In Eco-political analysis

John Price
Managing Director
AMI

This Latin American market analyst has long argued that politics (in the short term) did not determine economic growth in our region. My reasoning was simple: Latin Americans keep the bulk of their long term savings (roughly $8 trillion USD) outside of the region for lack of faith in the governability of their countries. As a result, all Latin American governments and many of its companies are obliged to borrow in dollars from abroad to capitalize their operations and must repay that debt in dollars. Therefore, what really drove growth in the short term was the price of a country’s leading commodity(ies), and secondarily the interest rate cost of servicing that debt.

The best example of this thinking was the election of Hugo Chávez in late 1998, a populist leader who served as president of Venezuela until his death in 2013. From the outset, Chavez promised to re-engineer Venezuela’s economy (and delivered on that promise), putting the state in command. Chávez’s policies and actions frightened investors provoked massive capital flight and all but destroyed the private sector of Venezuela. Nonetheless, the Venezuelan economy grew at an impressive clip for the next decade despite his policies; this was because outweighing his leftist populism were two external forces at work: historically low US interest rates and dramatically ascendent oil prices.

Venezuela GDP vs Price of Oil (1997-2020)

Today’s Unlucky Leftist Populists

The slew of leftist populists presidents elected in Latin America since the economic debacle of COVID are not blessed with the same good luck as Hugo Chávez. Today, the cost of US capital is high and will remain so because the baby boomer generation (in Europe, US, Canada) who nourished our capital markets with their savings over the last 30 years are now withdrawing those savings to pay for retirement. The global commodity outlook is mixed: healthy in EV-driven metals, stable to healthy in food, neutral to negative in precious metals, negative in construction-driven metals as China slows, and negative in conventional energy as the world transitions. Furthermore, Latin American governments (with few exceptions) are broke after suffering tax revenue losses during COVID.

Latin America represents roughly 10% of the global economy but its capital market volumes are less than 2% of the global total. Convincing the rich world’s institutional investors to bet on Latin America is very challenging when they can safely earn 5% per annum on US treasuries. As a result, investor tolerance for populist policymaking and combative left-wing rhetoric has all but dried up.

The latest roster of left-wing populists elected to lead in Latin America irk investors, especially the domestic monied classes. However, their ability to disrupt is reigned in, to varying degrees, by power-balancing institutions, including hawkish central banks who bolster currencies in spite of private capital flight.

In Mexico, AMLO’s Morena party controls the house and senate. His government’s (questionably legal) intervention in Mexico’s energy, mining and transportation sectors spooked domestic investors and may have provoked more than US$150 billion of capital flight over the last five years. However, the geo-political miracle of nearshoring, a deftly managed US bilateral relationship and a hawkish central bank together have kept investment flowing into Mexico, the peso strong and overall economic growth modestly positive.

In Chile, the election of Boric and a disruptive constitutional assembly frightened the nation’s conservative investor class. However, the subsequent voter rejection of constitutional reform, Boric’s post referendum pivot to the center and global mining interest in Chilean copper and lithium have helped to improve the outlook for Chile.

Colombia, Peru and Ecuador are less fortunate. Their political firestorms are not sufficiently contained by institutional or market forces. As a result, foreign direct investment and economic growth has and will continue to suffer. In Colombia, Gustavo Petro is hell-bent on reforming every aspect of government policy and sectoral economics. The political opposition and central bank have been useful breaks on his power, but his continued aggressive rhetoric and unholy alliances shock investors who long relied upon Colombia as a legally safe place to do business. Colombia is in an economic recession today and its foreign direct investment prospects continue to dwindle.

The election of Castillo in Peru and his subsequent impeachment was the last straw of a decade of political disfunction in Peru. Long lauded for its fiscal and monetary policy stability, Peru nonetheless suffered unprecedented capital flight and devaluation when Castillo’s awkward exit from power generated unrest across the country, including Peru’s mining regions. Growing security concerns, volatile local community-project relations, and too many layers of bureaucracy have hurt Peru’s ability to continue attracting mining investment, despite its enviable copper endowment.

In Ecuador, the election of a pro-business candidate in Daniel Noboa might have lifted investor spirits, were it not for the realization that his more experienced pro-investor predecessor, Guillermo Lasso, failed to accomplish most of his goals. Ecuador may be dollarized, blessed with good infrastructure and plentiful resources, but Ecuador is also hamstrung by combative political and illicit forces. Former President Correa still wields enormous influence and can engineer public dissent. Pachakutik, the patchwork political party centered around indigenous votes and issues is an effective opponent of natural resource development. Organized criminal groups, a relatively new phenomena in Ecuador, have helped raise the homicide rate by 500+% over the last seven years. Foreign investors have taken notice and shied away from Ecuador.

Investors Are Ready to Reward Good Political Behavior

Foreign Direct Investment as a % of GDP 2022-2028

The Dominican Republic, one could argue, has been governed by pro-business presidents for years. However, political authority in the DR is highly concentrated in the executive branch, a fact that some point to as the root of its history of corruption and poor transparency. The election of Luis Abinader in 2020 brought a more transparent approach to governance from a candidate whose background is more steeped in business than politics. He has bolstered the private sector in the DR by simplifying regulations, privatizing, and inviting more investment. The DR is a more competitive economy as a result and FDI forecasts point to enthusiasm for his leadership, which will likely be given a second four-year mandate in the 2024 elections.

The dramatic pivot by Argentina’s President-elect Milei from radical campaigner to pragmatic and mission bound leader with a cabinet made up of political veterans is warmly welcomed by investors.  Argentine ADR listings in the US appreciated dramatically (20-60%) and the Dólar Azul (Argentina’s freely traded black market currency), gained 17% in one week.  Milei will introduce a ‘shock and awe’ package of tax, labor and political reforms on day 1 of his administration.  The promise of privatizations, looser regulations and eventually a floating currency has investors rediscovering Argentina after a long stint of neglect. 

In Brazil, local investors bemoaned the return of Lula in 2022, even if the rest of the world was relieved by the defeat of Bolsonaro. Lula began his latest mandate by threatening to reverse the hard-won reforms achieved by Brazil’s centrist congress and senate. But Lula’s party, the PT, has a small number of legislative votes, so Brazil’s pro-investment political trajectory continues, evidenced by the senate’s recent passage of tax reform. Lula spends much of his energy and time involving himself in global issues outside of Brazil. Investors are pleased by that. The reform agenda engineered by former Finance Minister Paulo Guedes and voted into action by a center-right legislative branch is the real political story in Brazil and seasoned investors know it.

Capital Scarcity Leads to Better Governance

A world of shrinking capital will spend it more wisely. That means less money for silly start-ups and less and/or much more costly capital for inept, ideological, corrupt and sloppy governments. In such an environment, well-governed, fiscally prudent governments in Latin America will easily source capital while those espousing bad ideas or bad behavior will go hungry. Latin America today is fixated on Argentina, with good reason. If the Milei administration continues to make the right moves that please investors, then capital will flow into Argentina’s capital markets, real estate, natural resources and eventually main street. Other leaders in the region will take note and learn not to demonize the monied classes or foreign investors but rather embrace them. Wealth must first be attracted and generated before it can be distributed. It is a common-sense truism whose time has come to return to Latin America.

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