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Broad-based economic expansion
Global economic growth is surging again and carrying Latin America with it. It has been over a decade since Latin America enjoyed such positive external economic conditions led by i) near maximum growth in the US, Europe and China; ii) continued low inflation and interest rates; and iii) rebounding resource prices. Such a perfect storm cannot last forever, so investors are betting now on Latin America. Global Finance magazine predicts that 2018 FDI levels in all of LatAm’s top six markets will grow in nominal terms as well as a % of GDP.
Investor confidence among Latin American business leaders has returned to heights not reached since the pinnacle year of 2012. Their optimism is built not only on healthy global conditions but also the hard work their companies have undergone since resource prices fell in 2013/14, crashing Latin currencies and exposing their corporate debt vulnerability, much of it denominated in dollars. Painful restructuring of multilatinas included record bankruptcies in Brazil, the region’s most dynamic corporate sector, but also paid dividends with resurging bourses helping finance corporate expansion.
Latin American consumers went through their own restructuring, paying down record levels of retailer and credit card issued debt that helped fuel a consumption craze during the resource boom of 2004-2013. Consumer credit is growing once again and should gather more steam in some Latin American markets where central banks have the latitude to lower interest rates.
Far less impressive has been the response of Latin American governments to the challenge of recession. Falling resource prices dented tax revenues quickly in 2015, but only a handful of governments came close to matching the bravery of Latin corporate leaders when it came to cost cutting. Most governments ran larger deficits than they could afford. When they finally did cut costs, voters grew angry and, armed with smartphones and social media, unleashed a level of scrutiny of public spending that Latin America has never witnessed. Corruption scandals were exposed in Brazil, Mexico, Colombia, Argentina, Peru, Ecuador, Bolivia, the DR, Panama and elsewhere. The political map in Latin America has changed over the last two years, much of it driven by voter intolerance of corruption and nepotism. Despite improving economics this year, voters are still angry, reflected by record low presidential approval ratings in every major market.
The 2018 elections in Brazil, Mexico and Colombia will be transformational because all incumbent leaders are constitutionally barred from re-election. Such uncertainty scares investors and indeed, 2018 may produce some unwelcome electoral results with populists like Andrés Manuel López Obrador (AMLO) in Mexico, and a wide field of candidates in Brazil, including leftist Marina Silva and Trump-like Bolsonaro who presently lead the polls.
However, we see a silver lining in what amounts to a tectonic shift in democracy across most Latin American countries. Latin American voters are older than ever before (and thus wiser) and thanks to social media, they are also better informed. While social media may be discounted as a channel of fake news in mature media markets, in Latin America, social media fills vital gaps in a media landscape that continues to be beholden to corporate and government interests and/or ill-equipped to conduct robust investigative journalism that is the hallmark of the fifth estate. A better informed and more seasoned voter put Macri in office and then punished Peronists in the Argentine mid-term elections; denied Evo Morales a 4th term in Bolivia; eschewed Rafael Correa when he returned to Ecuador hinting at a coup d’état; applauded (and thereby protected) a brave judiciary in Brazil; chose a proven technocrat in PPK in Peru over a mercurial Keiko; and brought a more centrist Piñera (versus his first term) back to power in Chile.
An empowered and informed electorate is an essential ingredient of a democratic Latin America that can consistently elect pragmatic and honest leadership. For those who have analyzed the region for decades, recent events offer a glimmer of hope that some nations in Latin America are en route to building an independent judiciary, an achievement that has eluded the region since its constitutional authors first put pen to paper.
The rule of law and the leadership of constitutionalists may have the tide of change working in their favor, but populists will not go down without a fight. Case in point is Keiko Fujimori, who effectively used her party’s congressional majority and, some speculate, also employed counter-intelligence techniques to embarrass PPK’s government by exposing errant behavior of two cabinet members, then road-blocked budgets and finally engineered a near impeachment of the President. PPK was saved from ousting by dissenting votes within Keiko’s Popular Force party, most likely to negotiate the release from prison of Alberto Fujimori, the disgraced former President. Congressman Kenji Fujimori, Keiko’s brother, led the dissenting faction in a modern day palace coup, demonstrating how populists can also win in this era of ultra-transparency.
Latinobarometer’s 2017 poll results showed increasing cynicism among voters in almost every Latin American jurisdiction. Voter anger is not pinpointed on Presidents but extends across the political establishment that they hold accountable for the corruption and poor governance that plagues their countries. A “throw the bums out” sentiment provides fertile ground for the resurgence of populist leaders. Brazil and Mexico will put this to the test in 2018 elections. In Brazil, Jair Bolsonaro brings a strong-man’s flair to the electoral contest and has risen in the polls on an anti-everything campaign. He lacks any clarity on economic, trade or foreign policy but is crystal clear in his disdain for corruption, government waste and insecurity, three issues that motivate Brazilian voters. Some hope that Bolsonaro’s small government message will translate into laissez-faire trade and investment policies but more likely his anger politics would morph into a “Brazil-first” protectionism, which many Brazilian private sector leaders rely upon to keep their businesses thriving.
The January 24th, 2018 verdict in Porto Alegre’s appeals court to extend former President Lula’s sentencing from 9.5 to 12 years effectively removes from the Presidential election the highest polling candidate. Though the PT defiantly announced that Lula will head the party ticket, some PT voters will turn elsewhere, either to be counted or because the most likely alternate PT candidate, Fernand Haddad, fails to inspire them. Perhaps best positioned to gain those diverted votes is Marina Silva, the former PT Senator and Minister of the Environment under Lula. Unlike many associated with the Partido dos Trabalhadores, Marina Silva is (still) not stained by accusations of corruption. Her clean image and the fact that she is the only female candidate running combined with a possible PT vote gain could thrust her to the top of the polls over the next couple of months. Marina Silva is not a populist like Bolsonaro but she is ideologically left wing, opposes Brazil’s long-overdue pension reform, and is at odds with Brazil’s powerful agro-industry due to her green policies. Affiliated today with the tiny Rede party limits government funding and will force her to partner with other parties to govern, which may moderate her policies. Regardless, both Marina Silva and Jair Bolsonaro worry foreign investors.
More generally, the fluid and uncertain path ahead of the Brazilian presidential campaign concerns all investors. A faction of Brazil’s congress now wants to revoke Lei Ficha Limpa that bars indicted politicians from running from office. Haddad’s position as the back-up PT candidate to Lula is in doubt with other candidates jockeying for the spot. The PSDB is yet to name its candidate and then there’s Luciano Huck, the telegenic Rede Globo TV star with millions of fans — who is still looking for a political party to which he can hitch his celebrité. Each week brings new revelations and new personalities to Brazil’s presidential race. The optimists expect that a rationalization process will weed out the most controversial voices. However, as the 2016 U.S. Republican primaries demonstrated, a populist can win a wide-open race.
Thirty years ago, Mexico’s political and business elite devised a strategy to embrace globalization and neo-liberal economic discipline. Free trade agreements were subsequently signed with 45 countries, representing more than 70% of global trade. The bold shift upended Mexico and destroyed the domestic industrial sector, but also ushered in waves of foreign investment that modernized Mexico’s economy.
From Carlos Salinas to Enrique Peña Nieto, Mexico has maintained a pro-free trade policy. That may soon change. Andrés Manuel López Obrador (AMLO) has lost two previous bids at the presidency. He is a seasoned campaigner and has cleverly positioned himself as the anti-Trump candidate, promising to “stand up to the American bully”, a message that resonates with Mexicans of all social classes. AMLO’s closest advisors herald from two distinct backgrounds: left wing academics with an UNAM fostered anti-American bend and ex-PRI dinosaurios who have mastered corruption as an art form. AMLO’s biggest financial backer is Carlos Slim, the world’s 7th richest man, and major shareholder of over 200 companies, the majority of which would benefit from less foreign competition in their home market, Mexico. Given where NAFTA negotiations are headed, how indignant Mexican voters feel and the money and advice backing AMLO, it is hard to envision Mexico maintaining its ardently pro-globalization path. It may be a Trump-led Washington crying wolf the loudest on globalization, but it is more likely that Mexico takes the lead on building trade walls with its northern neighbor. If a tide of protectionism is to engulf Mexico, it needs a catalyst in the form of a messy collapse of NAFTA, the region’s leading potential black swan (Ugly) event.
Roughly 50% of NAFTA clauses have been renegotiated and put to rest. However, the most contentious ones remain unresolved, including North American and U.S.-only automotive content minimums, dairy & agriculture, dispute panels, government procurement, cross-border e-commerce and a 5-year sunset clause which would kill the agreement unless it is re-ratified by all three countries. The U.S. department of Commerce appears to be playing a high stakes game of chicken, pushing what many consider as unreasonable proposals and waving the threat of a cancellation letter from President Trump. Some speculate that the Americans are trying to jolt the Canadians and Mexicans out of their “cling to the status quo” starting positions, but ultimately want to maintain a NAFTA accord.
The U.S. tactics, as crude as they sometimes appear, are making progress. The Canadian team has already tabled compromise proposals on auto trade minimums and the sunset clause. For Canada, there is no turning back from NAFTA and both major political parties (Liberals and Conservatives) are united in their desire to keep NAFTA in play, at almost any cost.
For Mexico, a concession-riddled deal would be the kiss of death for the incumbent PRI in the July 2018 elections, and would therefore hand the Presidency to AMLO, a prospect that frightens many Mexican elites. Signing a NAFTA accord that is perceived as damaging to Mexico will represent a poisoned chalice for the PRI that could haunt the party’s political future for years to come. A messy end to NAFTA talks close to the July elections will trigger a 20+% drop in the Peso, and also anger voters. It’s a lose-lose situation for the PRI in Mexico.
A Hawkish Fed
Latin American currencies are highly sensitive to movements of the U.S. Federal Reserve Bank interest rate policy. At present, the market anticipates three x 25 basis point movements upward this year by the Fed, with the first change to be announced in the March 2018 session. The Fed’s new leader is neither clearly dove nor hawk but somewhere in the middle. More relevantly, the Fed is a very egalitarian institution where all voting members voices matter. The Fed almost always sticks to its mission of targeting inflation. And many signs point to wage inflation in the U.S. combined with a weakening dollar and rising commodity prices as forces that will move core inflation higher and faster than Fed watchers presently predict. The U.S. labor pool is now shrinking as droves of baby-boomers enter retirement. Without a massive influx of immigrants, wage increases will soon accelerate, especially at the low skill service sector levels where productivity enhancing technology is less impactful.
If core inflation jumps to 3%, the Fed will need to accelerate its plans to raise interest rates and 2018 may witness a Fed rate jump of 1% or even 1.25%, the likes of which could devalue Latin American currencies by 5-10%.
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