March 16 (Bloomberg) -- Latin America’s economy may contract 4 percent this year, the most since at least 1980, as consumer confidence deteriorates and governments from Mexico to Brazil face limited room to boost spending, according to Morgan Stanley.

The New York-based bank lowered its previous forecast for a 0.5 percent contraction in the region this year. Mexico’s economy may weaken most, shrinking 5 percent, while Brazil’s gross domestic product may drop 4.5 percent, Morgan Stanley said.

“It is hard to handicap the magnitude or the duration of the current downturn in Latin America,” Gray Newman and four other economists for Latin America at Morgan Stanley wrote in today’s report. “We are concerned that it will suffer -- along with many other emerging economies -- from much more limited space to engage in counter-cyclical policy.”

The first global recession since World War II is choking demand for Latin American goods and cutting commodity prices. The region, whose exports range from oil to soybeans and iron-ore, won’t recover before the global economy turns around, said Daniel Volberg, a Morgan Stanley economist in New York. Even as interest rates fall, business and consumer confidence will drop and overpower the effect of lowering borrowing costs, the bank said.

61 Years

Morgan Stanley’s forecast for a contraction in Brazil, Latin America’s largest economy, would mark the biggest drop in the country’s GDP in at least 61 years, according to figures by the national statistic agency, whose annual GDP series starts in 1948. BNP Paribas SA economists say Brazil’s GDP may shrink 1.5 percent this year, while economists surveyed by the central bank forecast a 0.59 percent expansion this year, according to the median estimate of the survey published today.

Brazilian officials speaking at a conference in New York today offered a rosier outlook. The economy will resume growth in the first quarter, may gain strength in the following three months and is unlikely to slip into a recession this year, Cabinet Chief Dilma Rousseff said. Finance Minister Guido Mantega said the government has the resources to combat the global economic slump and the “fiscal breathing room” to carry out the necessary policies. Brazil’s economy contracted 3.6 percent in the fourth quarter from the previous three months.

“The Brazilian economy is much better positioned to withstand the difficult environment that we are facing today than most emerging markets,” Citigroup Inc. Senior Vice Chairman William Rhodes said at the same conference.

Brazil’s benchmark stock index is up 4.5 percent this year and the currency has gained 2 percent against the dollar.

Fiscal Targets

Brazil has met its savings goals every year since fiscal targets were established in 1999. The program of budget austerity persuaded Standard & Poor’s to award the world’s biggest emerging market debtor its first-ever investment grade rating on its dollar-denominated debt in April.

Now, as tax revenue declines and spending keeps rising, Brazil’s budget surplus before interest payments, known as the primary surplus, may slide to zero this year, from 4.1 percent of GDP last year, Morgan Stanley said in a report on March 2.

The overall budget deficit grew to 9.25 billion reais ($4 billion) in January compared with a surplus the same month last year. Lula, who vowed last month to increase spending on infrastructure projects by 28 percent through 2010 to spark growth and protect jobs, said today in New York that he won’t cut social and infrastructure spending.

Mexico, Argentina

Mexico, the second-biggest economy in the region, may be the most affected by the global economic crisis in 2009, Morgan Stanley said. Argentina’s GDP may drop 4.7 percent; Chile, 1.4 percent; Colombia, 1.6 percent; and Venezuela, 4 percent.

Peru’s economy probably will be the only one of the seven economies tracked by Morgan Stanley in the region to expand. It may grow 0.9 percent, the bank said.

Peru’s economy grew 3.1 percent in January from the same month a year earlier, the national statistics institute said in Lima.

Interest rate cuts across the region will also do little to stimulate growth in Latin America, Morgan Stanley said.

“It is difficult to imagine that credit growth will play a meaningful role in boosting economic activity even as monetary policy is eased, given the sharp declines that we envision in consumer and business confidence, the weakness in labor markets and the risks to the quality of the loan portfolio,” Morgan Stanley’s Latin American team wrote today.

Economists covering the Brazilian economy expect the central bank to cut the benchmark rate next month for a third straight meeting to a record-low 10.25 percent in a bid to revive a slowing economy, according to the central bank survey published today.

Chile’s central bank slashed its benchmark interest rate by 2.5 percentage points on March 12, bringing cuts this year to 6 percentage points, the steepest reduction since the bank started using its interest-rate policy 15 years ago.

To contact the reporters on this story: Andre Soliani in Brasilia at at soliani@bloomberg.net;

Last Updated: March 16, 2009 14:23 EDT