Economists are fond of the saying: “a rising tide lifts all boats”. But the phrase, popularized by JFK, will not prove to be the case in Latin America in 2021. This presents a real dilemma to businesses who seek to improve upon their 2020 performance in a region harshly impacted by COVID-19. Latin America will recover next year some of what was lost in 2020 but recovery will be uneven, be it measured by country, industry, or societal class. Understanding where growth will be found will be crucial to designing effective marketing, sales, and corporate development plans.
For Latin America, the rising tide in 2021 will consist of i) over $350bn of imported capital, both returning to the region as well as finding its way to emerging markets in general after close to $12 trillion of new money was introduced into the global economy; and ii) rising Latin American exports and commodity prices. When COVID took capital markets by surprise in March 2020, money fled indiscriminately from all emerging markets (even China) in search of safe asset havens. However, as investors tread back into emerging markets, in search of yield, they will be far more discriminating, be it purchasing sovereign bonds or equities. How countries reacted to COVID from an economic policy standpoint will strongly influence how much of the returning capital they can capture. Cross-border flows of funds matter in Latin America where capital markets are thin, and a large portion of savings are kept off-shore in dollars. While Latin America’s real growth declined by c. 8.5% in 2020, its GDP measured in dollars fell closer to 15% because of capital flight induced currency depreciation. Similarly, as the region rebounds, countries that attract foreign capital will strengthen their currencies, realizing outsized growth, when measured in dollars. This is critical to multinationals operating in the region, most of which measure and repatriate profits in dollars.
In 2020, countries and their governments were measured by their ability to manage the COVID healthcare crisis. In Latin America, the economic, political and societal crises will outweigh the healthcare crisis in 2021.
Policy Drivers of Economic Rebound
Each year, Latin American governments and corporations issue c. $120bn of bonds in the international market. According to the world bank, Latin American equities collectively enjoyed a market cap of close to $2.3 trillion USD prior to COVID. A high percentage of those equities are owned by foreign investors. How those (mostly institutional) investors judge Latin American economic policies and fortunes influences all investors in LatAm assets, be they foreign or domestic buyers.
For sovereign bond investors, how countries manage their fiscal debt has always been crucial. The fiscal response to the COVID-19 economic crisis in Latin America, triggered primarily by the length and intensity of lockdown measures, varied dramatically across the region, but every country assumed record debt levels. In Brazil, Peru and Chile, the Keynesian response to lockdowns was impressive, saving millions of small businesses from bankruptcy, and keeping the poor afloat. Mexico, Colombia, and Argentina were less generous with their spending, either out of choice (Mexico) or for lack of monies (Colombia and Argentina). Around the world, governments overspent — Fitch downgraded 24 EM sovereigns in the first three quarters of 2020 alone. In the same October 15th, 2020 report, Fitch named 30 EM sovereigns on a Negative Outlook, up from 13 at end-2019, signaling that further downgrades (in 2021) are likely.
The unsung policy hero in Latin America’s leading economies has to be its central bankers. Thirty years of political volatility has been kept in check by three decades of steadily improving, independent policy making by central bankers. Their decades long discipline helped attract record foreign capital, increase national savings, build foreign reserves, and temper inflation. As a result, central banks had the ammunition to lower interest rates in the face of an economic crisis when capital was fleeing, an historic first for many countries. The increased liquidity helped save the corporate and SME sectors in 2020 and with them, millions of jobs.
Brazil, Colombia, Peru, Chile and Argentina all followed a dovish path with negative real interest rates in 2020 and will continue to do so in 2021. Their policy making will keep liquidity growing, but will also temper any recovery of currencies. Mexico’s more hawkish central bank was the only leading institution in the region to maintain positive real interest rates in 2020, which helps explain the peso’s remarkable recovery after an initial 25% depreciation in Q1, 2020. However, the jury is still out as to whether Banco de México will stay the course. In early December 2020, the Central bank’s most hawkish governor, Javier Guzmán, was term limit replaced by AMLO’s 3rd appointment (of a five-governor policymaking body). AMLO has publicly called for more expansionary central bank policies in the face of an historic recession.
Exports and tourism receipts are incredibly important in Latin America where foreign debt dependency is endemic. Latin American economies have traditionally exported their way out of an economic crisis. The COVID-19 crisis, the worst economic downturn to hit Latin America in over 70 years, will be no different.
Record gold and silver prices will benefit big producers like Peru, Mexico, Brazil, and Bolivia. Stable food prices throughout COVID has helped minimize the export downturn this year in Guatemala and Chile. Currency depreciation will spur the export of food, industrial metals, and some manufactured goods for countries like Brazil, Mexico, Colombia and Chile. The anticipated rebound in aviation will lift oil prices in 2021, aiding Colombia, Mexico, Ecuador, and Argentina and aviation equipment sales from Brazil. Countries that open to tourism (DR, Panama) will fare better than those who keep their borders closed (Trinidad & Tobago, Chile). Expanded infrastructure spending in China and possibly the US will help lift prices of industrial metals. Generally speaking, as the global economy rebalances, traditional industries and exports will catch up, proving tailwinds to Latin America’s mostly analogue economy.
The Diminished Role of Foreign Direct Investment
In 2020, foreign direct investment flows into Latin America are anticipated to drop by 55% versus a global decrease of 40%. But COVID is just another bump in the road for FDI levels in Latin America, which have been dropping steadily since they peaked in 2012 at the height of the last commodity cycle.
FDI tends to lag domestic investment trends in Latin America. It is not foreign companies that first pursue distressed assets in Latin America but rather well positioned domestic investors who act swiftly. 2021 will repeat this pattern. Brazil’s plans to privatize state assets in energy and transportation as well as open new concessions in alternative energy will likely draw the strongest interest from Brazilian investors, aided by record low interest rates. In other markets where capital is scarcer, as many as 25% of domestic corporations are under strain, burdened by debt that has been downgraded. There will be significant shake-ups of ownership in most Latin American industries. The coming consolidation will likely be led by domestic buyers, not foreign ones.
Finding Gems Requires a Sector-Focused Magnifying Glass
After dropping 8.5% in 2020 (c. 15% in USD), Latin America will rebound moderately (4%) in 2021. Just as all economies in the region declined in 2020, all of them will grow in 2021. Some countries will grow faster than others depending upon how much capital they can attract and their export mix. But an even greater degree of differentiation is found by industry. Latin America’s largest companies are decidedly old fashioned, led by energy, retail and mining, a fact that exacerbated the economic downturn in 2020.
The true economic disruptive power of COVID is to be found at the sector level and that is the lens through which investors must look to find their hidden gems, be it in search of distressed assets or upside revenue growth. Stay tuned for the next chapter (part II) of this extended forecast of Latin America’s uneven post-COVID recovery where we will explore the winning and losing sectors of 2021.
Beyond the second part of this analysis, please feel free to explore some of our other analyses for 2021, such as our 2021 Forecast for Latin America and our 2021 Risk Symposium for Latin America. These analyses are fee-based, though we also have upcoming events that will be free, such as our Thought Leadership Workshop for Latin America on January 21 and our February 4 webinar on 6 mega-trends in Latin American payments.
Finally, please feel free to contact us if you need a deeper analysis to help drive your business decisions in Latin America in 2021, such as opportunity benchmarking, competitive intelligence, market landscape and risk assessment.