LATIN ECONOMY: Winners and losers

As Brazil prepares to be the focus of global attention next year when it hosts the football World Cup, investors are aware that gauging the forecast for the wider region is very much a game of two halves.

“The outlook for Latin America in 2013 is mixed,” says Rafael Amiel, chief Latin America economist at the consultancy IHS Global Insight. For Amiel the dividing line is the quality of economic management, especially in areas such as inflation targeting, exchange rate regimes, and sound management of external debt. These were the precise areas where failure of economic management occurred in the decades prior to the turn of the millennium, characterized by high inflation, weak growth, and a succession of budget and current account crises.

So who are the cup winners and who run the risk of getting yellow cards from global investors? For Amiel there are three countries where those weaknesses are most apparent.

“Countries where macroeconomic mismanagement reigns such as Venezuela, Ecuador and Argentina will decelerate in 2013 as the impact of low investment in previous years takes its toll,” he says. Venezuela and Argentina already exhibit very high inflation – prices in Venezuela probably rose 23% last year, while inflation in Argentina averaged just below 10%.

André Loes, chief economist for Latin America at HSBC, says their central banks will not be able to cut interest rates to boost growth for fear of further stoking inflation. “As a consequence of sticky inflation, central banks cannot afford to go overboard with easing,” he says. Loes echoes Amiel’s concern over investment levels. “In Argentina especially there has been a huge deceleration in investment since 2011.”

At the same time Argentina is still struggling to cope with the fallout from its $100 billion default in 2001. Buenos Aires is appealing against a US court judgement that would force it to treat the original bondholders, who have gone unpaid for a decade, on the same basis as those who bought debt issued in 2005 and 2010 when Argentina restructured its defaulted bonds.

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If upheld, the ruling will leave the government with a difficult choice: pay the holdouts – which it has until now sworn it would never do – or fall into default with existing creditors in order to prevent holdouts from accessing seized funds. Luis Oganes, chief Latin American economist at JP Morgan, says the case could sap confidence in Argentina. “All this takes time, and Argentina could still be pushed into a technical default, and that is not a good place to be. There is the potential for more negative headlines, and this will conspire against the appetite for investing in Argentina near term.”

The outlook for Venezuela is overshadowed by the death of President Hugo Chávez, which was announced two weeks ago.

His death has created a power vacuum that will be hard to fill as the country prepares for new elections at the beginning of next month. Given the force of Chávez’s personality, this will create uncertainty among investors as potential successors jostle for power.

RUNNERS AND WALKERS

Into the camp of well-managed economies fall Mexico, Brazil, Colombia, Chile and Peru – and to some extent Uruguay and Panama. “Strong macroeconomic fundamentals and high-quality policy frameworks will support the continuation of relatively strong growth,” Amiel says.

Indeed at last October’s annual Emerging Markets awards, it was Colombia’s José Darío Uribe Escobar who picked up the gong for best central banker, while Luís Miguel Castilla Rubio of Peru was named top finance minister.

Eric Curiel, strategist at Esemplia Emerging Markets, an equities fund, says Peru is the “rising star” with strong growth and inflation under control. “The government has turned out to be a lot more market friendly than we had feared,” he says. “You can see the investment demand feeding into domestic demand.”

HSBC’s Loes, who forecasts regional growth of 3.2% this year after 2.6% in 2012, makes a slightly different distinction between the “fast runners” on Latin America’s Pacific shore and the slower-growth “walkers” on the Atlantic coast. He says that the key differentiating factor has been investment, which has shown a “huge” deceleration in the “walker” countries but is now running well above GDP growth in the other group.

For Oganes, Mexico has clearly emerged as the star of the region. Although its close economic ties to the US meant it was badly hit by the Lehman crisis, it is predicted to be on track for growth of above potential growth of 3.6%. He says Mexico has worked hard to reduce the wage gap with China, which was as high as 200% in 2000 when China joined the World Trade Organization. Since then, though, wages in China have risen fast, while the increase in salaries in Mexico’s economy was much slower.

“Wages in Mexico were on average three times wages in China. But that wage differential has shrunk,” Oganes says. “Mexico has managed to partially decouple from the low growth dynamics in the US, and that’s why it has started to attract a lot more attention in markets. Mexico has managed to regain wage competitiveness vis-à-vis China, so Mexico looks like a more attractive place to set up manufacturing plants in relative terms.”

But the economic powerhouse of the region remains Brazil, the region’s representative in the Brics (Brazil, Russia, India, China and South Africa) group of fast-growing emerging economies. It saw growth fall to just around 1% last year, and the IMF now expects it to post a 3.5% expansion in 2013.

Loes says many of the measures taken by the Brazilian government to reduce the cost of production such as cuts in labour charges and the cost of energy should deliver rewards in 2013 in terms of a pick-up in GDP growth to 3% this year. IHS’s Amiel says growth will be led by a rebound in investment, driven by government spending and the need to complete infrastructure projects needed for the 2014 World Cup and the 2016 Olympic Games. But, Oganes says, while sporting investment is important, it only accounts for $25 billion out of a $600 billion five-year investment pipeline of state and private-sector projects.

Meanwhile on the monetary policy front, the central bank has brought down the main interest rate from 12.50% to 7.25%. “Policy stimuli, both monetary and fiscal, will also support the acceleration of domestic demand,” says Amiel.

Curiel at Esemplia is more cautious: “I think we will see a pick-up in the Brazilian economy, but I don’t think it is to be that strong and, given the amount of policy loosening that has been put in place, it’s actually quite worrisome.”

One issue simmering beneath the surface that has broken through in recent weeks is concern that rich countries are manipulating their currencies.

It was Brazil’s finance minister Guido Mantega who coined the phrase “currency war” in 2010 and its president Dilma Rousseff who used a different metaphor to condemn a “tsunami of cheap money” two years later.

STORM WARNINGS

The start of this year has seen renewed anger at the quantitative easing (QE) programmes announced by the US, UK and most recently Japanese governments. Overt statements by Japanese prime minister Shinzo Abe over the need for a cheaper yen created a firestorm that forced the G20 group of nations – which includes Brazil and Mexico – to take steps to attempt to calm the waters. In their joint statement their finance ministers said: “We will not target our exchange rates for competitive purposes. We will resist all forms of protectionism and keep our markets open.”

Neil Mellor, currency strategist at BNY Mellon, dismisses the idea that thisrepresented a unified view as an “insult to the intelligence”, adding that tensions were brewing in emerging markets such as Latin America. “This new battle is largely concentrated on the majors, but there is potential for overspill onto emerging markets,” he says.

The Mexican, Chilean, Colombian and Peruvian currencies all appreciated against the US dollar last year, and some countries have started to take action to protect their export economies. Jan Randolph, director of sovereign risk analysis at IHS, says currency appreciation pumps up stock and debt markets and makes controlling inflation more difficult. “It also puts unacceptable upward pressure on emerging market currencies, making exporting more difficult and leading to lower growth.”

Manoj Pradhan, global economist at Morgan Stanley, says that while the world’s eyes are on Japan and the other rich nations, there are signs that Latin American countries are responding. He points to Colombia’s recent rate cut as likely influenced by the peso’s strength, while concerns about the currency war were also probably a factor in the U-turn by Mexico’s bank towards a dovish stance from a hawkish one between October and January.

Mexican central bank governor Agustín Carstens used his speech at the G20 meeting to warn “a perfect storm might be forming” as large capital flows to emerging economies fuelled credit and asset price bubbles that could burst, once rich countries finally moved to withdraw their stimulus measures.

According to EPFR Global Latin America equity funds took in fresh money in each of the first four weeks of the year. The easing of tensions over the US fiscal cliff, the containment of euro break-up risks and a soft landing in China have all fuelled risk appetite. Even Chile, which has proved to be one of the more stable Latin American economies, is discussing structural reforms to address the strength of its currency, which Felipe Larrain, Chile’s finance minister, has blamed on quantitative easing policies, which he has called the “new forms of trade protectionism”.

Policymakers will be determined to ensure that their attempts to secure sustainable economic recoveries are not fouled by currency manipulation. “Latin America will be participating in trying to contain the currency appreciation pressure that’s going to be generated this year by QE policies,” Larrain says. “Even though we may not hear more talk about currency wars, that does not mean Latin America policymakers are going to sit tight and do nothing about the currency appreciation pressures they will most likely continue to face.”


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