2017 was supposed to be Latin America’s comeback year, that is, until Donald Trump mucked things up. As the region struggles to lift-off after three years of decline, the US President will become a popular scapegoat across the political capitals of several countries, starting with Mexico. But not all blame lies at the feet of Mr. Trump. Latin America’s declining competitiveness is again under focus as the region comes to grips with the fact that commodity prices are not roaring back any time soon to their 2012 historical highs. That is a positive realization if it helps marshal the political capital needed to accelerate much-needed reforms in Latin America.
In 2017, the region’s reformers will be rewarded. After losing $1.1 trillion USD of GDP over the last two years, Latin American GDP (measured in USD) will grow over $500bn in 2017 and another $600bn+ in 2018. Driving close to two-thirds of net regional growth both years will be Brazil and Argentina, whose economies took a beating in recent years but are poised for comebacks thanks to the political support of pro-investment reforms. Peru, Colombia and Chile will combine for another 12-15% of regional growth as their currencies recover and more monies pour into ambitious infrastructure plans, financed mostly by private investors.
No country will be more punished by Trump than Mexico. Instead of growing at 2.5% as many predicted six months ago, 2017 may bring less than 1% growth, and in dollar terms will likely only deliver 15% of net regional growth, in spite of representing a much higher portion of Latin America’s economy. Not long ago, most analysts looked at declining U.S. unemployment, high U.S. factory utilization rates, and recent Mexican reforms as a winning combination for the Aztec nation. But under the cloud of Trump-inspired uncertainty, investors are freezing their Mexican plans…and jeopardizing growth.
Central America, which also depends upon the U.S. market to buy its manufactured goods and outsourced services, has escaped the wrath of U.S. protectionists till now. The region should therefore, for the third year running, lead hemispheric growth at close to 4%. Similarly, the Caribbean will profit from a strong U.S. dollar (and the tourism it generates) and continued low energy prices, which eat up so much of both region’s imports.
On the eve of Donald Trump’s inauguration, economic forecasters admit their numbers lack certainty. No one is really sure how the world will fare as his administration rewrites (or not) the world economic order that for six decades has relied on a free trading U.S. economic engine. Out of habit (and reader insistence), we publish our economic forecast table at the bottom of the article, but pay it little heed. Instead, we encourage you to monitor the following five trends to determine how the region’s economic prospects will evolve over the next twelve months.
Trend #1: Trump Vs. Yellen
In the U.S. Presidential campaign, candidate Donald Trump picked a fight with Federal Reserve Chair, Janet Yellen, claiming she “is very political and should be ashamed of herself” and questioning the U.S. central bank policy of low interest rates. As president, Trump will continue to demonize the Fed, but his line of criticism will change from hawkish to dove-like. With the Republicans controlling both houses, only the Federal Reserve stands in the way of Trump’s plans to fiscally lever the U.S. economy into higher growth by cutting taxes and spending more on infrastructure.The Fed’s inclination (or not) to throw cold water on what it perceives as an irresponsible fiscal fiesta will have a huge impact on Latin American economies. A hawkish Fed will strengthen the dollar and suck capital from emerging markets, hurting the region’s most heavily traded currencies (Mexican peso, Brazilian real, Colombian peso, Chilean peso), though it could also help stimulate exports in Central America, drive more tourists to the Caribbean and bolster consumption in dollarized economies, Panama and El Salvador. If Trump gets his way, and the Fed chooses not to get ahead of U.S. inflation, then emerging markets will continue to attract monies, gold prices will stay strong and consumption led growth in commodity exporting countries will resume.
Clear signals of this ongoing battle will be found in who Trump appoints to replace outgoing governors of the Federal Reserve, including the two vacant seats that he can fill as soon as he is inaugurated. By the end of 2018, Trump can appoint a majority of Fed Governors, including a new Fed Chair to replace Yellen whose term expires Jan 31st, 2018.
AMI PREDICTION: Trump will move quickly to appoint monetary doves to the Fed but the Fed will remain hawkish through Q3, 2018 when Trump has enough governor appointees to turn the tide.
Trend #2: Brazil Rediscovers Its Animal Spirits
Throughout the political tumult in Brazil over the last two years, foreign direct investment levels, quite surprisingly, have barely waivered. While capital flows have ebbed and flowed wildly, wreaking havoc on the Brazilian Real, strategic investors have continued to bet on the future of the world’s 9th largest economy and 5th largest populous. In 2017, that long term confidence in Brazil will begin to pay off.
A shallow glance at Brazil’s politics today would send most sane investors running: Under Temer’s brief reign, six Ministers and top aides have been indicted and sent to prison. Another two, including Minister Moreira Franco may soon follow suit. The plea bargaining testimonies of jailed former managers at Odebrecht is devastating the political class of Brazil and could eventually lead to an indictment or impeachment of President Temer himself. The political mess has triggered a capital strike by Brazil’s banking system which is afraid to lend money to Brazilian corporates for fear that their top managers might be implicated in future investigations. For the same reason, Brazilian firms struggle to issue new equity on the Brazilian exchange.
So why are foreign Brazil investors buying assets in Brazil? In contrast to other LatAm markets, Brazil has a corporate sector that has grown out of the clutches of family ownership and is regularly bought and sold by both strategic and financial investors. For the first time in more than a decade, Brazilian corporate assets are under-valued.
Brazil remains a good growth bet in the medium term thanks to its demographics. Shrinking family sizes and more working women is great for household balance sheets. Instead of buying clothing and food, Brazilian families have more disposable income (versus 15 years ago) to buy cars, computers, educate their kids, and save. It is the same trend (along with favorable commodity prices) that drove the region’s growth from 2003-2013 and will continue to drive it for another 15-20 years, by which time, Latin America will resemble Japan, with too many elderly and too few immigrants.
Beyond the obvious financial signs that point to a bottom in Brazil six months ago, there are strong signals pointing to a political turnaround as well. For the first time in living memory, there is a pro-reform political coalition in congress with a 60-68 seat cushion collectively supporting fiscal restraint and economic reform. Controlling the most important positions of public power in Brazil is a team of highly capable professionals including Pedro Pullen Parente, CEO of Petrobras; Ilan Goldfajn, President of the Central Bank; Henrique Meirelles, Minister of Finance; and Maria Silvia Bastos Marques, President of BNDES, Brazil’s development bank. With private sector tested professionals running the public coffers in Brazil, the promise of fiscal discipline and less graft seems real.
These appointments helped reverse capital flight in Brazil in late 2016, which coupled with the fiscal pact is now taming Brazil’s double digit inflation. If that trend continues, which it should, then interest rates can be dropped and Brazil’s domestic capital strike will soon end. Though Brazilian companies and households continue to pay down debt, making more capital available to the best balance sheets will provide a much needed boost to Brazil’s economy.
AMI PREDICTION: Brazil will meet or slightly exceed 2017 growth forecasts and should easily outgrow today’s 2018 growth predictions.
Trend #3: Trump vs. Mexico
A Trump Presidency is a quintuple threat to Mexico that might act to: i) scrap the TPP; ii) renegotiate NAFTA; iii) impose import taxes on outsourcing; iv) militarize the Mexican border; v) deport (another) million Mexicans. Together, these threats are nothing less than a declaration of economic war on Mexico by the United States, the repercussions of which could impact Mexico for a generation, both economically and politically. Diffusing this threat is the top priority for Mexico’s government and corporate elite, both of which are highly exposed to any breakdown of the economic partnership with the U.S.
Even without acting upon any of these threats, Trump’s verbal and tweeted outbursts have already destroyed billions of dollars of wealth in Mexico by dissuading strategic investors from pursuing their expansion plans in Mexico and inciting capital flight. The Friday after Trump’s election victory, the Mexican Association of Industrial Parks (AMPIP) surveyed members internally on what implications it had for business. The survey found that 37.5 percent of pending projects had been put on hold. Since he won the election, Trump has continued his threats against firms, American or otherwise, who plan to invest in Mexico and export any part of their production to the U.S. market. The value of Mexican investments cancelled or frozen by the time of Trump’s inauguration could exceed ten billion USD. By some estimates, FDI into Mexico could drop 40% from 2016.
Judging by his threats and the personalities entrusted with trade policy in his new Cabinet, Trump appears to be serious about disrupting a 30-year trend of shifting low to mid value manufacturing out of the U.S. and into Mexico (and other jurisdictions). TPP seems a certain victim of a Trump Presidency. Less certain is the future of NAFTA. Ratified by a series of legislative initiatives voted in Congress, it is still unclear that a U.S. President can unilaterally withdraw from NAFTA without Congressional support. Given the corporate interest ties of Congress, it is unlikely that they would undo a trade agreement to which thousands of U.S. companies tie their supply chains. Furthermore, opening NAFTA to renegotiation lifts the lid on a Pandora’s box of grievances harbored separately but no less emphatically by the Mexicans and Canadians, such that reaching, let alone ratifying a substantially revised agreement in three countries seems next to impossible.
A tax imposed upon imported assembled goods made in Mexico would contravene the most basic tenets of the NAFTA. The accord’s chapter 11 allows for private companies and individuals to sue for compensation when government actions harm their investments. A 35% import tax would represent pretty compelling cause to launch a law suit.What is not protected by the NAFTA is the movement of people across the U.S.-Mexican border. Barrack Obama deported more foreign nationals than all U.S. presidents combined over the last century, over two million in all. Laws dating back to 2005 permit the deportation of anyone apprehended breaking the law (including crossing the border) with limited due process. But politics is about perception and Mexicans deported by Trump will provoke much more animosity in Mexico than the same number deported under Obama. Of even greater political symbolism will be any expansion of the already extensive border wall. Today the wall is a rallying cry of political extremism on both sides of the border. U.S. nativists want it built. Mexican anti-Americanists hate every inch of it.
If Trump pursues his wall, and Mexico’s economy stutters further from lack of investment, Mexican politics could be upended in the 2018 Presidential elections by either an independent candidate like Jaime Rodriguez “El Bronco” or AMLO (Andrés Manuel López Obrador), who will run for a third time under the Morena party. Either could conceivably sail to power on a rising tide of anti-Americanism, a predictable reaction to the insulting rhetoric streaming out of Washington today. With an AMLO in power, NAFTA may in fact meet its end, because at the end of the day, the trade agreement has been even more destructive to Mexico’s corporate sector than to the Americans. There is no shortage of NAFTA naysayers south of the Rio Grande.
Mexico’s elite will fight to prevent a populist political whiplash in their country. In December, Carlos Slim, whose become Mexico’s unofficial corporate ambassador, dined with Donald Trump in his Palm Beach, Florida estate in an effort to convince the President elect of the depth of economic integration between their countries and the risks of unwinding those bonds. The Mexican government has since named as its new foreign minister, Luis Videgaray, who was the architect of Trump’s controversial campaign visit to Mexico and meeting with Peña Nieto. For now, Mexico has chosen the path of engagement in reaction to Trump’s taunting. Though practical, engagement may prove politically costly if little progress is shown in stemming the tide of Mexico bashing alive today in Washington.
AMI PREDICTION: The U.S. exits from TPP. Trump explores the legal and political obstacles to revamping NAFTA, only to abandon the idea in his second year of his administration. Likewise, the idea of an outsourcing tax is dropped after fierce corporate lobbying. Trump continues Obama’s deportation of foreigners with a criminal record and a constitutional battle ensues with municipalities who provide amnesty to the undocumented. The U.S. Congress funds the expansion of the wall and the installation of monitoring equipment. Mexico elects AMLO as their President in July, 2018.
Trend #4: Metals up, Energy Flat
No sector moves the terms of trade (and currencies) in Latin America quite like natural resources. Latin America attracts one third of the world’s mining investment, is home to 25% of the world’s arable land and 20% of its oil reserves. Metals (both base and precious) and energy suffered pricing collapses in 2013 and 2014 respectively. 2017 may see continued upward progress in metals pricing while energy prices remain flat.
With Republicans controlling both legislative houses and the presidency, the much-anticipated expansion in U.S. infrastructure may prove viable, combining public and private funding. Rising U.S. interest rates may dampen enthusiasm somewhat but not enough to stop a 6-7% per annum increase in spending in each of 2017 and 2018, lifting total construction spend in the U.S. to $1.3tn. In Asia, slowing Chinese and Japanese demand for infrastructure will be compensated for by booming spending trends in South and South-East Asia. At close to $1.8 trillion, Asian construction spending outflanks that of the U.S. and should grow at over 5% in 2017. Base metals will continue their recent pricing gains, proving helpful to the currencies of Peru, Chile, and Brazil.
Precious metals are more difficult to predict and gold has taken a wild ride since Trump’s election, first surprising many investors by dropping only to start rising as Trump assembled what is perceived as a protectionist Cabinet. At the start of 2017, gold was priced at $1,151 per oz. and consensus forecasting placed the metal at $1,300/oz. by the end of the calendar year. Should that prediction bear out, several Latin American governments will benefit fiscally.
For economies tied to the price of oil and/or gas, most acutely Venezuela but also Colombia, Trinidad & Tobago, Mexico, Ecuador and Peru, 2017 will bring another year of fiscal austerity. The production cuts finally cobbled together by OPEC will almost entirely be substituted by the expansion of U.S. output. The removal of EPA regulations that trapped U.S. natural gas within its continental borders will be lifted in 2017 and gas will begin to move through a series of Gulf coast LNG port terminals under construction, bringing cheap energy to the Caribbean basin and further disrupting Trinidad supply contracts. Even American coal may resurge somewhat under Trump, further punishing the Colombian peso.
AMI PREDICTION: Base metal index to rise by more than 10% in 2017. Gold to reach or exceed $1,300/oz. Energy prices to remain flat or rise less than 5%.
Trend #5: Echa la Basura
Most political analysts point to “a widespread rejection of populism and the re-embrace of neo-liberal policies” to explain the change of political tide today in Latin America. But in reality, only political wonks think like that when they line up to cast their votes. For most of us who are not married to one political party or another, we cast our ballot either in favor of the party or candidate that has fattened our wallet or in rejection of them if our wallet has thinned. At the end of the commodity super-cycle (2013/4), a majority of governments in Latin America were ruled by left-leaning parties.
As purchasing power plummeted in 2015 and 2016, the “bums being thrown out” were the populists and they were replaced by their natural foes, the center-right technocrats. More might follow as Chile and Ecuador go to the polls in 2017. At the same time, if Macri fails to deliver growth, legislative elections may resurge the Peronist left in Argentina in 2017. In Mexico, a rejection of neo-liberal policy is a genuine risk come mid-2018.
Political discontent in Latin America is not a simple pendulum swing. It is a groundswell of anger among voters who are better informed than ever, thanks in no small part to social media and daring investigative reporting: of the graft, nepotism and generally selfish behavior of Latin America’s political class. In Brazil, federal judge Sergio Moro has gained folk hero status by indicting dozens of his nation’s political and corporate elite on corruption charges. Polls suggest that were he to run for president, he could win. Across the region, voters yearn for leaders who offer a clean slate from the tainted world of party politics—i.e. Latin Americans want their own Donald Trump.
Those Who Compete Will Grow
The commodity super-cycle injected billions into Latin American economies. It also brought political recalcitrance. Latin America led economic reforms in the 1990s, but it fell behind other emerging markets during the populist decade that followed. The ability of countries like Venezuela and Argentina to grow at >5% per year proved that it was better to be lucky than good.At the start of what many hope will be another growth cycle in Latin America, the world is economically a meaner place than it was in 2003. Rising interest rates and political uncertainty in general drive investors to low risk assets, particularly in the U.S. At the time of publishing this forecast, U.S. stocks were priced at P/E levels above 25. Since the S&P bottomed out in March, 2009, U.S. equities have grown at CAGRs over 18%, more than double global markets. After the “Trump bump” in equity prices, sustaining such gains will prove impossible in the U.S. Therefore, some capital will begin to seek returns elsewhere. But without a cheerful commodity story to entice investors, Latin America must compete with emerging markets in Asia for scarce capital. Growth in Latin America this time round will come to those countries whose leadership continually reforms their economies, as well as their legal and political systems to deliver greater transparency, opportunity and certainty to investors. In short, only the most competitive economies will win.
Latin America Economic Forecast Figures
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