Latin America: Crisis or Opportunity?
It has been a little more than 10 years since the Great Financial Crisis. Since then, the world has been recovering gradually and although some economies have reached one of their largest expansive cycles in their history by duration, such as the United States, other economies have experienced at least a contraction or recession in this period.
Latin America is a great example because there are rumors that the region is approaching a second lost decade, similar to the one experienced in the 80’s, when the region suffered from unpayable external debts, large fiscal deficits, high inflation, and exchange rate shocks.
It is not a secret that the region is not going through its best moment. Since 2012, economic growth has not exceeded 4%, a level that would boost the countries with the lowest incomes in the region. In 2016, the region faced a severe oil crisis. The black gold dropped to about $ 25 per barrel, causing different countries in the region to fall into recession. The oil crisis, together with some other events, such as the crisis in Venezuela, Latin America’s real GDP growth over the last five years was shy of 0.6% on average, a very low figure given its need for economic growth. It is true that the economic output is not synonymous with greater well-being – because it can hide great inequalities in countries – but it is clearly a very important variable to measure economic development.
In addition to the volatility of commodity prices, the US Dollar plays an important role in Latin America. It has been very strong recently, partly because of rising interest initiated by the Federal Reserve in 2015 on the grounds of solid economic growth in the US, especially compared to the rest of the world.
Likewise, the recent trade war has been an additional tailwind for the greenback. Emerging market currencies tend to depreciate to offset trade tariffs, and also suffer more in times of political uncertainties. If we look at the Chinese Yuan, it has fallen about 3% since President Trump announced that he plans to increase China’s tariffs up to 25% from June 2019. Trade uncertainties have also affected Latin American currencies. Depreciating currencies uncover the region’s need to further improve the governments’ fiscal balances and to reduce the private sector’s foreign currency indebtedness, as foreign currency debt increases as domestic currencies depreciate.
Consequently, growth has not really picked up recently. We are still waiting for an inflection point. In fact, the three largest economies in the region – Brazil, Mexico, and Argentina – that represent approximately two-thirds of the regional output, contracted in the first quarter of 2019. Nothing encouraging.
Brazil, the largest economy in Latin America, contracted 0.2% in the first quarter of 2019, compared to the 0.1% growth seen in the last quarter of 2018. The contraction was not a real surprise. In fact, the Brazilian central bank, as well as the consensus of economists predicted a similar figure, due to well analyzed temporary headwinds, such as the tragic collapse of the Brumadinho dam. Therefore, the economic contraction leaves a bitter taste, but did no really affect financial markets. The most important success factor for Latin America’s giant is the approval of the urgently needed pension reform, which we hopefully get in the next two months. The future of the Brazilian economy depends heavily on this reform. The pension system is completely unsustainable. Pensions devour 58% of the nation’s budget, three times the amount invested in health and education.
Moving to Mexico, the contraction was of the same magnitude, 0.2%, which is the first drop since the second quarter of 2018. Economics still expect the economy to grow 1% in 2019. It is important to remember that Mexican assets have been relatively resilient this year, especially the currency. But the recently threatened 5% export tariffs by Donald Trump, the credit rating downgrades by major credit agencies, the difficult situation of Pemex, and domestic political uncertainties are important downside risks.
Argentina contracted 6.8% in March, the eleventh consecutive year-on-year monthly drop, representing the longest contraction period since 2012. However, the support of the International Monetary Fund and the ongoing reform process initiated by President Mauricio Macri seem to be on the right track. The imminent risk is the presidential elections in October 2019.
But not everything is negative, the Andean economies have presented a positive behavior, especially Colombia, which grew 2.8% during the first quarter. According to the IMF, the fourth largest economy in the region will grow 3.6% thanks to accommodative economic policies, Venezuelan migration, spending on infrastructures and higher spending by the corporate sector.
Overall, is the current situation in Latin America really critical? No. The current scenario has some similarities to that period called the lost decade, such as low growth and a challenging external environment. But the difference is that nowadays, there is a greater confidence due to the monetary discipline of central banks, the willingness to correct fiscal shortcomings, and less budget imbalances. This reduces the risk of a deep crisis and massive defaults in the region.
There are a lot of headwinds for Latin America, but there is also hope for recovery given structural reforms, low inflation levels, and a relatively low starting point. Most asset classes in Latin America offer attractive valuations. However, the tipping point does not seem to be close at least until global trade issues get resolved.