Latin America’s current situation is one of the best in the entire international environment, and the region is taking advantage of this by enjoying strong economic growth, an influx of foreign capital, and rising stock market prices. Experts say that some of the key factors moving the region forward are low interest rates in international markets, rising prices for its raw materials, and the lower risk premium for Latin American economies. Overall, during the past two years, conditions have been very profitable for investors. Will 2006 also bring good results?
According to Hugo Macías Cardona, coordinator of the CIECA research center at the University of Medellín (Colombia) that belongs to the Econolatin Network, Latin American countries have benefited from four global factors: Excess spending, international liquidity, the terms of trade (higher prices for its primary products), and higher global demand (especially in Asia). All of these factors have brought funds into the region through investments, credits, and higher-priced exports. The variable that gives a “general idea of economic performance at an aggregate level is the GDP, which is now at a healthy level of 5%,” he says. “Some countries are growing even faster than that, but in reality, this performance does not reflect the fact that economic conditions are very good. It shows that the region is emerging from a very serious crisis, during which there was negative growth for several years in [countries like] Argentina and Venezuela.
The rising prices of its primary products have injected enormous amounts of foreign exchange into Latin American economies. Take Chile, for example, where copper is the main export. Each time the average annual price of copper rises one cent [U.S.], it adds more than $40 million to the Chilean treasury and some $72 million in the country’s balance of payments. Nicholas Morse, director of Latin American variable income at Schroders, the U.K.-based investment bank, is positive about the economic prospects for the region in general, and Chile, in particular. “At the moment, Chile benefits from the large surplus that separates [the value of] its copper exports from its oil imports. As with Brazil, a key factor will be how the Chilean government responds to any future decline in its revenue stream from that metal. It is likely the government will promulgate a law that officially calls for a budget surplus of 1% of the GDP in the immediate future.”
The Most Profitable International Area
International fund managers have discovered that Latin America is the most profitable region in investments, whether it’s for three months or three years. Stock market funds that invested in Latin America have risen to the top in all the profitability rankings released by Standard & Poor’s and Morningstar. Over the last year, investment funds pegged to gold stocks, and share prices from China, India and Turkey, were at the top of the global roll of honor. Now Brazil, Chile and Argentina are outperforming other emerging countries. “Global investors are being attracted to the strong results for variable income [funds] in Latin America, invested in those companies that are better managed and more responsive to their shareholders,” says Morse.
One example is the São Paulo Stock Exchange. Its index, the Bovespa, has risen about 25% since January. That is an attractive net return, but the result is even more exciting if one considers the impact of foreign exchange movements. The Brazilian real has risen 40% against the euro in 2005, so 1,000 euros invested in Brazilian shares is now 1,250 euros because its stock market has risen [by 25%]. On the other hand, when it is time to repatriate this investment to Europe, one has to add an additional 40%; that means the initial 1,000 euros becomes 1,750 euros — a return of 75%.
At the moment, every global investment firm that has launched an investment fund in euros and invested in Latin American stock markets is enjoying better results. In just one month, the HSBC GIF Brasil Equity fund rose 14%, the equivalent of a 40% return over three months. It is the best short-term fund. In the medium and long term, the results are much more spectacular. For example, the Merrill Lynch Latin America Equity fund (the most profitable three-year fund) has risen 241% since 2003. It is followed very closely by a similar product from JPMorgan, which has earned 229%. The 10 most profitable three-year funds on the stock market are investing in Latin America.
Pablo Rión, Mexican analyst at Pablo Rión and Associates, provides a quick sketch of the largest Latin markets. “In Mexico, the stabilizing factor is that inflation is at a low level, and interest rates are also down. Foreign investment is open, the country belongs to NAFTA, and it supports the FTAA (Free Trade Area of the Americas.) In South America, commodity prices are helping. All of the countries that have controlled inflation and are open to foreign investment (such as Chile, Peru and Colombia) are growing. Argentina continues to have problems because President Kirchner gives no clear sign of any plans to open the country. Argentina will lag behind because it wants to stay with a closed Mercosur model, involving Brazil,” he explains.
In Rión’s opinion, Mexico showed no signs of an economic slowdown during the third quarter. Economic growth through the first half of 2006 will be similar to that in 2005. “Foreign investment in Mexico will be about $18 billion in 2005, whereas it was typically $12 billion. This reflects the stability of the Mexican economy, which is attracting foreign investment. There are no signs of a slowdown in Mexico; apparently the third quarter through the first half of 2006 will show similar growth to that of 2005 — an annual rate of between 3% and 3.5%. The Mexican stock exchange continues to be strong.”
Taking Care of Debt and Interest Rates
Low interest rates in international capital markets and growing internal demand are driving emerging economies such as Latin America. The region had been hit hard earlier in the decade by its high rate of indebtedness and the high premiums it needed to pay to build confidence from foreign investors in its economies. However, some things never change. The debt is still there. Although governments have adopted more responsible fiscal policies and attempted to make their economies less vulnerable, the debt — which has ignited all of the regions’ foreign exchange crises over the past 20 years — has barely been reduced.
Theotonio Dos Santos, economics professor at the Federal Fluminense University in Brazil, reviews the key factors: “The latest report of ECLA (the Economic Commission for Latin America) points out something that is very critical in the current situation — the increase in prices for raw materials, the primary products that the region exports. This condition is influenced by increased demand from Asia, especially China,” he says, adding that trade surpluses are being generated that enable the region to lighten the foreign exchange burden.
Another important aspect for Dos Santos is the regional integration process, which has helped to increase exports of [Latin American] manufactured products. In addition, he says, “It is clear that the way U.S. interest rates fell from 6.5% in 2002 to 1% last year — even if it is neutralized by the current climb up to 4% — still suggests that interest rates will be low, which will make it easier to reduce the debt burden. Nevertheless, the upward movement of global interest rates could increase the pressure on Latin American economies in coming months.”
Risks on the Horizon in 2006
As a result, experts warn that there is a high Latin American currency risk. They cite recent upward movements against the dollar and the euro that could bring excessive investor euphoria into the market. According to Macías Cardona of the University of Medellín, “short-term funds have entered the region, taking advantage of the capital markets, and they are focused basically on speculation, as you can see from the high growth rate in the stock market indices. Note that a significant growth in demand for financial assets led to a speculative rise in prices. That’s because these are liquid markets that investors can leave whenever returns are higher in another market, or when the optimistic expectations about the local market change.”
In 2004, Latin America reached an average growth rate of 5.8%; forecasts point towards growth of 4.1% in 2005 and 3.9% in 2006, according to Consensus Forecast. All the forecasts were pointing toward a slowdown in 2005 and 2006, because it would be hard to repeat all the factors that led to the expansion of 2004 (high prices for raw materials, low interest rates, and strong global economic growth). Nevertheless, the stock markets continue to assume that the investment environment will be profitable.
Macías Cardona spells out the risks and challenges for 2006: “The most serious short-term threat in most countries is the process of deindustrialization. Nevertheless, there are other threats, such as rising interest rates in the United States, the quite likely decline of commodity prices, and the instability caused by the elections that will take place in 12 countries in the region next year. Rising interest rates in the U.S. will bring some money back to the U.S., and reduce the appetite for taking risks in Latin America. Lower growth in developed countries will cause commodity prices to drop, and the elections [in Latin America] will generate some uncertainty,” he concludes.
The Two Sides of Petroleum: Venezuelaand Ecuador
Just as in 2005, Venezuela will enjoy the greatest economic growth in Latin America, supported by a strong inflow of foreign exchange from petroleum. In 2005, the Venezuelan GDP grew by about 8.3%, while the country’s growth is projected to drop to 5.6% in 2006. Macías Cardona summarizes the current condition: “Venezuela is undergoing a slowdown in its recent expansionary economic cycle, which was sustained by high petroleum prices and the recovery of domestic demand through public spending programs. Since 2003, trade with Colombia is proceeding under very good conditions, after having recovered from a deep crisis two years ago. In Ecuador, after several years of ‘dollarization’, they have managed to control price rises.”
Compared with Venezuela, Ecuador represents a very different sort of economy exposed to petroleum, says Macías Cardona. At a time when prices are at their peak, Ecuador has been unable to take advantage of that situation. “Dollarizing the economy is an extreme strategy that you must only adopt when the central bank is openly declared to be incompetent to manage local exchange policy; it means renouncing the possibility of making monetary decisions inside your country. Dollarization is the ultimate strategy for controlling the hyper-inflation process.”
Ecuador’s GDP could grow by 3% in 2005 and by 3.1% in 2006, which would be the poorest growth figures in the region today, despite enormous flow of revenues from petroleum exports. “Although Ecuador’s economy was dollarized for several years, its inflation rate remained high. Inflation is now under control, but growth is not responding positively. Its growth is the lowest and poorest in the region, and it is sustained only by the high price of petroleum. As in Venezuela, people expect that public spending in 2006 will lead to higher growth in domestic demand,” notes Macías Cardona.