total employment. Moreover, manufactur- of underlying healing in the labor market together with sub-
ing seems unable to leave stagnation behind, with production target realized inflation is likely to limit nominal wage gains
running at a feeble 0.2%3m/3m in October. We have high- and, thus, non-tradable prices increases, despite the improved
lighted the risk spanning from the recent CLP appreciation, in activity momentum. On top of that, the central bank is still
particular for the export-oriented manufacturing branches, weighting risk for disinflation pressures, jeopardizing the ac-
conspiring against a sustained recovery in this key sector. We tivity recovery strength in 2018. We still see further disinfla-
still see as a relevant risk the inability of manufacturing pro- tion pressures ahead and believe a 25bp cut in 1Q18 should
duction to gain momentum and grow sequentially for more dissipate concerns about inflation convergence to the target.
than a quarter, with the seesaw quarterly behavior that has Later in the year, and once the output gap starts to narrow,
characterized the sector since early 2016. BCCh should commence to normalize real policy rates, hiking
50bp by 4Q18, and driving the policy rate to 2.75%.
Figure 8: Manufacturing production
%3m/3m saar Figure 10: Tradable and non Tradable CPI
20 %oya, both axis
15 7 Non Tradable CPI
6 Tradable CPI
10
5
5
4
0
3
-5 2
-10 1
-15 0
-20 -1
09 11 13 15 17 -2
Source INE and J.P. Morgan 2011 2012 2013 2014 2015 2016 2017
Source: INE, BBCh and JPMorgan
Inflation is to print below the target floor in 1H18, but

consolidate higher in 2H18. We forecast inflation at External balances remain lackluster despite higher copper
2.16%oya by the end of December 2017, below the level prices. The current account deficit logged US$1.5bn in 3Q17
BCCh forecasted in the 3Q17 Monetary Policy Report, and (2.2% of GDP), wider than expected, leaving the last 4-quarter
the risk is still tilted to lower levels. In our base case scenario, sum at 1.7% of GDP. We expect the current account deficit to
inflation would hover below the central bank target range close the year at 1.2% of GDP (upside risk), while we see the
floor in 1H18, averaging 1.9%. We see headline inflation re- 2018 current account deficit widening to 1.4% of GDP, ex-
turning to BCChs inflation target band by June, and averag- plained by narrowing trade balance on lower copper prices.
ing 2.75% in 2H18, closing 2018 at 2.7%.
The main factor behind a wider current account was rents paid
Figure 9: CPI forecast to the rest of the world, which on a net basis printed
%oya,
US$2.8bn on the quarter, and was not offset by the positive
6
trade balance and current transfers. Indeed, the trade balance
5 surplus reached US$1.7bn in 3Q17, almost doubling the 3Q16
4 surplus. The correlation of copper prices, the trade balance,
and net rents outflows is not new: both the trade balance and
3
net rents outflows (as reported in the current account) are very
2 sensitive to copper prices. Importantly, the swelling behavior
1 of the CAD on higher copper prices should be read with cau-
0 tion, as a decent share of the net rent outflows is registered as
10 11 12 13 14 15 16 17 18 an inflow in the financial account. Indeed, reinvested earnings
Source: INE, BBCh and JPMorgan are accounted as inward FDI, representing 60% of the overall
inward DI in the last four years.
30
Figure 11: Current account

new regime focused on unleashing productivity gains, should
4-quarter moving sum trigger investment growth. We thus expect inward direct in-
15 $bn (LHS) 6.00 vestment to jump to US$16bn in 2018, and net direct invest-
ment at US$10bn.
10 % GDP (RHS) 4.00
5 2.00 The 2018 Budget Law assumes the overall public deficit
0 0.00 narrowing 0.8%-pt of GDP, to -1.9%. In the government
-5 -2.00 estimations the increase in revenues is to dominate expendi-
tures growth next year, driving the realized central government
-10 -4.00
deficit lower to 1.9% from 2.7% in 2017. We are less construc-
-15 -6.00 tive regarding revenues, and thus incorporate in our base case
03 05 07 09 11 13 15 17
Source: BCCh and JPMorgan scenario an overall deficit of 2.2% of GDP. In this case, gross
public debt, estimated at 24% of GDP by the year end, should
reach 26.2% by end 2018. Regarding the fiscal rule, by con-
Investors have recently expressed concerns about FDI behav-
struction the budget is designed in such a manner that the struc-
ior. As seen in Figure 12, direct investment has converged to
tural fiscal deficit is to (ex-ante) decline by a quarter point of
zero as a % of GDP, spurring questions on the drivers for
GDP. Thus, with the structural parameters entertained in the
such a meager performance for a country that received 3.5%
2018 budget, the structural deficit is expected to narrow to
of GDP in net DI in the period 2008-2016. We note that both
1.5% of GDP from 1.7% in 2017. If so, 2018 would mark a
inward and outward direct investment have decelerated, con-
third consecutive year of structural deficits: 1.1%, 1.7%, and
verging at around 2% of GDP (making net DI null). While
1.5%, in 2016, 2017, and 2018, respectively.
lower commodity prices, in particular copper prices, and the
global cycle are pointed to as the usual suspects, it could be
We are less constructive in regards to the structural bal-
seen as a puzzling fact a priori the hefty drop in inward DI
ance going forward. It is worth noting that all candidates are
commencing by mid-2016 (when copper prices started to re-
entertaining higher public spending ahead. The question is
cover). In our view, the fact is that local branches resorted to
whether budgets will pencil-in real spending growth above or
borrowing from parent companies to finance themselves back
below real GDP growth. That will determine whether Chile
in 2014 and 2015, when the commodity price rout material-
will find a fiscal compass ahead, or whether the cyclical-
ized, which is particularly evident in 2H15. The financial as-
adjusted deficit will remain elevated in years to come (see
sistance ebbed in 2016 (as copper prices started to recover),
Chile: Still looking for a fiscal compass for a review of the
and in fact we have observed repaying of debt to parent com-
fiscal stance). Why is that relevant? First, the public sector
panies in 2017. Debt repayments together with a deceleration
indebtedness has been growing at a worrisome speed, as seen
in net equity investment have explained the bulk of the drop.
in Figure 13. Arguably, the public sector debt remains well
below the Latin America average. But the main risk, in our
Figure 12: Direct investment view, is that fiscal deterioration starts to put pressure on the
% of GDP, 4-quarter moving sum back end of the curve, making it more expensive for the pri-
Direct investment liabilities
14 vate sector to rollover debt. Private sector indebtedness is
Direct investment assets
12 indeed above peers average, with the corporate sector debt
10 around 100% of GDP, and households leverage at around
8 60% of GDP.
6
4 Figure 13: Public sector debt
2 % of GDP
50
0 LatAm average (gross)
03 05 07 09 11 13 15 40
Source: BCCh and JPMorgan 30 LatAm average (net)
20
Going forward, we expect inward direct investment to print Gross government debt
10
US$6.8bn in 2017 (compared to US$12.3bn in 2016). That
would drive net direct investment (subtracting outward direct 0
investment) to a mediocre US$2.0bn in 2017 on the back of a 2006 2008 2010 2012 2014 2016 2018F
-10
delay in investment decisions due to uncertainty related to the Net government debt
-20
political cycle. The resolution of election uncertainty, and a Source: Ministry of Finance, BCCh and J.P. Morgan
31
Ben Ramsey (1-212) 834-4308 Latin America 2018 Outlook
Katherine Marney (1-212) 834-2285
katherine.v.marney@jpmorgan.com
in 2018 to 2.7% and 3.8%oya, respectively. Net exports

Colombia: Searching for mo- imply a modest drag on growth as imports rebound.
mentum as elections loom Figure 2: JPM forecasts for Colombia real GDP growth
4
GDP growth on a sturdy platform to accelerate to 3% in
2018, up from 1.6%y/y for 2017 3
Lower short-term CPI will allow 50bp of cuts by 1Q18, 2 %q/q, saar
but inflation to be sticky at the top of the range and we
see hikes before year-end 1
%oya
Twin deficits underwent a significant adjustment, yet 0
incremental gains will be harder won
-1
1H18 elections seem benign but worth watching
Source: J.P. Morgan
Growth on the mend in 2018
Growth is slow but returning to more solid ground, and Benign inflation opens space for easing
better momentum should carry into 2018. 3Q17 GDP Inflation temporarily popped above 4% in 4Q17, yet it
growth printed at 2%oya, still slow in annual terms, but a re- should consolidate in the target range in 2018. Our modal
spectable 3.2%q/q, saar, as all industrial sectors expanded on inflation forecast sees CPI hitting the low point below 3.3% in
the quarter. Mining and manufacturing, both of which sagged February (as the VAT impact wears off) and averaging 3.5%
in the last year, are staging a comeback. Retail activity is also for the year, before converging to 3.8% by December. We
bouncing back from the VAT-induced hit of 1Q. On the de- expect the drivers of this years disinflationespecially food
mand side, a positive contribution from net exports carried the pricesto normalize in 2018. Next years call is premised on
day in 3Q, as domestic demand still looks sluggish. Consump- core tradables inflation averaging around the 3% target
tion is coming back, though public-sector outlays are outpac- much higher than it posted in the strong COP years of the oil
ing private spending. Investment sagged in 3Q, despite better boomwhile non-tradables would hover just above the 4%
civil works with higher oil investment, but should be poised target ceiling as domestic demand recovers.
to recover. We have now nudged down our full-year 2017
growth forecast to 1.6% (from 1.8% before the release). Figure 3: Colombia headline inflation
%oya
9.0
Figure 1: Contribution to real GDP growth
Gross fixed invesment 8.0 Headline CPI JPM
%-pts to contribution to oya real GDP growth 7.0 forecast
Total Consumption
12 6.0
10 Net Exports 5.0
8 Real GDP 4.0
6 3.0
4 2.0
2 1.0
0 0.0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
-2
Source: DANE and J.P. Morgan
-4
10 11 12 13 14 15 16 17 18 19 Table 1: Colombia inflation profile and forecast
Source: DANE and J.P. Morgan forecasts (2017-19)
2014 2015 2016 2017f 2018f avg 2018f eop
We see growth recovering to 3% in 2018. Decent sequential
Headline 3.7 6.8 5.7 3.9 3.5 3.8
momentum from 2H17 leaves 2018 growth with a non-
Tradable 2.0 7.1 5.3 3.7 3.0 3.6
negligible level of statistical carryover (about 1%pt). We ex-
Non-tradable 3.4 4.2 4.9 5.3 4.3 4.1
pect oil and mining will continue to rebound, helped by new
Capex and better prices, while construction has solid, if not Regulated 4.8 4.3 5.4 5.4 4.2 3.6
spectacular, prospects underpinned (finally) by 4G, which Food 4.7 10.8 7.2 2.0 2.8 3.8
together should boost investment. Consumption should re- Source: J.P. Morgan
main on the mend supported by lower interest rates and disin-
flation. We expect consumption and investment to accelerate
32
Steady downward surprises in monthly inflation have We expect the board to continue cutting the policy rate
helped re-anchor medium- and longer-term inflation ex- deeper into stimulative territory in an attempt to boost
pectations for 2018. 12-month-ahead expectations in growth, taking the policy rate to 4.25% by 1Q2018. If so,
BanReps analysts survey have oscillated around 3.6% in this would lower the real ex-ante policy rate from 1.31%, al-
2018 and end-2018 at 3.5%, compared to 4.2% in the same ready below BanReps estimate of a neutral level, to 0.9% by
period last year. BanReps technical staff is more constructive mid-year (Figure 5). However, as we see higher inflation in
in this respect, with its expectations settling at the 3% target 2H18, a stubborn CAD despite better oil prices, and external
by mid-2018 according to the latest Inflation Report. risks with the Fed tightening, BanRep may be compelled to
hike again before end of year. With this in mind, we see
Figure 4: Medium- and longer-term inflation expecations BanRep on hold after 1Q before hiking the policy rate by
%, average response
75bp starting in September to end the year at 5%.
5.0
12-mo ahead Of note, BanRep made a significant logistical change in
4.5 the frequency of meetings to only eight voting meetings (at
which monetary policy can be changed) a year from the cur-
4.0 rent twelve. These voting meetings will be held in January,
end '18
March, April, June, July, September, October, and December.
3.5 3.46 BanRep justified this selection of months as taking into ac-
24-mo ahead 3.27 count the publication schedule for key macroeconomic varia-
3.0
Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18
bles. BanRep will still hold monthly non-voting meetings to
Source: BanRep
consider topics under its purview.
Easier monetary policy helps growth External accounts with a bit more to go
Amid a more benign inflation outlook and below-potential Colombias CAD dropped to 3.7% of GDP in the first 9
growth, BanRep has cut the policy rate 300bp to 4.75% months of 2017, down from 4.3% in full-2016 and 6.4% in
since initiating an easing cycle in December 2016. BanRep 2015. We now forecast a current account deficit (CAD) at
was able to act aggressively as rapid disinflation took hold, 3.5% of GDP for 2017 (US$10.8bn), incorporating the better
and after a brief pause in September, two subsequent cuts in than expected 3Q17 results and a large backward revision to
the October and November meetings surprised market expec- 1H17. Underlying trade trends have been healthier in 2017:
tations and revealed a more dovish bias. Even the more hawk- non-oil exports have been coming in stronger than expected
ish members of the board have agreed with cuts, as slower driven by coal, coffee and non-traditional exports, while oil
monthly inflation and the staffs better medium-term CPI out- export volumes have stabilized. Oil production was consist-
look has calmed concerns about the pace of convergence to ently at 850kbpd in 2017 after three straight years of declines.
the 3% target. The boards dovish wing continues to be Our CAD forecast for 2018 is now down to 3.6% of GDP
swayed by soft activity data, and believes BanRep should (from 3.8% before) helped by further improvements in oil
shift to a more stimulative monetary policy stance. pricesJ.P. Morgans Brent forecast at $60/bbl is 10% higher
than last yearbut offset by an ongoing rebound in goods and
Figure 5: BanRep shifting to a more stimulative stance services imports and outflows from profit remittances. We are
%
10 not convinced that non-oil traditional exports will continue
JP Morgan
forecast their impressive performance next year, although better exter-
8 Nominal policy rate nal demand should bode well for non-traditional exports. In
6 this context, and given the aforementioned narrowing of inter-
4
est rate differentials, we see a gradual depreciation of the COP
to 3150 by end 2018.
2 1.31 1.35
Deflated by 12-mo ahead expectations 0.92
0
-2
14 15 16 17 18
Source: BanRep and J.P.Morgan
33
Long-term oil production is seen at 840kbpd in 2018 and

Figure 6: Less incremental narrowing in current account deficit 805kbpd by 2028. This factor, combined with a more sub-
$bn, 4q rolling sum dued price outlook hardens the permanent nature of the oil
10
Goods price shock sustained since 2014. Oil-related revenues, which
5 fell from 3.4% of GDP in 2013, to basically nil in 2016-2017,
0 are expected to come back on the margin, but only to 0.3% of
Service
-5 GDP by 2018. With more permanent sources now on the
-10 books following last years fiscal reform, revenue increases
largely rest on favorable growth assumptions and to a lesser
-15
Income extent stabilization in oil prices/output.
-20
Current account
-25 Figure 9: Scarce recovery in oil-related revenues
10 12 14 16 % of GDP Dividends $/bbl, brent
Source: BanRep 4 120
Oil tax revenue long-term oil price,
3.5
1yr lag 100
Figure 7: Colombia oil and non-oil trade balance (FOB-CIF) 3
$bn 2.5 80
3 2
60
2 1.5
1 40
1 0.5
0 20
0
-1 -0.5 0
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
-2 Oil TB
-3 Source: Finance Ministry
Non-oil TB
-4 The authorities have not yet provided full guidance into
05 06 07 08 09 10 11 12 13 14 15 16 17
how a US$1.5bn arbitration claim against two telecom
Source: DANE and J.P.Morgan
companies will be incorporated into its 2017/18 fiscal
Tough fiscal tasks ahead planning. Previously, the government had indicated that
US$1bn of the total would be used towards meeting 2018
A gradual fiscal consolidation is the name of the game. external funding needs. Combined with US$0.9bn in 2018
Successful approval of the tax reform last December should pre-financing tapped externally in August 2017 and other
deliver an estimated 0.7% of GDP in additional revenues in multilateral support, this hard currency inflow from the arbi-
2017. Even so, lower-than-expected growth is otherwise tration claim could enable the Santos government to stay out
weighing on revenue projections, even with the tax reform, of markets until leaving office in mid-2018. The government
and expenditures are up on the margin. This combination ex- would then have some discretion about how to allocate the
plains the upward revision in the 2017 fiscal deficit to 3.6% remaining US$0.5bn (0.15% of GDP) as above-the-line reve-
from 3.3%. 2018s deficit should fall to 3.1% of GDP, a nar- nue, either toward closing the gap on its 2017 deficit target, or
rowing that is dependent on cuts to capital expenditure and to pre-pay 2018 expenditures.
growth recovery. That said, an arbitration windfall provides
some margin for error (see below). The Finance Ministry outlined estimated spending for
post-conflict and peace-related investments. The plan en-
Figure 8: A more gradual pace to fiscal adjustment visages roughly 15% of GDP in spending through 2031 (i.e.,
% of GDP 1% of GDP per year). The Marco Fiscal de Mediano Plazo
-0.5
(MFMP) 2017 touched briefly on the challenge of incorporat-
-1.0 Structural deficit path
ing extra post-conflict spending into the broader budget with-
-1.5
out defining specifics. Nonetheless, the plan emphasizes that
-2.0
-2.2 theoretically any incremental spending would need to fit with-
-2.5 -2.7 MFMP16
in the parameters of the Fiscal Rule. The national budget, in-
-3.0 -3.3 -3.1 Headline fiscal MFMP17 cluding transfers to subnational entities, would fund roughly
-3.5 -3.9 -3.6 deficit path 2/3 of post-conflict spending. In these cases, it is unclear how
-4.0 -4 much would amount to a reorientation of spending versus
-4.5 additional budgetary pressures. A royalties reform and other
14 15 16 17 18 19 20 21 22 23 24 25 26 27
Source: Finance Ministry
private/international sources would provide the remaining
funding.
34
The crux of the challenge for Colombias fiscal policy is positioned to reach the run-off, a scenario that could rattle
how spending will be adjusted consistent with the deficit re- markets. (FARC participation will also be a novelty.) None-
duction path envisioned, while also incorporating post- theless, we see slim prospects in a run-off for an anti-
conflict spending. Colombias structural fiscal rule mandates system candidate who could depart from the pro-market
that the deficit decline to 2.2% of GDP in 2019 and converge framework. While the peace process will be a campaign
on 1% by 2022. From there, much of the heavy lifting to theme, the fast track implementation and favorable court
comply with the Rules targets should occur under the incom- decisions should allow much of the deal to take root. The fis-
ing government after 2018, and it is far from clear that any cal rule may also be debated as the next government grapples
incoming administration after the 2018 vote would enthusias- with a significant fiscal consolidation.
tically embrace the challenging spending reduction path im-
posed by the Rule. Recognizing this challenge, the Santos Table 3: Colombia electoral calendar
administration has formed a new special independent com- Event Date
mission that will recommend how to redirect spending. It Cabinet members resign if they intend to run for Congress or
will hand down its findings by year-end, and turn them over 1H17
President, one year before respective election
to the next administration, which takes office next August.
Congressional elections for both houses 11-Mar-18
Figure 10: Expenditure to be cut, but how?
Presidential election first round 27-May-18
% of GDP
20 Current Investment Interest

Presidential election second round between top 2 candidates
(required if the winner of first round does not receive more than 50% 17-Jun-18
+1 of valid votes)
15
Source: J.P. Morgan
10
Figure 11: Fajardo leads the favorability ratings in Colombia
5 60 % voting preference
Unfavorable Favorable
0 40
20
Source: Finance Ministry 0
S&P pulled the trigger and dropped Colombia to BBB-, -20
but the outlook is now stable and other agencies seem -40
more sanguine. S&P took a critical view of Colombias
-60
longer-term fiscal risks amid subdued growth in 2016-17, but S Fajardo ML H de la G Petro G Vargas I Duque
seems comfortable with the countrys investment grade status. Ramirez Calle Lleras
Source: Invamer, December 2017
The outgoing Santos administration remains committed to
meeting its 2017-18 fiscal targets, and thus far agencies are
Table 4: Colombia: economic indicators
not too concerned over the outlook for the upcoming election. Avg
While the fiscal rule may be debated, it is unlikely to be dis- 2016 2017f 2018f 2019f
2011-15
carded, and an improved oil price and (in our view) growth Real GDP, % change 4.6 2.0 1.6 3.0 3.3
outlook, along with the sizeable external correction and Co- Consumption 3.7 1.6 1.7 2.2 2.5
lombias institutional credibility should keep other rating Investment 2.6 -1.3 0.2 1.1 1.3
agencies from moving their own ratings (one notch higher Net trade -1.7 1.6 -0.3 -0.3 -0.5
than S&P) any time soon. Consumer prices, %oya 3.3 7.5 4.3 3.5 3.5
% Dec/Dec 3.7 5.7 3.9 3.8 3.5
Election seems benign, but worth watching Government balance, % of GDP -1.4 -4.0 -3.6 -3.1 -2.7
Goods trade balance (US$ bn) -1.0 -9.9 -5.9 -5.5 -5.8
Colombia will hold congressional elections in March and
Exports 54.9 33.3 38.7 41.4 43.4
presidential elections in May (with a June second round)
Imports 55.9 43.3 44.6 46.8 49.2
to define the successor to President Santos. Early polls in- Current account balance (US$ bn) -14.4 -12.2 -10.8 -11.1 -11.6
dicate that centrist ex-governor Fajardo has superseded cen- % of GDP -4.1 -4.3 -3.5 -3.6 -3.6
ter-right ex-Vice President Vargas Lleras in the lead. These International reserves, (US$ bn) 40.8 46.8 46.8 46.8 46.8
two will compete against an Uribe-backed candidate (Centro Source: J.P Morgan 1. Contribution to GDP growth
Democraticos Duque or Conservative Ramirez) and Liberal
de la Calle (the pro-Santos peace deal candidate) for spots in
the second round. Leftist ex-Bogota mayor Petro is also well-
35
Katherine Marney (1-212) 834-2285 Latin America 2018 Outlook
katherine.v.marney@jpmorgan.com December 12, 2017
Ben Ramsey (1-212) 834-4308
benjamin.h.ramsey@jpmorgan.com
Ecuador: Mixed signals issue at hand in each question would need to be approved
by an absolute majority of voters (50% of valid votes + 1).
President Morenos bold referendum bid to marginalize Considering Morenos high approval rating, which grew as
his predecessor looks likely to succeed his personal feud with Correa intensified, and the fact that
most opposition groups have indicated that they will support a
The question is whether Moreno will pivot toward tack- yes vote, the referendum is expected to be successful for
ling structurally slow growth and wide twin deficits Moreno.
Progress in growing the oil sector could be a silver lin-
ing Figure 1: Presidential approval ratings
% of total
100 Correa Moreno
A pivotal vote in the consulta popular (referendum) will
set the tone in 2018. President Moreno has so far defied ex- 80
pectations that he would be a compliant placeholder for his Approve
60
predecessor. Morenos decisive moves to politically separate
40
himself from ex-President Correa have earned him strong Disapprove
approval ratings and ample political capital. While Ecuadors 20 Unsure
economic challenges are still on top of the mind, economic 0
adjustments are seen as in a holding pattern until after the
February 4 vote as political forces focus on Morenos high
Source: Cedatos
stakes political gamble that seeks to marginalize Correa and
his supporters influence. The question for markets is whether
Moreno will pivot toward tackling structural economic chal- Will Moreno tackle the economy with the
lenges once Correa is in the rearview mirror, or if he is con- same vigor he seized the political reins?
tent to muddle through with more of the same
There remains an inherent tension between Morenos ini-
tial apparent pragmatism on the economy and his social
Morenos political gamble on the consulta seems to be a
conscious leanings. Morenos opening bids on the economic
winner. Among the two most far-reaching issues contemplat-
adjustment have underwhelmed, but probably should be seen
ed in the referendum are re-imposing term limits and restruc-
in the context of pre-referendum politics. An economic law
turing a key institutional body (CPCCS), both of which seek
introduced by Moreno was significantly changed by the AP-
to sideline ex-President Correa and his loyalists still scattered
controlled legislature, and walked back agreements made be-
throughout the government, and appear critical to realign the
tween Moreno and the private sector (eg. reforms to the e-
political forces in Morenos favor. Other questions include a
money) at the cost of valuable political capitalMoreno is
lifetime ban on public servants convicted of corruption, elim-
still mulling whether to sign or veto the law. For now, mar-
inating an unpopular capital gains law on real estate. After
kets and locals seem willing to afford Moreno the benefit of
submitting the questions to the Constitutional Court on Octo-
the doubt, in the hope that a successful vote could open a path
ber 2, the Moreno government had been waiting on a ruling as
for Moreno to more aggressively tackle structural weaknesses,
to whether they could be put to a vote. In the meantime, Pres-
possibly with some fresh faces on the economic team. Nota-
ident Correa returned to Ecuador and began to campaign
bly, holdouts from the prior economic team, who were seen as
against the referendum, openly declaring himself in frontal
loyalists to ex-President Correa, left the administration in No-
opposition to the President he helped elect just 9 months prior.
vember.
However, after urging more haste from the Court, President
Moreno invoked a separate legal provision that circumvented
Structurally high fiscal deficits have resulted in significant
the Court and sent the questions directly to the Electoral
financing needs. All told, unconsolidated government debt
Commission (CNE) to begin organizing the vote. Shortly af-
increased from 39% of GDP in 2016 to 47% by October, of
terwards, the CNE scheduled the vote for February 4, and
which over 6% was high-cost bonded debt. Efforts to lower
Correa retreated back abroad, unsuccessful in his bid to oust
fiscal deficits will help contain financing needs in 2018, from
Moreno from the Alianza Pais (AP) party or stop the referen-
16% of GDP in 2017. Yet, we still expect financing require-
dum.
ments at 13% of GDP, taking into account external amortiza-
tions at 4% of GDP and deficit closer to 5% of GDP. As do-
Popular support for President Moreno and the referen-
mestic financing sources remain tight, we expect Ecuador to
dum initiative remains quite high. As of November, More-
continue tapping markets next year
nos approval rating has consistently stayed above 70% with
similar levels of support for the questions themselves. The
36
Katherine Marney (1-212) 834-2285 Latin America 2018 Outlook
katherine.v.marney@jpmorgan.com December 12, 2017
Ben Ramsey (1-212) 834-4308
benjamin.h.ramsey@jpmorgan.com
Figure 2: Government debt by source Indebtedness has driven Ecuadors strong economic per-
% of GDP formance in 2017. The economy grew at a robust 8%q/q,
50 Bonds China Other* Domestic saar in 2Q17 (3.3%oya) as the outgoing Correa administration
40 leaned into the finish line before leaving office, buoyed by
private consumption. The government also spent heavily in
30 2Q to prop up local governments and infrastructure spending
ahead of the elections, leading pubic consumption to expand
20
2.1%oya. We subsequently revised up our 2017 growth fore-
10 cast to 2.4%. That said, the current model of debt-fueled
growth looks unsustainable. More limited access to financing
0 along with tighter fiscal policy could weigh on growth, which
08 09 10 11 12 13 14 15 16 17
Source: MOF and J.P.Morgan, 2017 reflects data through ytd
we see at 1% in 2018. Rebounding domestic demand and a
lifting of import restrictions is gradually whittling away at
The 2018 budget assumes a shallower and more gradual
Ecuador's current account surplus, which narrowed to 0.9% of
path to lower the deficit largely due to high expenditures.
GDP in 2Q17 from 1.8% in 1Q. We now see a deficit of 0.4%
The 2018 deficit would decline to 4.1% of GDP compared to
of GDP in 2017 and in 2018.
over close to 6% in 2016 and 2017. Next years consolidation
rests on a slightly better performance for revenues and even
The oil sector may represent a more concrete silver lining
more so, deep cuts to capital expenditure. Yet, many of these
to the prevailing structural issues facing the Ecuadorean
gains would be offset by high spending on goods and services
economy. The new Minister of Hydrocarbons, Carlos Perez,
and subsidies/transfers, in part linked to new programs intro-
is a respected industry veteran with ample experience in the
duced to fulfill President Morenos campaign promises.
private sector. He is heading up a strategy to raise the coun-
trys oil production by 30% to 700kbd by the end of Morenos
Preserving dollarization remains a political priority, but
4-year term. The strategy to increase production is mainly
the current model is testing the limits of what is viable under
focused on tapping into reserves in the ITT fields, which the
the regime, as seen for example in the expansion of the BCEs
authorities estimate could eventually contain up to 1.7bn bar-
balance sheet through loans to the government. Recall these
rels of reserves. President Morenos proposed referendum
loans are essentially BCE purchases of more illiquid treasury
initiative includes a proposal to formally reduce the area of
paper using other deposits on the BCEs balance sheet, in-
the park open to oil exploration, though still maintaining
cluding reserve requirements from the banking system. A full
open for business the main areas that Petroamazonas in-
IMF program could be an option, but probably only if forced
tends to develop. The new authorities may also be question-
by a crisis, in which the monetary regime would be more test-
ing the amount of oil deliveries committed to pre-sales of oil
ed. Engagement with the IMF has so far been limited to tech-
to Chinese and Thai firms.
nical assistance such as Article IV reviews, the next of which
is anticipated in 1Q18. Even so, a more fragmented Con-
gressbetween the Correista and Morenista wings of AP,
Ecuador: economic indicators
and the opposition could complicate governability and
preclude Moreno from embracing a full adjustment. Average 2016 2017f 2018f 2019f
2011-15
Real GDP, % change 4.4 -1.6 2.4 1.0 1.4
Figure 3: Expansion of BCE balance sheet
$mn Consumption 2.8 -2.5 2.2 1.1 1.0
10,000.0 Net external assets Investment 1.0 -2.6 0.3 0.2 0.7
8,000.0 Net internal assets Net trade 0.7 3.5 -0.1 -0.3 -0.2
6,000.0 Total liabilities Consumer prices, %oya 4.0 1.7 0.5 0.8 1.5
BCE credit to CG % Dec/Dec 3.9 1.1 0.0 1.4 1.6
4,000.0
Government balance, % of GDP 3.1 0.1 1.0 1.0 1.0
2,000.0
Goods trade balance (US$ bn) -0.5 1.6 0.1 0.4 0.7
0.0
Exports 23.8 17.4 19.2 21.0 22.6
-2,000.0 Imports 24.3 15.9 19.1 20.6 21.9
-4,000.0 Current account balance (US$ bn) -0.9 1.4 -0.4 -0.4 -0.2
-6,000.0 % of GDP -0.9 1.5 -0.4 -0.4 -0.2
16
06
07
08
09
10
11
12
13
14
15
17
International reserves, (US$ bn) 3.3 3.7 3.0 3.0 3.0

Source: BCE and J.P.Morgan, 2017 reflects data through ytd
Source: J.P Morgan 1. Contribution to GDP growth
37
Banco J.P.Morgan, S.A., Institucin de Banca Economic Research
Mltiple, J.P.Morgan Grupo Financiero Latin America 2018 Outlook
Gabriel Lozano (52-55) 5540-9558 December 12, 2017
gabriel.lozano@jpmorgan.com
Steven Palacio (52 55) 5382-9651
steven.palacio@jpmorgan.com
down purchasing power. Ongoing fiscal consolidation efforts

Mexico: A year of uncertainties should also lean on domestic demand. In contrast, external
Below-par growth to remain in place in 2018 as invest- demand should remain a tailwind, as US demand proves ro-
ment uncertainty lingers on electoral and NAFTA risks bust. The outlook should improve in 2H18, when sources of
uncertainty could abate and inflation should be near 3.5%.
Inflation to return to corridor in 2Q18; we expect 3.6% Together, lower inflation and diminished uncertainty should
by year-end boost domestic demand in 2H18, although a negative fallout
All options open on monetary policy next year, but our on NAFTA negotiations or the uncertainty that could follow
base case is for the easing cycle starting in 4Q18 an AMLO victory in presidential elections could derail this
outlook. All said, we think growth will be nearly unchanged
We still expect a win-win-win in NAFTA negotiations at 2.2%oya next year, but acknowledge that risks are skewed
and a two-horse race ahead of the July 1 election slightly to the downside.
Going into this year multiple factors supported our call

Figure 2: Mexico GDP demand side breakdown
for GDP to grow at a subdued 1.8% pace in 2017. Uncer- %-pt contribution
tainty following the US election and the possibility of the US Net exports Investment
3.0
withdrawing from NAFTA, rising inflation on currency Consumption
2.5
passthrough, and the ensuing policy tightening and hit to dis-
2.0
posable income were among the chief factors. These factors
1.5
largely unfolded as thought, although their impact on activity
is likely to prove smaller than expected. US-related uncertain- 1.0
ty indeed sent sentiment spiraling down, and investment has 0.5
remained a meaningful drag on activity. But despite inflation 0.0
ballooning well beyond our expectations, consumption proved -0.5
to be much more resilient than expected on the back of a 2017 2018 2019
Source: J.P. Morgan forecasts
tightening labor market. Consumption is now clearly slowing.
However, on balance, consumption growth is likely to outper-
form our original estimate. Another tailwind to activity has Table 1: Economic indicators
been the pickup in external demand. That said, these two posi- Average
tive developments are likely to be partly offset by softer-than- 2011-15 2016 2017f 2018f 2019f
expected investment. We now expect growth to stand at 2.1% Real GDP, % change 2.9 2.3 2.1 2.2 2.8
this year (Figure 1), still below potentialwhich we estimate Consumption 2.3 2.0 1.8 1.9 2.1
at 2.4%. Investment 0.3 0.2 -0.2 -0.1 0.5
Net trade 0.2 0.0 0.5 0.3 0.1
Figure 1: GDP growth quarterly profile Consumer prices, %oya 3.6 2.8 5.8 3.5 3.5
%q/q, saar % Dec/Dec 3.5 3.4 6.1 3.5 3.6
6 Government balance, % of GDP -2.8 -2.6 -1.3 -2.1 -2.1
Goods trade balance (US$ bn) -1.7 -14.6 -13.0 -11.1 -7.9
4
Exports -3.8 -13.1 -6.6 -5.8 -6.4
2 2.8 Imports 376.2 374.3 406.7 440.3 481.2
2.1 2.2
0 Current account balance (US$ bn) 380.0 387.4 413.3 446.1 487.6
% of GDP -21.9 -22.4 -21.1 -24.8 -25.9
-2 %oya (annual average)
International reserves, (US$ bn) -1.8 -2.1 -1.9 -2.0 -1.9
-4 Source: J.P Morgan 1. Contribution to GDP growth
12 13 14 15 16 17 18 19
Source: INEGI and J.P. Morgan forecasts.
Sticky inflation should fall next year

Next year should bring little change to these trends, at least
through the first half of the year, when we expect NAFTA Consumer prices inflation has by and large overshot ear-
uncertainty, coupled with that arising from the outcome of ly-year expectations. We looked for a weak currency and the
general elections in July, which should keep investment sub- ensuing passthrough pressures to bring inflation toward the
dued. Consumption is also likely to muddle through in 1H18, upper bound of the central banks target range (4%), but un-
as softer employment gains and modestly high inflation weigh expected, severe one-off shocks sent inflation spiraling much
38
higher. A 20% increase in gasoline prices early in the year former board member and head of public credit at the Minis-
and continued increases in liquefied and agricultural prices try of Finance. Whether his close relationship with the current
were each a driving force, as were the indirect effects of such government in the context of presidential elections approach-
increases on other CPI components. ing will be enough to push Daz de Len toward the dovish
side remains to be seen, but we believe his experience as cen-
However, shocks to inflation this year should prove transitory. tral banker will be enough to maintain inflation targeting as
In fact, we expect inflation to drop sharply as early as Janu- the ultimate objective.
ary, as gasoline price increases drop off the annual calculation
(Figure 3). Additionally, passthrough pressures present during For the time being we do not project additional changes to the
the first half of the year, which have by now subsided, should policy rate in the foreseeable future. We expect Banxico to cut
generate a benign base effect and help pull inflation lower rates until 4Q18 (Figure 3). While we believe Banxico will
through the first quarters of 2018. Agricultural and liquefied not hesitate to increase the policy rate to anchor inflation ex-
gas prices shocks should also subside, particularly the former, pectations, the big question is what could happen if the board
which have been increasing well above their trend growth opts to hike again and the currency resumes its weakness in
pace. From a fundamental perspective, economic activity the context of elections and NAFTA risks, or if the Fed adopts
should remain below trend, keeping the output gap negative. a more hawkish stance. Is Banxico ready to engage in yet an-
This in turn should help cool the labor market and prevent other hiking cycle?
wage pressures to arise.
Figure 3: Mexico policy rate path and inflation dynamics
To be sure, wage growth has recently accelerated, but we at-
%
tribute this largely to the inflation spike. Were inflation to 8 nominal policy rate
drop as rapidly as we expect, wage growth should shift back
toward 4%, particularly as employment gains moderate. That
said, we think inertial inflationthrough high wage growth 6 post recession
neutral rate*
and renewed currency weakness are the main sources of up-
side risk to our inflation call, which remains that inflation will 4
fall rapidly toward 3% through 3Q18 and end the year slightly
CPI
higher at 3.6%, well within the central banks target range.
2
13 14 15 16 17 18
Monetary policy to remain flexible Source: Banxico and J.P. Morgan forecasts. *Banxico's estimate.
With inflation expected to recede next year, benefiting

from statistical base effects and anchored inflation expec- NAFTA upgrade on track but doubts remain
tations, we expect the real policy rate to increase sharply,
As the fifth round of negotiations concluded in Mexico in
paving the way for Banxico to adopt a dovish stance to November, several issues remain on the table, almost con-
refrain from adopting a super tight bias. However, given
firming that finishing with the modernization of NAFTA be-
the significant domestic and external risks to be present for
fore the presidential election in Mexico will be tight. Most
most of next year at the very least (elections, NAFTA, Fed
importantly, it seems increasingly likely that contentious top-
hiking) we believe Banxico will opt to wait and see before
ics will only be discussed early next year in Canada at the
taking any decisive action. In recent weeks, a more hawkish
earliest. Before the start of Round 5, only two chapters had
board has made it clear that it is keeping its options open giv-
been closed (on competition and small and medium enterpris-
en the challenges ahead and the fact that inflation remains
es) and gradual progress on e-commerce, services, govern-
stubbornly high (6.6% in November) in the context of a tight
ment procurement, phytosanitary rules, intellectual property,
labor market and minimum wages increasing 10%.
anticorruption, and textiles suggested important progress was
to be expected in that round. While this lack of progress was a
While we believe a hawkish stance is consistent with the cur-
bit disappointing, trade representatives added an intersession-
rent risks, delivering additional hikes is inconsistent with in-
al meeting in mid-December to unclog pending chapters, an-
flation expected to drop early next year and inflation expecta-
nexes, and technical details.
tions for 2018 anchored below 4%. With the central bank
changing leadership late in November, understanding the re-
Even though it is difficult to gauge the progress made so far,
action function is a bit more difficult, although we
before the start of Round 5 the percentage of completion was
acknowledge that it has turned a bit more hawkish given the
less than 20%, according to comments from Minister of the
dovish nature of the salient governor and a more neutral en-
Economy from Mexico, Mr. Ildefonso Guajardo. With modest
trant one. The new governor is Mr. Alejandro Daz de Len,
39
accomplishments to date, negotiations have been extended efforts, but has already contributed to improving public fi-
through 1Q18 and the hope now is to have an agreement nances himself. In other words, we think that choosing Gon-
ahead of July elections in Mexico. We still believe there is zlez Anaya as the new Finance Minister sends a clear mes-
room to achieve positive results given the recent comments sage of the governments intent: maintain a primary fiscal
from Mr. Guajardo, who suggested Mexico is open to assess surplus that allows the public sectors debt burden to decline
NAFTA periodically, something that was a no-go originally. at least through the last year of Pea Nietos administration.
Other contentious issues that are expected to be sources of We continue to expect a primary surplus this year and next.
uncertainty and volatility are the dispute-resolution mecha-
nism (Chapter 19 of the original agreement), rules of origin, We believe elections could become a two-horse race, as the
and national content. Political dynamics in the US are equally right-left coalition of the PAN-PRD seems to be rather unsta-
ble and Jose Antonio Meade could gather more right-wing
important, as midterm elections will take place in November
votes given his experience as technocrat rather than PRI poli-
6. Our base case scenario is still one in which NAFTA re-
tician. Internal disputes within the PAN led to the resignation
mains in place, with all three countries bridging important of Margarita Zavala, who had been ranking highest across
differences and managing to reflect the technological progress polls to lead the coalition. The fracture within the PAN has
made in the last 25 years, in addition to the structural reforms undermined the PAN-PRD prospects, and while it is too early
observed in recent years. The main concern is the materializa- to tell, it now seems the race will boil down to two parties:
tion of adverse, or severely adverse, case scenarios. The for- Morena (AMLOs party) and the PRI.
mer would be one in which the renegotiation is delayed, hurt-
ing investment and the cost-efficiency would be reduced by Figure 4: Presidential poll- Meade as PRI's candidate
significantly increasing US national content, particularly in % of answers
the auto sector. The latter is consistent with no NAFTA (the 35
28.7
so-called NoFTA), with US withdrawing from negotiations 30
23.2
and bilateral trade with the US taking place under World 25
20
Trade Organization (WTO) rules. While we still do not pro-
15 11.5
ject a severe recession/depression as a central scenario, stag- 8.1
10 4.3
nation and below par FDI would end up hurting potential 5
growth severely. We believe potential growth would be easily 0
below 2% under the severely adverse scenario. AMLO Meade Zavala Anaya Mancera
(Morena-PT) (PRI-PVEM) (Independent) (FCM) (PRD)
Presidential elections: Two-horse race? Source: GCE, 27 Nov '17. Others, 5.8%; None, 8.5%; Do not know, 7.4%; No answer, 2.8%.
However, we advised that polls should be taken with cau-

tion, since other major parties were yet to announce their Table 2: NAFTA and elections timeline
candidates by mid-December. Now that the incumbent PRI 2017
chose Dr. Jose Antonio Meade as its presidential candidate, Kick-off of NAFTA update Aug 16
things are starting to change, with AMLO now leading by less Round 2 (Mexico) Sep 1 - 5
than 6%-pts (Figure 4). Round 3 (Canada) Sep 23 - 27
Round 4 (US) Oct 11 - 17
The resignation of Meade as Minister of Finance to become Round 5 (Mexico) Nov 15 - 17
the PRIs presidential candidate, replacing him with Jos An- Intersessional meetings (US) Dec 11 - 15
tonio Gonzlez Anaya as new Minister of Finance emphasizes Pre-campaigns - presidential election Dec 15 - Feb 11
the governments intent to keep fiscal policy as unchanged as 2018
possible during the last year of the administration. Gonzlez Round 6 (Canada) Jan 23 - 28
Anaya had already worked in the Ministry of Finance as Un- Additional NAFTA rounds Feb - Mar
dersecretary of Revenues, the National Health System (IMSS) Presidential campaign in Mexico Apr - Jun
and CEO of Pemex. Interestingly, during his tenure at the First presidential debate Apr 22
Second presidential debate May 20
IMSS and Pemex he was fully focused on financially turning
Third presidential debate Jun 12
around both entitiesand it can be said that he did so with
TPA expires Jun 30
success, particularly in terms of reducing each entities pen-
Presidential election in Mexico Jul 1
sion liabilities. As Pemex CEO he worked closely with the
Mid-term US election Nov 6
MoF in dealing with the companys sizable pension liabilities,
which led to Pemex undertaking austerity measures in return Source: J.P. Morgan, Reforma newspaper, CNN, INE, El Financiero
for support from the government to also help bring down pen-
sion liabilities. In this sense, Gonzlez Anaya is not only ac-
quainted with the governments ongoing fiscal consolidation
40
behaved in 2018. Inflation reached 4.9%oya in October,

Paraguay: We do not expect pushed higher by food prices (+9.3%oya). Inflation has been
political change to jeopardize well behaved through the year, which is evidenced by core
inflation printing 3.0%oya in October. But the marginal head-
the healthy macro framework line inflation acceleration observed in October prompts an
upward revision of 2017eoy inflation to 4.2% from 4.0%,
We expect 2018 GDP growth to keep upbeat momentum previously. We expect inflation to print at 4.0%oya by year-
at 4.2%y/y end 2018, in line with the central banks target.
BCP to hold for the foreseeable future
Figure 2: Headline national CPI
We do not expect political change to jeopardize the %,oya
healthy macro framework 15
13
A healthy macroeconomic backdrop as we go into the gen- 11
eral election next year. The Paraguayan economy has expe- 9
rienced elevated growth rates over the last five years, despite 7
regional headwinds. The economy grew 4.9% on average in 5
2012-2016 and we expect 2017 GDP to close at 4.0% y/y. 3
1
Indeed, the real sector activity indicators are tracking our
growth forecast for this year and showing upbeat expectations
entering into 2018. Source: BCRP and J.P.Morgan
Headline activity grew 3.2%oya in 3Q17, while excluding We expect the central bank to hold for the foreseeable
agriculture and bi-nationals (electricity and water) pro- future. On the monetary policy front, the monetary authority
duction printed even higher at 5.5%oya. On a sequential
adjusted lower the inflation target to 4.0% from 4.5% in Feb-
basis, headline activity gained traction in 3Q17, following a
ruary 2017, keeping a 2%-tolerance range. More recently, the
weak 2Q17 at 9.9% q/q saar, and a 12.4% contraction in 1Q17.
central bank eased monetary conditions, cutting the policy
The softness in 2Q17 was due largely to adverse weather con-
ditions that particularly affected the construction and livestock rate by 25bp in July to 5.25%, a level currently deemed as
sectors. We expect bi-nationals (electricity and water, around consistent with the inflation target. The policy decision came
9% of overall GDP) to subtract 0.7%-pt from GDP in 2017. in reaction to the secondary and tertiary sectors deceleration
in 2Q17. In the eyes of the central bank, the different inflation
Figure 1: Monthly activity index trend measures suggest a downward trajectory, although they
%oya, 3mma Activity are consistent with the convergence of total inflation to the
14.0 Ex agriculture and binationals target over the projection horizon (4%). Furthermore, the in-
12.0 flation expectations of economic agents have remained an-
10.0 chored to the target. We believe the central bank will hold the
8.0
policy rate stable at 5.25% for the foreseeable future.
6.0
4.0
2.0 External accounts started to experience deterioration at
- the margin. The trade balance reached US$2.3bn (12 month
(2.0) sum), compared to flat in August 2016. Exports have softened
Jan-14 Jan-15 Jan-16 Jan-17 4.2%oya YTD, while imports jumped +28.4% YTD (through
Source: BC Paraguay and JPMorgan
October). Breaking down the imports growth, capital goods
tops the charts, up 28.4%ytd, followed by consumption goods
2018 GDP is expected at 4.2% and inflation at 4.0%. We +23.0%.
expect 2018 activity growth to maintain upbeat momentum
supported by growth in Brazil and Argentina. In terms of The acceleration of imports with respect to export growth
growth engines, the base has improved as reliance on primary has its implications for the regional trade balance. The
sectors has diminished, with a higher contribution of industry surplus with Mercosur has narrowed a bit in the last months,
and construction sectors. but most important has been the deterioration of the trade bal-
ance with Asia. The merchandise deficit reached US$3.2bn,
Inflation accelerated in November placing upside pres- widening US$1.0bn in the last 4 quarters.
sures to 2017 CPI, but we expect inflation to remain well
41
Figure 3: Trade balance

Paraguay has seen an increase in the level of dollarization
since 2008, following the de-dollarization effort that tran-
$bn, last 12 months
spired in the period 2003-2008. Despite low public sector
2.0
indebtedness at 24.1% of GDP, public external debt stands at
1.0 Mercosur
a high 78.1% of total debt. Moreover, private sector USD
0.0
deposits and credit also have followed an upward trend but
-1.0
have decelerated slightly over the past year standing at 46.8%
-2.0
Total and 45.2%, respectively, as of Oct-17 (Figure 6). Admittedly,
-3.0
Asia high credit dollarization does not imply significant currency
-4.0
mismatching risks as most of it relates to USD-revenue gen-
-5.0
erating sectors. Yet, the high level of dollarization limits
08 10 12 14 16
Source: BC Paraguay and JPMorgan monetary policy effectiveness and raises moderate financial
risks, as BCP continues to tap the external markets.
The trade balance deterioration has penalized the current
Figure 5: Reserves
account, but inward direct investment continues to anchor
$bn
external flows. The current account returned to a mild deficit
9.0
of US$343mn (last-4-quarter sum). We expect current ac-
count deterioration to linger through 2018, turning into a 8.0
0.8% of GDP red by year-end. But net direct investment con- 7.0
tinues to hover around US$371mn in 2Q17, which together 6.0
with portfolio inflows has pushed international reserves 5.0
US$1,135mn higher in the last four quarters.
4.0
3.0
Figure 4: Current account balance and FDI 10 12 14 16
$bn Source: BC Paraguay and JPMorgan
1.5
FDI We do not expect political change to jeopardize the
1.0
healthy macro framework. The two main traditional parties,
0.5
the Asociacin Nacional Republicana (aka Colorado Party)
and Partido Liberal Radical Autntico (PLRA) will have pri-
-0.5 maries on December 17. The two main contenders for the
-1.0 Colorado Party nomination are Santiago Pea and Mario Be-
Current account balance
-1.5 nitez. Pea seems closer to President Cartes in terms of eco-
Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 nomic and institutional policies, but even if Benitez wins the
Source: BC Paraguay and JPMorgan
nomination we do not expect a relevant deviation from the
current framework. For the PLRA, Efrain Alegre will compete
International reserves stand at $7.9bn, representing a with Carlos Mateo Balmelli for the presidential candidacy.
sizeable 27% of GDP. Total external debt of the public sec-
tor amounts to US$5.6bn by 3Q17, leaving the net external The general election is scheduled for April 2018. While there
position of the economy at -US$7.7bn, of which US$5.2bn is still uncertainty surrounding the polls, it seems that by to-
accounts for the FDI stock in the country. days odds the Colorado Party candidates stand to win the
Presidential election in April. If this is the case, we do not
The 2018 Budget message entails a fiscal deficit of 1.5% in expect major changes with respect to the macroeconomic
line with the Fiscal Responsibility law. The Fiscal Respon- framework, despite the debate on the fast external indebted-
sibility Law limits the potential negative spillovers of the po- ness pace the economy has experienced under President
litical cycle. For 2018, the budget entails a 1.5% of GDP Cartes.
headline fiscal deficit. In terms of 2018 financial needs, the
government expects to issue US$0.6bn in bonds, of which
half of the proceeds will be directed to debt service. Accord-
ing to the Budget Law, the gross public debt would end 2018
at US$30.7bn, or 23.8% of GDP, just 0.3%-pt above the cur-
rent level.
42
We project above-consensus 4.4% GDP growth for 2018,

Peru: Leaving behind 2017 above both the central bank and Treasury estimates. Our
blues tunes constructive forecast is predicated on both technical and eco-
nomic drivers. First, we pencil in a strong statistical carryover
Reconstruction program and fiscal stimulus underway from 4Q17 sequential strength, of around 1.0%-pt. Second,
to drive upbeat activity growth the government will continue to step up capital spending as
per the reconstruction program and fiscal stimulus through
We see BCRP on hold until 3Q18
2020. Public investment should accelerate to 17.5%y/y on
Risks associated with the political gridlock have abated, reconstruction efforts and other infrastructure work (e.g.
but not vanished PanAmerican games). Another key assumption behind our
upbeat activity forecast is that private investment is expected
Leaving behind 2017 blues tunes. In terms of activity, 2017
to crowd in, reversing the contraction trend in place for the
proved to be a year to forget, with the country hit by double
last three years. PPP projects should help to inflate invest-
whammy shocks amid political tensions. First, the Odebrecht
ment, with 11 projects listed for the next three years amount-
corruption scandal that broke in December 2016 took a toll on
ing to around US$30bn (although US$18bn in projects have a
activity via the delay/suspension of key infrastructure pro-
higher likelihood to transpire in the coming years).
jects. Second, the coastal El Nio, which brought the worst
flooding and landslides in decades, materially affected infra- Figure 2: Private sector investment
%oya
structure, and temporary raised domestic food prices. Activity 35.0
was severely affected by these compounded shocks, decreas- 30.0
ing by 0.9%oya in 1H17 from 3.7%oya growth in 2H16. The 25.0
authorities reacted swiftly, setting in motion a reconstruction 20.0
program and fiscal stimulus through 2020. The government 15.0
enacted a fiscal package of 1.3% of GDP targeted at recon- 10.0
struction needs and public investment. The authorities also 5.0
0.0
relaxed the medium-term fiscal consolidation path, adding
-5.0
3.2%-pt of GDP in fiscal deficit through 2020. The fiscal def- -10.0
icit was widened by 0.5%-pt of GDP to 3.0% this year, and by Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17
1.2%-pt to 3.5% next year. Source: INEI, BCRP and J.P Morgan
Inflation will likely flirt with both the floor and the ceiling
Yet, authorities swift reaction was offset partially by the of BCRPs target range next year. Limas headline inflation
prevailing political gridlock between the government and reached 2.04% by October, which was down significantly
the opposition-led Congress. Indeed, Peru has seen three from the 3.97% in March (explained by the Coastal El Nio).
different economy ministers this year, which does not bode We expect inflation to close 2017 at 1.91%, below the 2%
well for confidence and forward-looking decision making (i.e. mid target. Next year, base effects will also add substantial
investment). The political logjam relaxed in the last weeks, variation to the over-year-ago print, yet we see it inside the
helping activity to regain footing. We see real activity sequen- target band (2%1%). We expect inflation to reach 1.5% by
tial momentum averaging 5.5%q/q saar for 2H17, consistent March, only to accelerate towards 2.89% by September, clos-
with 2H17 real GDP rising by 3.0%y/y and 2017 GDP printing the year at 2.65%.
ing at 2.6%y/y. Figure 3: Peru CPI
%oya, Lima CPI
Fcst
Figure 1: GDP 5
%
15.0 4
%oya 3mma
%3m/3m saar 3
10.0
2 BCRP's inflation
target band
5.0 1
0.0 0
11 12 13 14 15 16 17 18
Source: INEI, BCRP and J.P Morgan
-5.0
07 09 11 13 15 17
Source: BCRP and J.P Morgan
43
We see BCRP on hold until 3Q18. The central bank cut the International reserves reached US$64.3bn (around 30% of
policy rate 100bp in 2017 to 3.25%, and our base case scenar- GDP), US$2.6bn above the level as of December 2016. The
io is for BCRP to stay put until 3Q18. Admittedly, in the near central bank has kept an active stance in the exchange rate
term any deviation from our current constructive view for market, buying US$5.3bn spot YTD. Despite dollarization
activity growth could prompt further easing, as upside infla- converging to levels as low as 39.6% of deposits from 47.5%
tion pressures will not materialize until 2H18. Thus, in our on February 2016 (28.8% of total credit) we believe the cen-
base case scenario, we expect BCRP to start tightening the tral bank will keep the upper hand on the exchange rate mar-
policy rate by 3Q18 with a projected 25bp increase in the pol- ket. Worth noting, BCRPs net FX reserves reached
icy rate, followed by another 50bp in 4Q18 driving the policy US$34bn, what compares to US$49.4bn high in April 2013.
rate to 4.0% by December 2017. We assume inflation would We expect USD/PEN to close 2018 around 3.20, a mild capi-
print at 2.3% in 2019 leaving the ex-ante real policy rate at tal appreciation of 1.5%.
around 1.7%, roughly in line with the policy rate level
deemed as the equilibrium by the monetary authority (1.8%).
Figure 5: Current account and fiscal balance
Figure 4: Monetary policy and output gap % GDP, last 4 quarters
% 4.5
Output Gap (LHS)
3.0 3 2.5
Policy rate (RHS) Fiscal balance
2.0 2 0.5
1.0 1
- 1.5
0.0 0
- 3.5
-1.0 -1
- 5.5 Current account balance
-2.0 -2 Mar-07 Mar-09 Mar-11 Mar-13 Mar-15 Mar-17
-3.0 -3 Source: BCRP and J.P Morgan
04 06 08 10 12 14 16 18 Risks associated with political gridlock have abated, but
Source: INEI, BCRP and J.P Morgan
not vanished. The tension between the government and the
We expect the overall fiscal deficit to reach 3.5% of GDP
Congress (led by the opposition) has abated following the
in 2018. The last 12-month fiscal deficit inched higher to
Congress approval of the new cabinet in October. Business
2.9% of GDP by September, from 2.6% in 2016. Current rev-
confidence has indeed recovered with forward looking expec-
enues inched lower to 17.9% of GDP, while non-financial
tations (next 3 months) back at last-4-year highs. However,
spending stood at 19.6%, of which capital spending represent-
risks remain in place, as ongoing corruption investigations
ed 3.9% of GDP, substantially below the 4.1% reached in
may prompt renewed tensions. In our view, the main risk for
2016. This is explained by the difficulties suffered in deploy-
the economic recovery we have penciled in for next year is
ing spending execution in 2Q and 3Q17. The fiscal deficit is
unchanged: perennial political gridlock that would impede
expected to widen further up to 3.0% this year, and 3.5% in
either smooth execution of public spending or the crowding in
2018, as the government is likely to continue to step up capi-
effect of private investment by public investment. Note that
tal spending with the reconstruction program and fiscal stimu-
public investment is seen as a catalyst that should galvanize
lus underway through 2020.
the private sector to end a fixed investment dry spell that
could jeopardize potential growth.
A more accommodative fiscal stance does not jeopardize
the credit premium as the external balances continue to Figure 6: Upbeat expectations going into 2018
improve on higher commodity prices and exports volumes. Index
The current account deficit converged to 0.9% pf GDP by 80
September 2017 (last 4 quarter sum), which compares to 3.6%
70
of GDP one year ago. Thus, the current account deficit Current conditions
nosedived by 2.6%-pts of GDP in just one year, opening room 60
for both an expansive fiscal and monetary policy. The notable 50
improvement of the merchandise trade surplus, which gained
US$5.9bn in four quarters, has explained the CAD narrowing. 40 Expectations next 3 months
We expect the acceleration in capex spending combined with 30
lower commodity prices to drive current account deficit wid- 08 09 10 11 12 13 14 15 16 17
ening reaching 1.0% of GDP by year-end and 1.6% in 2018. Source: BCRP and J.P Morgan
44
at around 1.2% for next year, driving 2018 GDP growth to

Uruguay: Growth to mask fiscal 3.3%y/y. Following the investment agreement with UPM, in
concerns our base case scenario we see the railway paired with infra-
structure projects starting to become noticeable on the nation-
Growth to remain above potential in 2018 at 3.3%y/y al accounts next year. The conditions for the railway tender
have already advanced, and we expect the government to pub-
We expect the headline fiscal deficit to close 2017 at
lish the tender conditions relatively soon. Nonetheless, a
3.4% of GDP compared to 3.9% in 2016
number of bureaucratic wrinkles will likely need time to be
Inflation likely to hover inside BCUs target range ironed out (for example, the more than 200 land expropria-
tions required to lay the 273km railway line). In all, we expect
Strong 2017 activity growth masked by the refinery re-
the construction of the railway and related infrastructure for
tooling. 2017 will be marked by a hefty drag associated with
US$1.0bn to start most likely by 4Q18.
the maintenance works in the ANCAP refinery. Originally,
the retooling shutdown was expected to extend for three
Advances in regard to the required infrastructure should
months, but the drag lingered through the end of September.
drive UPM to confirm the new mill investment by 2H19,
The manufacturing sector drag on GDP growth stands at 1.4-
with the actual works likely starting 1H20. According to
pt ytd, with the refinery retooling stoppage being the culprit
the announcement, the direct investment project would
(the refinery production has contributed with 13.6%-pt to the
amount US$2.3bn (or 4.1% of current nominal GDP). Beyond
IP 12.97% contraction YTD). Absent the drag, Uruguays
the investment for the pulp mill and the required infrastruc-
GDP would have printed above 4.5% this year. Going for-
ture, the estimates in regard to the economic impact of UPM
ward, while the performance of IP ex-refinery has been weak-
speak for themselves.
er than what we had expected, we keep 2017 GDP growth
forecast at 3.2%y/y.
Inflation is likely to remain inside BCUs target range.
Headline inflation returned to BCUs target range in February
Figure 1: GDP evolution
2017 and reached a cyclical low in July at 5.24%, bouncing
% %oya
back again to 6.04% in October. We expect inflation to reach
15.0 Q/Q saar
6.3% by year-end. Looking forward, in our base case scenario
10.0 we see inflation flirting with the range ceiling by September
and October on base effects, but it should grind lower to
5.0
6.7%oya by December 2018.
0.0
Figure 3: Headline CPI
-5.0
%oya, dotted lines correspond to BCU inflation target band
-10.0 12 Fcst
Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16
10
Source: BCU and JPMorgan
8
Figure 2: Industrial production 6

%oya, 3mma
Headline 4
30
Ex refinery
20 2
Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18
10 Source: INE and JPMorgan
0
In our view, taking comfort on current inflation cyclical
-10 lows could be risky as BCU needs to consolidate inflation
-20 within the range. We believe conditions are aligned for BCU
03 05 07 09 11 13 15 17 to finally consolidate inflation expectations inside the band
Source: INE and JPMorgan
for years to come if the authority holds to a mild contraction-
ary monetary bias. Yet more expansive broad M1 targets or
Growth to remain above potential in 2018. A stronger se- further reserve requirements cuts could jeopardize that long-
quential pickup in 4Q (exacerbated by the resumption of the standing endeared objective. In our view, measures as lower-
refinery production) should set the 2018 statistical carryover ing the midpoint of the inflation target range and/or narrowing
45
the tolerance band would be perceived by the market as credi- Figure 6: Primary spending
bility enhancers. We also advocate for BCU returning to a % of GDP, last 12-months
policy interest rate as the main instrument. 31.0
30.0
29.0
Figure 4: Inflation expectations
%oya, median 28.0
10 27.0
Next 12 months 26.0
9 Next 24 months 25.0
8 24.0
23.0
7 Jan-06 Jan-09 Jan-12 Jan-15 Jan-18
Source: MEF and JPMorgan
6
5 In terms of debt supply, we see total bond issuance to reach

Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 US$2,700mn in 2018 and the fiscal uses to reach US$3.1bn,
Source: BCU survey and JPMorgan
of which the primary fiscal deficit and interest account for
US$1,532mn, and debt amortizations and others for
We expect the headline fiscal deficit to close 2017 at 3.4% US$1,523mn. While the Debt Management unit has focused
of GDP. The last 12-month overall fiscal deficit stood at 3.6% during 2017 on developing a local currency nominal curve,
of GDP by July compared to 3.9% in 2016. We expect the the republic intends, subject to market conditions, to return to
headline fiscal deficit to close 2017 at 3.4% of GDP (of which the global dollar market next year. We expect US$1.2bn in
close to 0.2%-pt would be explained by BCUs financial external law hard currency bonds and the remainder to be
costs), implying a 0.5%-pt correction from 2016. An upbeat financed via GBI-eligible.
activity pace in the coming quarters, underpinned by brighter
regional prospects, may help to mask structural issues and The external balance anchors fiscal risks. The migration to
drive the fiscal deficit to committed 2.5% of GDP by 2019. the BoP Manual 6 prompted a number of surprises. The most
striking is the fact that, according to the revamped methodol-
Yet we continue to flag the upward trend in fiscal spend- ogy, Uruguay has a current account surplus of US$1.3bn by
ing, which is likely to close the year above 30% of GDP. 2Q17 (4-quarter sum). The trade balance surplus (of both
After a correction in 2015, upward pressures returned by mid merchandise and services) more than offset the rents outflow,
2016, and fiscal spending is unlikely to consolidate lower explaining the current account surplus. On the financial side,
before the election in 2019. Then fiscal consolidation we en- it has been a concern that inward direct investment has col-
tertain thus basically obeys to above-potential GDP growth, lapsed when compared to levels as of US$3.0bn a couple of
with scarce fundamental efforts to contain a growing tax bur- years ago. The central bank will continue intervening in the
den that exerts pressure on private sector profitability. exchange rate market. The central bank reserves reached
US$15.7bn in Nov-17 (26.7% of 2017F GDP), of which
Figure 5: Global and primary public sector balance US$8.2bn are FX reserves. The central bank seems to have
% of GDP, last 12-months reached a level of reserves above the threshold considered
6.0 Global Public Sector Balance optimal.
4.0 Primary Balance Public Sector
Figure 7: International and FX reserves
2.0
US$ bn
0.0 20
International reserves
-2.0 15
FX reserves
-4.0 10
Jan-06 Jan-09 Jan-12 Jan-15
Source: MEF and JPMorgan
5
0
03 05 07 09 11 13 15 17
Source: BCU and JPMorgan
46
2018 ($5.4bn) than PDVSA ($2.9bn). At the same time,

Venezuela: Past the point of no PDVSAs commercial activities abroad are exposed to litiga-
return? tion, while Republic creditors probably would need to prove
that PDVSA is the governments legal alter egoa time
Maduro has finally conceded servicing bonded debt is consuming ordealin order to try to attach assets. As such,
too costly, and late payments triggered credit events we do not rule out a selective default on Republic bonds go-
ing into 2018, while PDVSAs bonds are kept current.
A restricting seems impossible amid sanctions but we
think at least PDVSA might be kept current
OFAC might be trying to give the opposition a card to
Negotiations will set the framework for possible elec- play. Worth noting, on November 11 OFAC updated its Ven-
tions; the reeling economy will set the tone ezuela sanctions FAQs, including the following guidance:
OFAC would consider using licensing authority to allow U.S.
Paying (late) and restructuring (maybe). On November 2, persons to deal in new debt of the Government of Venezuela
President Maduro announced that PDVSA would pay a approved by the democratically elected Venezuelan National
$1.12bn principal payment (17Ns), while also decreeing a Assembly. This reminder has brought the debt issue to the
confusing refinancing and a restructuring of the external table of off-again/on-again political negotiations between the
debt. This effort is to be led by Vice President El Aissami, government and the opposition. The latest iteration of these
who happens to be subject to US individual sanctions. In the talks took place in the first days of December, monitored by
weeks that have followed, grace periods have been breached Chile and Mexico, countries that have confronted Maduro.
and ISDA and rating agencies determined that both Venezuela
and PDVSA have incurred Credit Events (triggering CDS). While the international community continues to put pres-
But the authorities have not declared moratorium. Rather, sure on Venezuela via incremental sanctions and efforts to
they have expressed their intention to continue honoring debt expose human rights abuses, opposition divisions have
serviceeven if latewhile they work with bondholders on a deepened after an enormously frustrating result in Octo-
restructuring plan for $36bn of Republic bonds and $27.9bn ber regional elections. The parties of the MUD coalition
of PDVSA bonds. So far, no formal proposal has been tabled, fiercely debated even going to the election in the wake of Ma-
and there is no clarity on the next steps to engage bondholders. duros installation of an all-powerful National Constituent
That said, with debt service on the PDVSA side trickling in, Assembly (ANC), and opposition abstention was somewhat
bondholders for now have opted not to accelerate their claims. high, even as the government used its institutional advantages
to compel votes. In the end, despite a massive deficit in pri-
Chart 1: PDVSA owes $2.9bn to bonds in '18; the Republic $5.4bn vate opinion polls, the official count gave a 55% majority and
18 of 23 governorships to the PSUV. Driving divisions even
3.5
further, 4 of the 5 opposition governors (all from the Demo-
3 PDVSA Republic cratic Action (AD) party) decided to swear in before the ANC,
2.5 effectively lending legitimacy to that internationally ques-
1.87 1.70 1.86
2 tioned body.
1.5
0.81 0.86 0.86
1 More elections to come. Municipal elections (for which
0.5 0.19 0.19 the MUD will formally abstain, but independent opposition
0 candidates will run) take place on December 15. The result of
4Q17 1Q18 2Q18 3Q18 4Q18 this vote, combined with the credibility of any dialogue con-
Source: PDVSA, FinMin, Bloomberg and J.P. Morgan cessions to ensure competitive elections going forward, will
help determine the oppositions next move. A unity opposi-
tion candidate for still-to-be-defined 2018 presidential elec-
Sanctions prohibit a restructuring. A restructuring deal
tions could be competitive, but the oppositions two most
involving an exchange into new securities seems effectively
attractive candidates, Lopez and Capriles, are out of the race,
impossible absent an OFAC license. The governments main
and the government seems dead set on staying in power. On
message so far to bondholders is that it is in their own interest
the Chavista side, Maduro seems to be imposing his reelection
to help lobby Washington to lighten up on sanctions. As of
bid, sidelining rivals in part by pursuing an aggressive corrup-
early December PDVSA bonds have slowly been serviced,
tion campaign at PDVSA, where the new president is a major
but over $600mn of Republic coupons are past their respec-
general from the national guard (Manuel Quevedo). But with
tive 30 day grace periods. With the hurdle of PDVSAs 4Q17
no sign of any improvement in the economy and some signs
amortizations ($1.96bn) now cleared, its worth noting that
Republic owes considerably more bonded debt service in
47
of dissidence to Maduros internal power play, the equilibri- On external accounts, import contraction continues to be
um within Chavismo may be more tenuous than meets the eye. the adjustment variable, as the better tone for oil prices is
offset by falling production (Figures 4 and 5). With sanc-
Economy still reeling, amid hyperinflation tions and operational uncertainty weighing on PDVSA, there
is no sign that these pernicious trends will reverse in 2018.
Venezuela has not published any macroeconomic statistics
since 3Q15. At that point, the government had suffered seven
Figure 4: Oil production decline is accelerating
straight quarters of economic decline, while inflation had
Kbd Rigs
crossed the 100% threshold, up from around 50% in Maduros
3100 Oil production 100
first two years in office (2013-14). The opposition controlled
2900 rig count (rhs) 90
National Assembly (AN) has stepped in to fill the information 2700 80
void. On the growth side, their GDP proxy figures reveal a 2500 70
13% decline in 2016, and an additional 12% decline in the 2300 60
first 3 quarters of 2017 (figure 2). 2100 50
1900 40
1700 30
Figure 2: A sharp and prolonged downturn 1500 20
% oya 2011 2012 2013 2014 2015 2016 2017
15 AN proxy
Source: OPEC (production) and Baker Hughes (rig-count)
10 GDP
5 Figure 5: Venezuela imports continue to fall according to partner data
0
$ bn, 12 mo sum
-5 60
-10 BCV BOP (dots)
50 INE
-15
-20 40
07 10 13 16 30
Source: BCV for GDP; National Assembly for AN GDP proxy 18.9
20 trading partner proxy* 12.5
X to Ven of US, China, EU, Bz, Col, Mx, Uy, Ec
Venezuela has crossed the threshold into hyperinflation. 10
The AN has also been publishing an inflation index that 0
showed prices accelerate from 18.5%m/m on average in 2011 2012 2013 2014 2015 2016 2017
Source: BCV, INE, National statistics agencies and J.P. Morgan calculations
1H17, to over 30%m/m in August and September and around
50%m/m by 4Qa pace consistent with the worst bouts of
Table 2: Venezuela economic indicators
South American inflation in the 1980s. The parallel FX rate
has moved in concert, jumping from an average rate of Average
USD/VEF 1,365 in 2016 to over 100,000 by December 2017. 2010-15 2016 2017f 2018f
These moves (Figure 3) have been driven by the monetary Real GDP, % change 0.3 -12.0 -10.0 -10.0
financing of the deficit, as observed by the expansion of the Consumption 1.0 -11.4 -10.9 -8.9
Central Banks balance sheet via its claims on PDVSA (which Investment -1.7 -6.4 -2.1 -2.5
is still forced to sell most of its dollars at the official Net trade 0.9 5.8 3.0 1.4
USD/VEF 10). Consumer prices, %oya 48.0 475.0 900 4000
% Dec/Dec 58.7 900.0 2000 3000
Figure 3: Hyperinflation takes hold Producer prices, %oya 50.7 400.0 750 1000
% oya
Government balance, % of GDP -13.8 -10.0 -10.0 -10.0
4000%
parallel fx
Merchandise trade balance (US$ bn) 28.5 7.8 17.4 15.8
3000% Exports 78.0 26.6 29.8 27.4
CB claims on Imports 49.6 18.9 12.5 11.6
2000% PDVSA
Current account balance 4.3 -6.8 2.5 1.4
M2 % of GDP 1.4 -0.1 2.1 1.2
1000%
International reserves, (US$ bn) 2 12.9 11.0 9.5 7.0
0% 1. Contribution to growth of GDP.
Dec 14 Dec 15 Dec 16 Dec 17 2. Excludes gold
Source: BCE , dolartoday.com and J.P. Morgan Source: BCV, Finance Ministry and J.P. Morgan
48
Analysts' Compensation: The research analysts responsible for the preparation of this report receive compensation based upon various
factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues.
Important Disclosures
Market Maker/ Liquidity Provider: J.P. Morgan Securities plc and/or an affiliate is a market maker and/or liquidity provider in securi-
ties issued by PEMEX.
Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for PEMEX within
the past 12 months.
Client: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as clients: PEMEX.
Client/Investment Banking: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as investment bank-
ing clients: PEMEX.
Client/Non-Investment Banking, Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following enti-
ty(ies) as clients, and the services provided were non-investment-banking, securities-related: PEMEX.
Client/Non-Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following entity(ies) as clients, and the
services provided were non-securities-related: PEMEX.
Investment Banking (past 12 months): J.P. Morgan received in the past 12 months compensation for investment banking services from
PEMEX.
Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services
in the next three months from PEMEX.
Non-Investment Banking Compensation: J.P. Morgan has received compensation in the past 12 months for products or services other
than investment banking from PEMEX.
Other Significant Financial Interests: J.P. Morgan owns a position of 1 million USD or more in the debt securities of PEMEX.
Company-Specific Disclosures: Important disclosures, including price charts and credit opinion history tables, are available for compendi-
um reports and all J.P. Morgancovered companies by visiting https://www.jpmm.com/research/disclosures, calling 1-800-477-0406, or e-
mailing research.disclosure.inquiries@jpmorgan.com with your request. J.P. Morgans Strategy, Technical, and Quantitative Research teams
may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477-0406 or e-mail
research.disclosure.inquiries@jpmorgan.com.
49
PEMEX - J.P. Morgan Credit Opinion History

Date Action Rating/Designation Ticker/ISIN
Issuer 24 Mar 16 Terminate Not Covered PEMEX
Issuer 07 Jul 16 Initiate Neutral PEMEX
Issuer 09 Nov 16 Downgrade Underweight PEMEX
Issuer 10 Jan 17 Withdrawn Not Rated PEMEX
Issuer 13 Feb 17 Restored Neutral PEMEX
Issuer 13 Jul 17 Withdrawn Not Rated PEMEX
Issuer 28 Jul 17 Restored Neutral PEMEX
Issuer 30 Oct 17 Upgrade Overweight PEMEX
6.5% '27 * 05 May 17 Initiate Overweight US71656MBQ15
6.5% '27 * 13 Jul 17 Withdrawn Not Rated US71656MBQ15
6.5% '27 * 08 Sep 17 Restored Neutral US71656MBQ15
6.5% '27 * 18 Oct 17 Upgrade Overweight US71656MBQ15
1.875% '22 EUR 16 Sep 16 Initiate Neutral XS1172947902
1.875% '22 EUR 10 Jan 17 Withdrawn Not Rated XS1172947902
1.875% '22 EUR 13 Feb 17 Restored Neutral XS1172947902
1.875% '22 EUR 13 Jul 17 Withdrawn Not Rated XS1172947902
1.875% '22 EUR 28 Jul 17 Restored Neutral XS1172947902
2.5% '21 EUR 29 Mar 17 Initiate Neutral XS1568875444
2.650% '18 FRN 07 Jul 16 Initiate Neutral US71654QBK76
2.650% '18 FRN 10 Jan 17 Withdrawn Not Rated US71654QBK76
2.650% '18 FRN 13 Feb 17 Restored Neutral US71654QBK76
2.650% '18 FRN 13 Jul 17 Withdrawn Not Rated US71654QBK76
2.650% '18 FRN 28 Jul 17 Restored Neutral US71654QBK76
2.75% '27 EUR 16 Sep 16 Initiate Overweight XS1172951508
2.75% '27 EUR 09 Nov 16 Downgrade Neutral XS1172951508
3.125% '20 16 Sep 16 Initiate Neutral XS0997484943
3.125% '20 10 Jan 17 Withdrawn Not Rated XS0997484943
3.125% '20 13 Feb 17 Restored Neutral XS0997484943
3.125% '20 13 Jul 17 Withdrawn Not Rated XS0997484943
3.125% '20 28 Jul 17 Restored Neutral XS0997484943
3.125% '20 EUR 07 Jul 16 Initiate Neutral XS0997484430
3.125%'19 02 Apr 15 Upgrade Neutral US71654QBQ47
3.125%'19 31 Jul 15 Downgrade Underweight US71654QBQ47
3.125%'19 06 Nov 15 Upgrade Neutral US71654QBQ47
3.125%'19 24 Mar 16 Terminate Not Covered US71654QBQ47
3.125%'19 07 Jul 16 Initiate Neutral US71654QBQ47
3.125%'19 09 Nov 16 Downgrade Underweight US71654QBQ47
3.125%'19 10 Jan 17 Withdrawn Not Rated US71654QBQ47
3.125%'19 13 Feb 17 Restored Neutral US71654QBQ47
3.125%'19 13 Jul 17 Withdrawn Not Rated US71654QBQ47
3.125%'19 28 Jul 17 Restored Neutral US71654QBQ47
3.250% '20 02 Apr 15 Initiate Neutral US71654QBU58
3.250% '20 06 May 15 Downgrade Underweight US71654QBU58
3.250% '20 22 Feb 16 Upgrade Neutral US71654QBU58
3.250% '20 24 Mar 16 Terminate Not Covered US71654QBU58
3.250% '20 07 Jul 16 Initiate Neutral US71654QBU58
3.250% '20 16 Sep 16 Upgrade Overweight US71654QBU58
3.250% '20 13 Oct 16 Downgrade Neutral US71654QBU58
3.250% '20 10 Jan 17 Withdrawn Not Rated US71654QBU58
3.250% '20 13 Feb 17 Restored Neutral US71654QBU58
3.250% '20 13 Jul 17 Withdrawn Not Rated US71654QBU58
3.250% '20 28 Jul 17 Restored Neutral US71654QBU58
3.500% '18 08 Jan 15 Upgrade Overweight US71654QBJ04
3.500% '18 02 Apr 15 Downgrade Neutral US71654QBJ04
3.500% '18 02 Jul 15 Upgrade Overweight US71654QBJ04
50
3.500% '18 31 Jul 15 Downgrade Neutral US71654QBJ04

3.500% '18 11 Sep 15 Downgrade Underweight US71654QBJ04
3.500% '18 19 Nov 15 Upgrade Neutral US71654QBJ04
3.500% '18 24 Mar 16 Terminate Not Covered US71654QBJ04
3.500% '18 07 Jul 16 Initiate Overweight US71654QBJ04
3.500% '18 29 Jul 16 Downgrade Neutral US71654QBJ04
3.500% '18 09 Nov 16 Downgrade Underweight US71654QBJ04
3.500% '18 10 Jan 17 Withdrawn Not Rated US71654QBJ04
3.500% '18 13 Feb 17 Restored Neutral US71654QBJ04
3.500% '18 13 Jul 17 Withdrawn Not Rated US71654QBJ04
3.500% '18 28 Jul 17 Restored Neutral US71654QBJ04
3.500% '23 31 Jul 15 Upgrade Neutral US71654QBG64
3.500% '23 11 Sep 15 Downgrade Underweight US71654QBG64
3.500% '23 19 Nov 15 Upgrade Neutral US71654QBG64
3.500% '23 22 Feb 16 Upgrade Overweight US71654QBG64
3.500% '23 24 Mar 16 Terminate Not Covered US71654QBG64
3.500% '23 07 Jul 16 Initiate Neutral US71654QBG64
3.500% '23 16 Sep 16 Upgrade Overweight US71654QBG64
3.500% '23 09 Nov 16 Downgrade Neutral US71654QBG64
3.500% '23 10 Jan 17 Withdrawn Not Rated US71654QBG64
3.500% '23 13 Feb 17 Restored Neutral US71654QBG64
3.500% '23 05 May 17 Upgrade Overweight US71654QBG64
3.500% '23 08 Jun 17 Downgrade Neutral US71654QBG64
3.500% '23 13 Jul 17 Withdrawn Not Rated US71654QBG64
3.500% '23 28 Jul 17 Restored Neutral US71654QBG64
3.75% '19 EUR 16 Sep 16 Initiate Neutral XS1379157404
3.75% '19 EUR 13 Oct 16 Upgrade Overweight XS1379157404
3.75% '24 EUR 08 Jun 17 Initiate Overweight XS1568874983
3.75% '26 EUR 16 Sep 16 Initiate Overweight XS1057659838
4.250% '25 08 Jan 15 Initiate Underweight US71654QBV32
4.250% '25 31 Jul 15 Upgrade Neutral US71654QBV32
4.250% '25 11 Sep 15 Downgrade Underweight US71654QBV32
4.250% '25 24 Mar 16 Terminate Not Covered US71654QBV32
4.250% '25 07 Jul 16 Initiate Neutral US71654QBV32
4.250% '25 10 Jan 17 Withdrawn Not Rated US71654QBV32
4.250% '25 13 Feb 17 Restored Neutral US71654QBV32
4.250% '25 13 Jul 17 Withdrawn Not Rated US71654QBV32
4.250% '25 28 Jul 17 Restored Neutral US71654QBV32
4.500% '26 02 Apr 15 Initiate Underweight US71654QBW15
4.500% '26 31 Jul 15 Upgrade Neutral US71654QBW15
4.500% '26 11 Sep 15 Downgrade Underweight US71654QBW15
4.500% '26 24 Mar 16 Terminate Not Covered US71654QBW15
4.500% '26 07 Jul 16 Initiate Neutral US71654QBW15
4.500% '26 10 Jan 17 Withdrawn Not Rated US71654QBW15
4.500% '26 13 Feb 17 Restored Neutral US71654QBW15
4.500% '26 13 Jul 17 Withdrawn Not Rated US71654QBW15
4.500% '26 28 Jul 17 Restored Neutral US71654QBW15
4.769% '22 FRN 05 May 17 Initiate Neutral US71656MBN83
4.769% '22 FRN 13 Jul 17 Withdrawn Not Rated US71656MBN83
4.769% '22 FRN 28 Jul 17 Restored Neutral US71656MBN83
4.875% '15 08 Apr 15 Terminate Not Covered US71654QAV41
4.875% '22 22 Feb 16 Upgrade Overweight US71654QBB77
4.875% '22 24 Mar 16 Terminate Not Covered US71654QBB77
4.875% '22 07 Jul 16 Initiate Overweight US71654QBB77
4.875% '22 09 Nov 16 Downgrade Neutral US71654QBB77
51
4.875% '22 10 Jan 17 Withdrawn Not Rated US71654QBB77

4.875% '22 13 Feb 17 Restored Neutral US71654QBB77
4.875% '22 30 Mar 17 Upgrade Overweight US71654QBB77
4.875% '22 05 May 17 Downgrade Neutral US71654QBB77
4.875% '22 08 Jun 17 Upgrade Overweight US71654QBB77
4.875% '22 13 Jul 17 Withdrawn Not Rated US71654QBB77
4.875% '22 28 Jul 17 Restored Neutral US71654QBB77
4.875% '22 18 Oct 17 Upgrade Overweight US71654QBB77
4.875% '22 27 Nov 17 Downgrade Neutral US71654QBB77
4.875% '24 10 Jun 15 Upgrade Neutral US71654QBH48
4.875% '24 02 Jul 15 Downgrade Underweight US71654QBH48
4.875% '24 31 Jul 15 Upgrade Neutral US71654QBH48
4.875% '24 22 Feb 16 Downgrade Underweight US71654QBH48
4.875% '24 24 Mar 16 Terminate Not Covered US71654QBH48
4.875% '24 07 Jul 16 Initiate Neutral US71654QBH48
4.875% '24 10 Jan 17 Withdrawn Not Rated US71654QBH48
4.875% '24 13 Feb 17 Restored Neutral US71654QBH48
4.875% '24 30 Mar 17 Upgrade Overweight US71654QBH48
4.875% '24 05 May 17 Downgrade Neutral US71654QBH48
4.875% '24 13 Jul 17 Withdrawn Not Rated US71654QBH48
4.875% '24 28 Jul 17 Restored Neutral US71654QBH48
4.875% '28 EUR 29 Mar 17 Initiate Overweight XS1568888777
4.875% '28 EUR 28 Jul 17 Restored Overweight XS1568888777
5.125% '23 EUR 29 Mar 17 Initiate Overweight XS1379158048
5.375% '22 05 May 17 Initiate Overweight US71656MBP32
5.375% '22 13 Jul 17 Withdrawn Not Rated US71656MBP32
5.375% '22 28 Jul 17 Restored Overweight US71656MBP32
5.375% '22 08 Sep 17 Downgrade Neutral US71656MBP32
5.375% '22 18 Oct 17 Upgrade Overweight US71656MBP32
5.375% '22 27 Nov 17 Downgrade Neutral US71656MBP32
5.5% '19 07 Jul 16 Initiate Overweight US71656MBH16
5.5% '19 09 Nov 16 Downgrade Neutral US71656MBH16
5.5% '19 10 Jan 17 Withdrawn Not Rated US71656MBH16
5.5% '19 13 Feb 17 Restored Neutral US71656MBH16
5.5% '19 13 Jul 17 Withdrawn Not Rated US71656MBH16
5.5% '19 28 Jul 17 Restored Neutral US71656MBH16
5.5% '25 EUR 07 Jul 16 Initiate Neutral XS0213101073
5.5% '25 EUR 16 Sep 16 Upgrade Overweight XS0213101073
5.5% '25 EUR 30 Mar 17 Upgrade Overweight XS0213101073
5.5% '25 EUR 28 Jul 17 Restored Overweight XS0213101073
5.5% '25 EUR 18 Oct 17 Downgrade Neutral XS0213101073
5.500% '21 11 Sep 15 Downgrade Underweight US71654QAX07
5.500% '21 19 Nov 15 Upgrade Neutral US71654QAX07
5.500% '21 22 Feb 16 Downgrade Underweight US71654QAX07
5.500% '21 24 Mar 16 Terminate Not Covered US71654QAX07
5.500% '21 07 Jul 16 Initiate Overweight US71654QAX07
5.500% '21 09 Nov 16 Downgrade Neutral US71654QAX07
5.500% '21 10 Jan 17 Withdrawn Not Rated US71654QAX07
5.500% '21 13 Feb 17 Restored Neutral US71654QAX07
5.500% '21 05 May 17 Upgrade Overweight US71654QAX07
5.500% '21 13 Jul 17 Withdrawn Not Rated US71654QAX07
5.500% '21 28 Jul 17 Restored Overweight US71654QAX07
5.500% '21 08 Sep 17 Downgrade Neutral US71654QAX07
5.500% '21 18 Oct 17 Upgrade Overweight US71654QAX07
5.500% '21 27 Nov 17 Downgrade Neutral US71654QAX07
5.500% '44 06 May 15 Upgrade Neutral US71654QBE17
5.500% '44 30 Sep 15 Upgrade Overweight US71654QBE17
5.500% '44 22 Feb 16 Downgrade Neutral US71654QBE17
5.500% '44 24 Mar 16 Terminate Not Covered US71654QBE17
5.500% '44 07 Jul 16 Initiate Neutral US71654QBE17
52
5.500% '44 10 Jan 17 Withdrawn Not Rated US71654QBE17

5.500% '44 13 Feb 17 Restored Neutral US71654QBE17
5.500% '44 30 Mar 17 Upgrade Overweight US71654QBE17
5.500% '44 05 May 17 Downgrade Neutral US71654QBE17
5.500% '44 13 Jul 17 Withdrawn Not Rated US71654QBE17
5.500% '44 28 Jul 17 Restored Neutral US71654QBE17
5.625% '46 02 Apr 15 Initiate Neutral US71654QBX97
5.625% '46 31 Jul 15 Upgrade Overweight US71654QBX97
5.625% '46 22 Feb 16 Downgrade Neutral US71654QBX97
5.625% '46 24 Mar 16 Terminate Not Covered US71654QBX97
5.625% '46 07 Jul 16 Initiate Neutral US71654QBX97
5.625% '46 10 Jan 17 Withdrawn Not Rated US71654QBX97
5.625% '46 13 Feb 17 Restored Neutral US71654QBX97
5.625% '46 30 Mar 17 Upgrade Overweight US71654QBX97
5.625% '46 05 May 17 Downgrade Neutral US71654QBX97
5.625% '46 13 Jul 17 Withdrawn Not Rated US71654QBX97
5.625% '46 28 Jul 17 Restored Overweight US71654QBX97
5.75% '18 08 Jan 15 Upgrade Overweight US70645KBD00
5.75% '18 02 Apr 15 Downgrade Neutral US70645KBD00
5.75% '18 11 Sep 15 Downgrade Underweight US70645KBD00
5.75% '18 30 Sep 15 Upgrade Neutral US70645KBD00
5.75% '18 19 Nov 15 Downgrade Underweight US70645KBD00
5.75% '18 24 Mar 16 Terminate Not Covered US70645KBD00
5.75% '18 07 Jul 16 Initiate Neutral US70645KBD00
5.75% '18 10 Jan 17 Withdrawn Not Rated US70645KBD00
5.75% '18 13 Feb 17 Restored Neutral US70645KBD00
5.75% '18 13 Jul 17 Withdrawn Not Rated US70645KBD00
5.75% '18 28 Jul 17 Restored Neutral US70645KBD00
6.000% '20 08 Jan 15 Downgrade Underweight US71654QAW24
6.000% '20 31 Jul 15 Upgrade Neutral US71654QAW24
6.000% '20 19 Nov 15 Downgrade Underweight US71654QAW24
6.000% '20 22 Feb 16 Upgrade Neutral US71654QAW24
6.000% '20 24 Mar 16 Terminate Not Covered US71654QAW24
6.000% '20 07 Jul 16 Initiate Overweight US71654QAW24
6.000% '20 09 Nov 16 Downgrade Neutral US71654QAW24
6.000% '20 10 Jan 17 Withdrawn Not Rated US71654QAW24
6.000% '20 13 Feb 17 Restored Neutral US71654QAW24
6.000% '20 13 Jul 17 Withdrawn Not Rated US71654QAW24
6.000% '20 28 Jul 17 Restored Neutral US71654QAW24
6.375% '21 07 Jul 16 Initiate Overweight US71656MBJ71
6.375% '21 09 Nov 16 Downgrade Neutral US71656MBJ71
6.375% '21 10 Jan 17 Withdrawn Not Rated US71656MBJ71
6.375% '21 13 Feb 17 Restored Neutral US71656MBJ71
6.375% '21 05 May 17 Upgrade Overweight US71656MBJ71
6.375% '21 08 Jun 17 Downgrade Neutral US71656MBJ71
6.375% '21 13 Jul 17 Withdrawn Not Rated US71656MBJ71
6.375% '21 28 Jul 17 Restored Overweight US71656MBJ71
6.375% '21 27 Nov 17 Downgrade Neutral US71656MBJ71
6.375% '45 31 Jul 15 Upgrade Overweight US71654QBR20
6.375% '45 30 Sep 15 Downgrade Neutral US71654QBR20
6.375% '45 08 Jan 16 Downgrade Underweight US71654QBR20
6.375% '45 22 Feb 16 Upgrade Neutral US71654QBR20
6.375% '45 24 Mar 16 Terminate Not Covered US71654QBR20
6.375% '45 07 Jul 16 Initiate Neutral US71654QBR20
6.375% '45 10 Jan 17 Withdrawn Not Rated US71654QBR20
6.375% '45 13 Feb 17 Restored Neutral US71654QBR20
6.375% '45 30 Mar 17 Upgrade Overweight US71654QBR20
6.375% '45 05 May 17 Downgrade Neutral US71654QBR20
6.375% '45 13 Jul 17 Withdrawn Not Rated US71654QBR20
6.375% '45 28 Jul 17 Restored Overweight US71654QBR20
6.5% '41 02 Apr 15 Upgrade Overweight US71654QAZ54
6.5% '41 31 Jul 15 Downgrade Neutral US71654QAZ54
6.5% '41 24 Mar 16 Terminate Not Covered US71654QAZ54
6.5% '41 07 Jul 16 Initiate Neutral US71654QAZ54
6.5% '41 10 Jan 17 Withdrawn Not Rated US71654QAZ54
6.5% '41 13 Feb 17 Restored Neutral US71654QAZ54
6.5% '41 30 Mar 17 Upgrade Overweight US71654QAZ54
53
6.5% '41 05 May 17 Downgrade Neutral US71654QAZ54

6.5% '41 13 Jul 17 Withdrawn Not Rated US71654QAZ54
6.5% '41 28 Jul 17 Restored Overweight US71654QAZ54
6.625% '35 31 Jul 15 Downgrade Neutral US706451BG56
6.625% '35 24 Mar 16 Terminate Not Covered US706451BG56
6.625% '35 07 Jul 16 Initiate Neutral US706451BG56
6.625% '35 10 Jan 17 Withdrawn Not Rated US706451BG56
6.625% '35 13 Feb 17 Restored Neutral US706451BG56
6.625% '35 30 Mar 17 Upgrade Overweight US706451BG56
6.625% '35 05 May 17 Downgrade Neutral US706451BG56
6.625% '35 13 Jul 17 Withdrawn Not Rated US706451BG56
6.625% '35 28 Jul 17 Restored Neutral US706451BG56
6.625% '38 31 Jul 15 Downgrade Neutral US706451BR12
6.625% '38 22 Feb 16 Upgrade Overweight US706451BR12
6.625% '38 24 Mar 16 Terminate Not Covered US706451BR12
6.625% '38 07 Jul 16 Initiate Neutral US706451BR12
6.625% '38 10 Jan 17 Withdrawn Not Rated US706451BR12
6.625% '38 13 Feb 17 Restored Neutral US706451BR12
6.625% '38 30 Mar 17 Upgrade Overweight US706451BR12
6.625% '38 05 May 17 Downgrade Neutral US706451BR12
6.625% '38 13 Jul 17 Withdrawn Not Rated US706451BR12
6.625% '38 28 Jul 17 Restored Overweight US706451BR12
6.625% Perpetual 07 Jul 16 Initiate Neutral US71656MAF68
6.625% Perpetual 10 Jan 17 Withdrawn Not Rated US71656MAF68
6.625% Perpetual 13 Feb 17 Restored Neutral US71656MAF68
6.625% Perpetual 30 Mar 17 Upgrade Overweight US71656MAF68
6.625% Perpetual 05 May 17 Downgrade Neutral US71656MAF68
6.625% Perpetual 13 Jul 17 Withdrawn Not Rated US71656MAF68
6.625% Perpetual 28 Jul 17 Restored Neutral US71656MAF68
6.75% '47 08 Sep 17 Initiate Overweight US71656MBT53
6.875% '26 07 Jul 16 Initiate Neutral US71656MBK45
6.875% '26 10 Jan 17 Withdrawn Not Rated US71656MBK45
6.875% '26 13 Feb 17 Restored Neutral US71656MBK45
6.875% '26 05 May 17 Upgrade Overweight US71656MBK45
6.875% '26 13 Jul 17 Withdrawn Not Rated US71656MBK45
6.875% '26 28 Jul 17 Restored Neutral US71656MBK45
7.375% '14 09 Jan 15 Withdrawn Not Rated US706451AH49
7.375% '14 08 Apr 15 Not Covered US706451AH49
8.000% '19 19 Nov 15 Downgrade Underweight US71654QAU67
8.000% '19 22 Feb 16 Upgrade Neutral US71654QAU67
8.000% '19 24 Mar 16 Terminate Not Covered US71654QAU67
8.000% '19 07 Jul 16 Initiate Neutral US71654QAU67
8.000% '19 10 Jan 17 Withdrawn Not Rated US71654QAU67
8.000% '19 13 Feb 17 Restored Neutral US71654QAU67
8.000% '19 13 Jul 17 Withdrawn Not Rated US71654QAU67
8.000% '19 28 Jul 17 Restored Neutral US71654QAU67
*Indicates representative/primary bond/instrument.
The table(s) above show the recommendation changes made by J.P. Morgan Credit Research Analysts in the subject company and/or instru-
ments over the past three years (or, if no recommendation changes were made during that period, the most recent change). Notes: Effective
April 11, 2016, J.P. Morgan changed its Credit Research Ratings System. Please see the Explanation of Credit Research Ratings below for
the new definitions. The previous rating system no longer should be relied upon. For the history prior to April 11, 2016, please call 1-800-
447-0406 or e-mail research.disclosure.inquiries@jpmorgan.com.
Explanation of Credit Research Valuation Methodology, Ratings and Risk to Ratings:
J.P. Morgan uses a bond-level rating system that incorporates valuations (relative value) and our fundamental view on the security. Our
fundamental credit view of an issuer is based on the company's underlying credit trends, overall creditworthiness and our opinion on whether
the issuer will be able to service its debt obligations when they become due and payable. We analyze, among other things, the company's
cash flow capacity and trends and standard credit ratios, such as gross and net leverage, interest coverage and liquidity ratios. We also ana-
lyze profitability, capitalization and asset quality, among other variables, when assessing financials. Analysts also rate the issuer, based on
the rating of the benchmark or representative security. Unless we specify a different recommendation for the companys individual securi-
ties, an issuer recommendation applies to all of the bonds at the same level of the issuers capital structure. This report also sets out within it
the material underlying assumptions used.
54
We use the following ratings for bonds (issues) and issuers: Overweight (over the next three months, the recommended risk position is ex-
pected to outperform the relevant index, sector, or benchmark); Neutral (over the next three months, the recommended risk position is ex-
pected to perform in line with the relevant index, sector, or benchmark); and Underweight (over the next three months, the recommended
risk position is expected to underperform the relevant index, sector, or benchmark). J.P. Morgan Emerging Markets Sovereign Research uses
Marketweight, which is equivalent to Neutral. NR is Not Rated. In this case, J.P. Morgan has removed the rating for this particular security
or issuer because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating no longer
should be relied upon. An NR designation is not a recommendation or a rating. NC is Not Covered. An NC designation is not a rating or a
recommendation.
For CDS, we use the following rating system: Long Risk (over the next three months, the credit return on the recommended position is ex-
pected to exceed the relevant index, sector or benchmark); Neutral (over the next three months, the credit return on the recommended posi-
tion is expected to match the relevant index, sector or benchmark); and Short Risk (over the next three months, the credit return on the rec-
ommended position is expected to underperform the relevant index, sector or benchmark).
Implicit in a J.P. Morgan credit rating is the analysts consideration of the underlying risks to the investment thesis. Risks may reflect com-
pany-specific, industry-specific, and, when relevant, macro factors. These factors are given weight to the extent that they impact a compa-
nys cash flow and leverage metrics, for example.
J.P. Morgan Credit Research Ratings Distribution, as of October 02, 2017

Overweight Neutral Underweight
Global Credit Research Universe 26% 58% 17%
IB clients* 62% 63% 61%
Note: The Credit Research Rating Distribution is at the issuer level. Please note that issuers with an NR or an NC designation are not included in the table
above.
*Percentage of investment banking clients in each rating category.
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55
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JP Morgan Latam Outlook

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JP Morgan Latam Outlook

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Completed 12 Dec 2017 06:13 PM EST

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Latin America 2018 Outlook: Contents

Cyclical recoveries have been supported by lower policy rates,

Inflation should stay close to targets in 2018, but move gradually

Emerging markets Venezuela -12.0 -10.0 -10.0 1.5

casts. Our LatAm nowcaster, introduced this past year, is 6

In regards to inflation pressures, prices associated directly

In Argentina, the government has shown commitment to

stance of fiscal gradualism. The 2018 budget projects a 1%

In Brazil, the cast of leading politicians could be significant-

Our baseline is that there is reasonable clarity on the key

We expect the currency to depreciate to 20.5-21.9 in the

UW Mexico: Lack of acceleration in the growth rate:

We hold our OW in Argentina despite consensus posi-

Argentina: Steering the ship Inflation to decelerate in 2H18, yet conver-

elections could create an inhospitable environment for in-

Rates should be lower for longer Table 3: Fiscal scenario

Chile: December election to by postponing investment decisions and keeping precau-

Former President Piera and incumbent Senator Guillier

what activity confidence indicators suggest. We have penciled

Loose labor market conditions and still feeble investment.

Inflation is to print below the target floor in 1H18, but

Figure 11: Current account

in 2018 to 2.7% and 3.8%oya, respectively. Net exports

Long-term oil production is seen at 840kbpd in 2018 and

20 Current Investment Interest

International reserves, (US$ bn) 3.3 3.7 3.0 3.0 3.0

down purchasing power. Ongoing fiscal consolidation efforts

Going into this year multiple factors supported our call

Sticky inflation should fall next year

With inflation expected to recede next year, benefiting

However, we advised that polls should be taken with cau-

behaved in 2018. Inflation reached 4.9%oya in October,

Figure 3: Trade balance

We project above-consensus 4.4% GDP growth for 2018,

at around 1.2% for next year, driving 2018 GDP growth to

Figure 2: Industrial production 6

5 In terms of debt supply, we see total bond issuance to reach

2018 ($5.4bn) than PDVSA ($2.9bn). At the same time,

PEMEX - J.P. Morgan Credit Opinion History

3.500% '18 31 Jul 15 Downgrade Neutral US71654QBJ04

4.875% '22 10 Jan 17 Withdrawn Not Rated US71654QBB77

5.500% '44 10 Jan 17 Withdrawn Not Rated US71654QBE17

6.5% '41 05 May 17 Downgrade Neutral US71654QAZ54

J.P. Morgan Credit Research Ratings Distribution, as of October 02, 2017

Legal Entities Disclosures

Country and Region Specific Disclosures

"Other Disclosures" last revised November 11, 2017.

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