6 September 2010 |
The smaller countries in Latin America outpace Brazil in the GDP growth race and - buoyed by domestic demand - strengthen, stabilise and diversify. Rodrigo Amaral investigates this trend and why the region should appeal to investors.
In the past three years, Latin America has gained a foothold in the portfolios of global investors, as the region's healthy economic numbers provide a strong contrast with the lacklustre performance of the developed world. But, for many people, investing in Latin America means an infatuation with Brazil, the largest country in the region. Opportunities, however, can be found well beyond São Paulo and Rio de Janeiro.
Despite performing well, Brazil is unlikely to be the fastest growing country in Latin America this year. According to analysts, Peru and Argentina are set to beat the Brazilians in the GDP growth race. The performance of Latin American countries, especially in South America, has baffled economists. Improvements in economic policy, including extreme fiscal discipline and some opening up to the outside world, have been well-documented.
"The main economies of Latin America are experiencing greater-than-expected acceleration of their growth"
But when the world was on the brink of financial and economic meltdown, no one expected Colombia and Peru to emerge almost unscathed. After all, economies that rely heavily on commodities exports tend to be hard hit by economic slowdowns. And common sense has always decreed that, when America sneezed, Latin America caught a cold. In the past three years, elements have been in place for the region to require another round of bitter economic medicine.
Instead, economists have been busy upgrading their forecasts. "The main economies of Latin America are experiencing greater-than-expected acceleration of their growth," according to BBVA, a Spanish bank with a strong presence in the region, in a research note. "Domestic demand is the key driver of recovery, boosted by a return of confidence, fiscal and monetary policies that continue to be expansive and sustained by high commodity prices." This is one reason why so many people have failed to spot the trend.
Many international analysts still see Latin America as a commodity exporting region, but in the best performing countries it is domestic consumption that has taken responsibility for pushing the economy forward. Millions of Peruvians, Colombians and Argentinians have moved upward in the income pyramid in the past decade. They have money in their pockets, and, more importantly, more access to credit than ever. As a result, they are spending, to the benefit of the whole economy. (article continues below)
In addition, China has largely filled the gap left by lagging rich world economies, as it buys ever more commodities from Latin America. Bilateral trade between the two has grown by up to 30% a year in the past decade, and should still increase by about 15% a year until 2020, according to the United Nations' Economic Commission on Latin America and the Caribbean (Eclac). Trade with China has helped to fill the coffers of governments, which, for a change, have decided to build up reserves rather than waste their commodity money. In a good fiscal position, governments were then able to mitigate the effects of the external slowdown by making investments that kept domestic consumption alive. All in all, for Latin Americans at least, it has been a propitious time to face a global crisis.
"What we have observed in these two episodes of adverse external shocks (Lehman Brothers and Greek crises) represents a dramatic break from the past in the region," notes BBVA in its report. "The normal state of affairs would have been that shocks of this type would be amplified by fiscal and exchange rate turmoil in these countries, which would have led to painful fiscal adjustments, devaluations and inflation, with a prolonged period of recession and stagnation and dramatic deteriorations in employment." Latin Americans are familiar with such scenarios.
But this time the painful adjustments of the 1990s have paid off. "Our perspective is that Latin America is entering a period of sustained growth, at a rhythm approaching its potential, which will allow it to reduce income disparities with developed countries," says BBVA. The bank points out that, in a development that was unthinkable a few years ago, collateralised debt obligations for countries such as Colombia, Mexico and Peru have fallen lower than those of euro economies like Italy and Spain. Investor confidence has also been boosted by the awarding of investment grade by credit rating agencies to Peru, Panama and others.
This new economic dynamism creates investment opportunities in Spanish-speaking America. Governments are eager to attract foreign investment to boost their stillflagging infrastructures. Large Latin American companies have been nursing expansion plans abroad to benefit from their sweet economic moment. Both public and private entities are issuing bonds in the international markets at rates rarely, if ever, seen before. Of course, Spanish America is a large and heterogeneous region, and some areas, such as Venezuela and Bolivia, with their left-wing leaders, remain a no-go area for investors.
However, Peru, an economic backwater in the 20th century, posted average rates of economic growth of 6.8% a year between 2002 and 2008. The economy faltered a little in 2009, as demand for its various mining commodities receded, but it still managed to increase its GDP by 0.9%. This year, Peru is flying high again. In July Eclac forecasted that the country would grow by 6.9% this year, but this has proved to be a bearish expectation. Standard & Poor's has raised its own forecast to 7.5%, while JP Morgan has mentioned 8%.
The growing optimism is based on a first half-year that surpassed all expectations. In June, GDP had expanded by 11.9% on a year-on-year basis, according to the Peruvian government.
Peru's remarkable performance has been driven by exports, boosted by demand from China. Ten years ago, trade with China had little relevance to Peru, says Eduardo Moron, an economist at the University del Pacifico, a Lima-based university. But it accounts for about 20% of the country's exports, he says.
"Peru has implemented a very attractive investment framework for mining companies, making sure that they wouldn't face tax surprises"
Moron argues, however, that the impressive growth has not made Peru completely dependent on the buoyancy of the Asian giant. "An important advantage is that China, the United States, the European Union and Latin America answer for roughly similar shares of our exports," he says. "At the same time, Peru doesn't rely on a single commodity, but we export a diversified basket of products." These include gold, copper, petroleum and zinc, as well as agricultural products like fishmeal and coffee.
Peru's total exports, which amounted to only $7 billion (£4.5 billion) in 2000, reached $32 billion in 2008, and after a little blip last year, should bounce back to $34 billion in 2010 and $54 billion in 2014, according to the Economist Intelligence Unit (EIU). Recently signed trade agreements with China and the European Union are set to keep the good news coming, and hard currency has also been arriving by the bucketful in the form of foreign direct investment (FDI). That has been largely thanks to improvements in the business climate, especially for the all-important mining sector. "Peru has implemented a very attractive investment framework for mining companies, making sure that they wouldn't face tax surprises and changes of the rules of the game," says Moron.
The money earned through trade has
trickled down to the economy, and domestic demand has recovered quickly from the impact of the global crisis. In the first half of the year, construction and manufacturing have been the main drivers of Peru's strong economic performance, according to INE, the national statistics office. Retailers and banks are also doing well, as purchasing power has increased by up to 70% in 10 years in the wealthiest parts of the country, says Moron. And, after having pumped up the economy with public investments in transport, communications and other areas last year, the Peruvian government wants to attract more foreign capital to carry on improving the country's still insufficient infrastructure.
A business climate survey by Fundação Getúlio Vargas, a Brazilian business school, and Ifo, a German research institute, found that Peru enjoys the most positive assessment among analysts of Latin American economies. The recovery has got into such a high gear that the Peruvian central bank has shown fears of overheating by raising interest rates twice already this year. The Peruvian currency, nuevo sol, has also gained value against the dollar, which some people fear could represent a risk by fuelling inflation pressures. Some analysts have also expressed fears about next year's presidential elections.
Peruvians have shown an anti-incumbent trait even in the midst of a booming economy that could lift the prospects of a radical nationalist candidate similar to Venezuela's Hugo Chávez. Such an eventuality would frighten investors. However, Moron argues the risk of any government reversing the gains of the past decade or so are much smaller than they used to be.
Peru is the most serious contender for the title of fastest growing Latin American economy in 2010. But it already endures a government that is viewed dimly by international investors.
Many countries have confounded international economists, particularly Argentina. Despite being led by a populist president and remaining on the blacklist of global financial markets, the country is set to grow by up to 10% this year, according to the most bullish analysts. Upward revisions of Argentina's growth forecasts have been dramatic. JP Morgan, for instance, has revised its 2010 forecast from 4.6% to 9.7%.
A JP Morgan analyst described Argentina's economy as "scorching". That is not bad for a country that has been cut out of international debt markets since its latest default, in 2001. A recently brokered bond swap deal could help change this situation, but it will take some time before markets recover their trust in a country that looks keen on not paying debts for political reasons, rather than financial constraints. In the past few years, President Cristina Fernández de Kirchner has done her best to keep investors worried. She has nationalised pension funds, manipulated national statistics, restricted exports of meat and picked fights with farmers and the media. But the government has boasted that it does not need to tap international markets anyway, because its finances are sound.
Argentina's change of fortune is the result of geographic luck, as its close trade links with Brazil, consolidated in the once much-derided Mercosur agreement, have paid off. With its giant neighbour growing rapidly, Argentina's exports have doubled in the five years to 2008, reaching $70 billion. In 2009 they inevitably receded, but volumes are expected to get back to pre-crisis levels between this year and the next. In 2009, exports could bring $109 billion a year to the economy, according to the EIU. The Brazilian media have celebrated that, with Brazil accounting for over half of Argentinian exports, the compatriots of Diego Maradona have become more dependent than ever on the country of Pelé.
But, if the numbers remain good, it is unlikely that Argentinians will complain much about that. Leonardo Chialva, a partner at Delphos Investments, a Buenos Aires-based investment banking and asset management firm, points out that the Brazilian recovery helped to boost exports of Argentina's cars, which for their part fuelled the recovery throughout the industrial sector via a large supply chain network. High commodity prices and favourable weather conditions gave a new life to the country's important agricultural sector, and lately domestic demand has been recovering too, especially in construction and private consumption, which has benefited from a credit boom. For him, conditions are set for the country to carry on enjoying the healthy growth. "The private sector is little indebted," Chialva says. "The workforce has higher levels of education than in other Latin American countries and the public sector faces no solvency problems either."
Chialva argues that, if investors can overcome their understandable reticence against Argentina's politicians, they could find interesting opportunities in the country. "The Argentinian government has generated an institutional noise that reverberates through the economy. We in Argentina are used to this kind of thing, but investors get frightened," he says. But he says that, thanks to the lack of confidence of investors, Argentina has become an inexpensive market. "Equities are really cheap compared to other emerging markets," he says. "Argentina's four listed banks combined are worth less than a single Peruvian bank, and, due to regulatory controversies, the energy sector is cheap too."
"Argentina's four listed banks combined are worth less than a single Peruvian bank"
Overcoming doubts about Argentina's institutional stability could take some effort though. For instance, analysts have criticised the government for boosting public spending in times of accelerated economic growth. Less daring investors could therefore be in a more comfortable zone by reverting to Chile, the region's most stable economy, which has also benefited from the high prices of commodities thanks to its large copper reserves. "Chile is a first world country, and there is a lot of coherence in the policies adopted by its government," says Alberto Bernal, an analyst at Bulltick Capital Markets, a Miami-based asset manager with a focus on Latin America.
Chile was quickly recovering from a difficult 2009 when it was hit by a horrific earthquake in February, which has affected production in several parts of the country. But it is testament to the organisation and stability of the country that Bulltick has decided not to change its 5% growth forecast for 2010 after the tragedy. If anything, says Bernal, reconstruction works that have been taking place since the earthquake are likely to give an extra boost to the economy. Chilean companies want to expand abroad. LAN, the Chilean flagship airline, created the largest air company in the region by absorbing Brazil's TAM. In addition to construction and mining firms, retailers have also fared well as more widely accessible credit has boosted Chileans' ability to consume.
"Chile has been able to diversify their economy away from copper, and manufacturing and services are strong sectors in the country too," says Bernal. Chile's status as a developed country has been certified by the Organisation for Economic Cooperation and Development (OECD), which accepted the country as a member earlier this year. And its capital markets have been boosted by the intense investment activity of Chile's pension funds, which have been spreading their large portfolios into equities, infrastructure and foreign investments. But unlike Argentina, Chile's assets are not as undervalued.
Investors who would like to benefit from a development similar to Chile's, can look north to Colombia, which is at an early stage in the process. "Colombia has an important mining sector, but they are sufficiently diversified in terms of manufacturing and services. It has been a very similar story to Chile," says Bernal. Better yet, in his view, is that successive Colombian governments have been applying sensible policies to boost economic growth. "The policies that have been implemented in Colombia have been common-sensical," Bernal says. "Despite the fact that it remains a very violent country, the policies adopted by the government should help it grow." GDP has grown readily in Colombia, and should reach between 4.5% and 5% by the end of the year.
But Colombia is relatively small compared with some of its neighbours. "Chile, Peru and Colombia haven't had as much attention from international investors because their populations are not as large as Brazil's," says Jimena Zuñiga, a Latin American analyst at Barclays Capital in New York. A similar point can be made about their capital markets, which remain puny by global standards. In a quest to make the domestic markets more attractive to Latin American investors, the stock exchanges of Bogotá, Lima and Santiago are merging to create a single trading platform and offer a wider range of investment choices. The unified exchange is expected to be ready by the end of 2011.
"Chile is a first world country, and there is a lot of coherence in the policies adopted by its government"
Mexico boasts Latin America's second largest economy and population. It represents a different proposition for investors, as it is less reliant on commodities markets. On the other hand, the luck of the country is closely related to that of America, which absorbs about 80% of Mexican exports. That is why, after a bright first half of the year, Mexican economists have been cautious about the country's prospects. "Economic growth was good in the first six months of 2010, but the story could be much different in the rest of the year," says Ricardo Aguilar, an analyst at Invex, a Mexico-based brokerage.
Even then, growth forecasts for Mexico remain good compared with those of America and Europe. Zuñiga predicts GDP will expand by 5% this year, boosted by exports recovery and a resurgence of domestic demand. But, as other Latin Americans, Mexicans still have a long to-do list before they can have some guarantee that economic growth is sustainable in the long run.
Zuñiga says that Mexico needs to reform its labour market, competition laws, energy sector, education and other areas if it wants to become less dependent on America. Something in such areas has already been done, but the toughest part remains around the corner. "The process of economic diversification tends to be slow," she says. "The share of exports to the United States has dropped from 85% to 80%, but that still is very high."
For all the good news coming from Latin America, there are plenty of challenges waiting for its leaders to tackle. With the exception of Chile, most Latin American countries are difficult to do business with. Colombians suffer from a persistent high unemployment level and an uncompetitive labour market that successive governments have hesitated to reform thoroughly. Peru still has high levels of poverty and has to deal with ethnic conflicts that can present risks to economic development. In Argentina, it would be much appreciated if politicians stopped messing about, and even Chile has been urged to improve its legal system.
More worryingly, corruption still is a big concern among investors and companies. In addition, higher levels of wealth have not prevented increased violence, even in previous havens of tranquility such as Buenos Aires. Mexico is waging a war against drug cartels that has turned parts of the country into some of the most dangerous places on the planet.
In short, Spanish America still is a work in progress. But, more than ever, it looks like a region that should befollowed closely.
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