The waiting game

By Geoff Spiteri, BNY Mellon IM EMEA

Latin America’s leading economies are facing serious headwinds but with a raft of upcoming elections in the second half of the year there may be scope for optimism say Insight’s Colm McDonagh (head of emerging markets fixed income) and Rodica Glavan (emerging market fixed income portfolio manager).

The Waiting Game

Latin America is in the throes of a prolonged fall from grace. After growth rates averaging above 5% for the first decade of the new millennium, a maelstrom of falling commodity prices and a slowdown in demand from China means forecasters are predicting neutral growth through 2015.

For the region’s commodity-focused economies the impact of a plummeting oil price has been especially devastating (See Figure 1 below). Oil accounts for more than 50% of Colombia’s exports; OPEC-member Venezuela, meanwhile, loses about US$700m in revenue for every dollar drop in the oil price.1

But political missteps and economic mismanagement have also been at play. In Brazil, the former poster child for growth in the BRICs, Dilma Rousseff’s second term as president got off to the worst possible start with a £2.5bn kickback scandal at state-controlled oil company Petrobras. In March, the country barely managed to cling onto its investment grade debt rating, with Standard & Poor’s citing “larger-than-expected fiscal slippage” in 2014 as well as the spill over from the Petrobras scandal as reasons to be fearful.

Meanwhile, rival ratings agency Fitch says approximately 18% of Latin American credits are on negative watch, principally concentrated in Brazilian corporates and financial institutions.2

From Colombia in the north, to Argentina in the south, it seems, the region’s economies are beset with political, macro and fiscal challenges.

Figure 1: Share of commodities in total exports, 2010-12 average

Chart 1 Exports

So far so gloomy but for Insight’s emerging market debt managers Colm McDonagh and Rodica Glavan the negative headlines obscure a wider truth. Latin America is a huge region with diverse political and economic systems. Scrape beneath the surface, they say, and there is scope for optimism.

In McDonagh’s words: “The region runs the gamut of countries that – at one end of the spectrum – are very well run, to countries that have made multiple mistakes. In that sense it’s a microcosm of emerging markets and it highlights the need to take a discriminating approach to investing. Our view is even countries that generate bad headlines can still present opportunity if you look hard and carefully enough.”

Colombia is one example. Hit by last year’s plunging oil price, the economy looks set to lose momentum over the next few years, according to the International Monetary Fund (IMF), with GDP growth forecasts falling from 4.6% in 2014 to 3.4% in 2015 and 3.7% for 2016. Slower exports have also affected the current account deficit, which is expected to grow well above historic levels to 4.9% in 2015.3 A civil war that has rumbled on for more than 50 years seems no closer to resolution even after recent peace overtures.

Nonetheless, says Glavan, Colombia’s prudent fiscal policy at the height of the commodities boom means it can face its current macroeconomic headwinds with a degree of equanimity. She explains: “Despite being among the hardest hit countries in Latin America by the fall in the oil price, Colombia is still better placed than many of its peers. During the commodities boom it didn’t squander the windfall of high oil prices, which means it now has more leeway than its peers to adopt counter cyclical measures.”

Meanwhile, the country remains the fourth largest recipient of foreign direct investment in the region and is likely to remain an attractive destination for capital inflows, according to the World Bank.

Figure 2: LatAm GDP growth

Chart 2 IMF

Not so bad at all?

Other areas offer similar scope for optimism. In Brazil, years of economic mismanagement have culminated in a sharp slowdown in GDP growth as well as persistent inflation. Faced with the second lowest approval rating ever recorded for a Brazilian president and the prospect of a total loss of investor confidence, Rousseff kicked off her second term in office by abruptly switching tack to a more orthodox economic approach.

In a move that garnered the approval of ratings agencies, she appointed Chicago-trained banker Joaquim Levy as finance minister while hinting at tax rises and budget cuts. Standard & Poor’s response was positive. It noted the new stance should "gradually restore lost policy credibility and pave the way for stronger growth prospects next year".

Observes Glavan: “The change of direction will be painful for Brazil in the short-term. This is always the case when you combine fiscal tightening with a central bank that has hiked interest rates to combat inflation. But over the long term we believe it represents an inflection point. It means the economy is on a far more sustainable growth path.”

The winds of political change are blowing elsewhere on the continent too. In Argentina, burdened with high government debt and an overvalued currency, an October election could indicate a new start since all potential candidates are seen as more market-friendly than current president Cristina Fernandez. In Venezuela, likewise, a mid-term election in September could be a bellwether of popular discontent over Nicolás Maduro’s presidency, especially given inflation above 60% and an economy forecast to shrink 7% this year.4 Midterms in Mexico in July and in Colombia in October could herald similar clues as to the future direction of these important regional economies.

Infrastructure spending on the continent is a further potential bright spot. The widening of the Panama Canal is one mega project that should benefit trade for the whole region, says Glavan. In the short term, likewise, the development of infrastructure associated with Brazil’s hosting of the Olympics is on track and could provide an economic shot in the arm should the games go well, she says.

Perhaps, then, disappointed investors in Latin America are only experiencing the darkness before the dawn. Overall, the World Bank forecasts 2.6% average regional growth for Latin America over 2015-17. This is a far cry from the heady days of the commodities boom of 2004-2008, says McDonagh, but represents an interesting entry point for those with the stamina to play a waiting game.

1. Reuters: Latin America 2015 outlook darkens as commodities sink, 15 January 2015
2. Fitch Ratings: LatAm Risks Skew Towards the Downside, 4 May 2015
3. World Bank, Global Economic Prospects, January 2015.
4. IMF, April 2015