Domestic Dynamics: Why Latin America's 'New Resilience' Will Keep Growth in ReachPublished: January 06, 2010 in Knowledge@Wharton
Besides hailing from the same region, what do Brazil, Panama and Colombia have in common? When it comes to the economic recovery, these countries -- along with Chile, Uruguay and Peru -- have become the stars of Latin America. Each of them has stood up to the crisis with what the Organisation for Economic Co-operation and Development (OECD) calls a "new resilience," paving the way for counter-cyclical policies without impairing fundamentals. According to the OECD's "2010 Latin American Economic Outlook," inflation-targeting in these countries has been particularly effective in building confidence-enhancing institutional strength.
In contrast, the recession and the fall in commodity prices in the early part of 2009 exposed weaknesses in a group of countries with leftist-leaning governments -- namely, Argentina, Venezuela and Ecuador. Each of them has pursued unorthodox economic policies and suffered from institutional frailties. Yet those hardest hit by the downturn in Latin America have been the countries with the closest ties to the U.S., namely Mexico and many of its neighbors to the south in Central America and the Caribbean. Not only is the U.S. their key market for goods and services; weaker remittances sent by immigrants working in America have also had a damaging effect.
Where does that leave the region as a whole? After contracting around 2% in 2009, it is expected to grow 4% in 2010 -- that is, stronger than developed markets but weaker than Asia, according to the U.N.'s Economic Commission for Latin America and the Caribbean. Although that doesn't come close to the 5% levels of the previous four years, there's plenty of reason for optimism.
'Very Positive Terms'
Many observers see upside risks to economic growth this year stemming from favorable global conditions predicted for 2010 (with downside risks building again in 2011, given the possibility of a double-dip recession or soft patch). Demand and prices for the region's commodities will be supported by China's 8% to 9% growth, and other exports will rebound, thanks to firmer demand in developed countries resulting from stimulus measures.
After falling by around a quarter in 2009, trade will pick up, growing 10% to 15%, according to Bladex, a supranational bank specializing in foreign trade in the region. Global liquidity will be abundant as policy makers in developed countries slowly begin to enter the "exit strategy" phase of highly accommodative monetary policies. According to analysts, this will facilitate Latin American sovereign and corporate financing, although some weaker credits will continue to face restricted access.
While acknowledging the persistence of structural constraints and high poverty rates, Wharton management professor Mauro Guillen views the economic and business outlook for 2010 for most of the region's countries in "very positive terms." Other experts agree. Felipe Monteiro, also a professor of management at Wharton, is "optimistic" about prospects in Brazil (which accounts for 40% of the region's GDP), noting that the rest of the region will be looking to that country to be a "growth driver" for their own economies.
Locals are equally bullish. A recent survey of 573 Brazilian companies by consulting firm Deloitte found that 95% of the respondents expect higher profits than in 2009, and around two-thirds plan to roll out new products and services in 2010. Meanwhile, 41% are considering acquisitions, up from 13% in 2009.
'Night and Day' Difference
Compared with a generation ago, the operating environment for companies in the region today is like "night and day," says Guillen, citing, among other things, more stable policy regimes, greater macroeconomic stability and less protectionism.
According to a report by Banco Santander's equity research team, Latin American companies are in "very good shape to deliver the earnings recovery and resume their investment plans" in 2010, and the region's companies are "shifting into high gear." A case in point: Petroleo Brasileiro (Petrobas), Brazil's state-controlled oil producer, plans to expand its $174 billion, five-year investment program ending in 2013. As it develops new offshore fields, it is also considering expanding investments in a range of areas, according to CEO José Sergio Gabrielli, including oil exploration, production and refining, as well as fertilizer output and electricity projects.
As for sectors to watch, energy is set to be one of the year's high flyers, thanks in large part to high international prices. Guillen cites greater investments in renewable energy -- led by Brazil -- which have helped develop a world-class ethanol industry on the back of successful public-private partnerships. More generally, Guillen predicts that policies addressing climate change will influence the business environment in 2010. Indeed, following December's U.N. Climate Conference, Brazil's government enacted climate change legislation, and reduction targets for various industries and other environmental measures are being finalized.
Food is another sector that will shine in 2010. Guillen expects major Latin food companies, such as Grupo Bimbo of Mexico and Group Arcor of Argentina, to expand abroad, particularly in Asia where competition isn't as stiff as in the U.S. and Europe. Companies like Bimbo and Arcor have weathered the downturn better than others, and are now well placed to take advantage of globally high food prices, he notes.
Assuming the recovery in risk appetite holds -- which in turn depends on benign market assumptions for OECD countries and China materializing this year -- investors will seek out higher returns in faster-growing emerging markets. Latin stock markets -- after ending 2009 close to their pre-crisis record highs -- are likely to see further gains. Geoffrey Dennis, global emerging markets strategist at Citigroup, predicts Brazil's Bovespa will rise to 80,000 by the end of this year, from 68,000 currently (compared with a previous peak of 73,000 in the spring of 2008).
In from the Cold
As for the underperforming countries, there are pockets of hope. Consider Argentina, where a good harvest season and high international prices will boost the country's agriculture sector, adding more than two percentage points to its GDP directly and a similar amount indirectly (through income effects), according to Daniel Marx, Argentina's former vice minister of finance who is now managing director of Buenos Aires-based consulting firm Quantum Finanzas.
Nonetheless, policy makers in Argentina will continue to face challenges. They will try to lower the cost of capital and discourage capital flight, which was averaging $2 billion a month from mid-2008 to late 2009, but has since slowed to a trickle as jitters over debt sustainability have subsided. Amid this, the government will spend the first half of 2010 trying to resolve the $30 billion of untendered bonds piled up during the debt restructuring of 2005, according to Marx.
The good news is that current global conditions increase the chances of a successful resolution which, together with a deal with Paris Club creditors (on arrears of around $6 billion), ought to improve Argentina's access to voluntary international finance. To bolster confidence in its ability to meet its outstanding external financing needs of around $8 billion, the government wants to use close to $6 billion of central bank reserves (currently $48 billion) -- a move that is not without controversy. Even if these rehabilitation efforts succeed, analysts say it will take a more pragmatic policy framework and several more years to rebuild credibility, as Brazil has managed to do recently.
Another country that has its work cut out is Mexico, which accounts for 25% of the region's GDP. Beyond its dependence on the strength of the U.S. recovery, other factors will continue to hold it back in 2010 -- including a lack of political will to open its investment-starved state oil monopoly to the private sector and, more generally, an environment stifling private enterprise and competition.
Mexico's congress passed a tax reform in 2009 after years of delays, and although it was diluted, it was a small step in the right direction. With non-oil tax revenues of only around 12% of GDP, Mexico's structural weaknesses underscore that, apart from Chile (whose policy framework is exemplary by global standards), countries in the region lack modern, rational tax systems, according to Guillen. Prospects for improvement are poor in 2010, he adds.
But even the region's stars aren't home free. Notably, there are questions about how balanced Brazil's economic growth is and whether it poses medium-term risks. The 2010 pick-up -- market consensus forecasts hover around 5% -- will be consumption-driven, resuming the pattern in the years before Lehman's collapse in 2008. But for Brazil to hit or exceed such growth rates on a sustainable basis, the investment rate will need to rise, notes Márcio Garcia, an economics professor at the Catholic University of Rio de Janeiro (PUC-Rio). Before the crisis, it had risen to 18% of GDP (from low double digits in previous years), but it now needs to rise further, to at least 22%.
Morgan Stanley's leading Latin American strategist, Grey Newman, notes there is also an increasing risk of policy mistakes in 2010. Indeed, policy-making in Brazil will be under intense scrutiny this year. Fiscal slippage, unorthodox measures and increased state intervention in recent months have raised eyebrows and led some experts like Paulo Leme, chief Latin America economist at Goldman Sachs, to warn that Brazil's policy framework is "beginning to corrode."
There are also a number of bottlenecks that need to be addressed to lift productivity and returns on investment. According to Garcia, much still needs to be done to improve Brazil's tax and legal systems, labor markets, infrastructure and above all, education. What's more, given the country's low savings rate, Brazil will inevitably need to tap foreign savings to fund more investment in the short to medium term. But with strong investor appetite for Brazil, that should not be a problem, experts predict.
Because Brazil will run a higher current-account deficit (3% of GDP and above) and experience a stronger currency as a result, the stakes are raised, reducing policy makers' room for error and increasing the risk of stop-go cycles. "It's worrisome," says Luciano Coutinho, head of the state development bank BNDES. "A deficit too far above 1.5% of GDP is not very healthy."
On the Campaign Trail
There's something else that will be attracting a lot of attention in 2010: With no fewer than 16 presidential elections being held between November 2009 and December 2012, the region's electoral cycle will be in full swing this year. Observers will be watching to see whether the political pendulum shifts from the left to the center or center right. This seems to be the case in Chile, where Sebastian Piñera of the center-right Alianza looks set to defeat the incumbent center-left Concertación candidate in a second-round vote later this month.
Perhaps most riveting will be the September congressional elections in Venezuela. The opposition boycotted the last elections in 2005, giving the radical president, Hugo Chávez, carte blanche to advance his so-called "21st century socialist revolution." With stagflation sapping support for Chávez after more than 10 years in power, this year's elections will reveal whether the opposition can gain a foothold ahead of the December 2012 presidential election. Alternatively, some observers say that Chávez could respond to a threat to his control by removing the remaining trappings of democracy in the country.
The other presidential election already causing a stir is Brazil's. With the highly popular Luiz Inácio Lula da Silva -- president since 2002 -- not standing for another term, October's presidential election will be hotly contested. José Serra, of the PSDB, is currently leading in early polls thanks to his high public profile, and his victory would see politics move towards the center.
Pre-electoral spending to support the incumbent candidate will prevent the country's fiscal position from improving with the economic cycle. This, together with the likelihood of populist and nationalist noises during campaigning by Lula's favoured candidate, Dilma Rousseff, may well temper investors' voracious appetite for all things Brazilian. It also would underscore the risk of volatile currency and asset markets -- but a sustained overshooting is unlikely, provided the incoming government makes an adjustment, which is what most observers expect to happen.
In the midst of this election cycle, and with most Latin American policy makers still focused on supporting the economy in 2010, advances in addressing the region's long-term competitiveness -- such as structural reforms, boosting innovation and avoiding protectionism -- are likely to be piecemeal, analysts say. But at the back of many minds in 2010 will lurk concerns over what happens to global growth once the exceptional fiscal and monetary stimuli seen over the last year are withdrawn -- a development that will have a strong bearing on Latin America's outlook for 2011.