Latin America: Political risks abound but upside potential is intact

By Stéphanie de Torquat, Macro Strategist

Latin America may turn out to be one of the most interesting emerging regions next year, given the potential premium associated with various political risks.

Indeed, 2018 will see presidential elections in Brazil, Mexico and Colombia, while the second round of the Chilean elections is taking place this coming Sunday (December 17), with front-runner Piñera and surprise finalist centre-left Guillier running neck and neck. Regardless of the eventual winner, Chile faces an increasingly polarized policymaking environment, making it challenging to pass new legislation. From an economic point of view, the country’s dependence on copper prices – admittedly problematic in theory – should prove supportive in 2018 as the rebound that began in 2016, after several years of decline, still appears to have legs.

In Brazil, sustainable economic take-off is difficult to envisage without tangible progress on pension reform to correct fiscal imbalances. And on that front, despite increased optimism over the past few weeks, the situation remains challenging. According to a poll conducted by Arko Advice, 57.8% of 218 congressional representatives do not believe that pension reform will be approved under the Temer administration (source: Global Source Partners). This means that the winner of the October 2018 general election will need to be sufficiently credible and determined to address this issue successfully. Given that a significant part of the Brazilian political landscape is tainted by alleged corruption, outsiders or anti-establishment candidates could have a shot at running competitive campaigns, likely making for a highly volatile election.

Trump’s anti-Mexican stance, NAFTA uncertainties, but also rising insecurity and corruption concerns, might support anti-establishment candidates like Andres Manuel Lopez Obrador (AMLO) in the July 2018 presidential election, while a large number of independent candidates could alter election dynamics. As such, Enrique Peña Nieto’s currently ruling Partido Revolucionario Institucional (PRI) might have to strengthen its rhetoric in NAFTA negotiations, in order not to lose voters to populist parties – creating further volatility and uncertainties regarding the final outcome. That being said, underlying economic fundamentals in Mexico appear rather strong and Mexican assets could offer interesting opportunities if the political and geopolitical situations evolve in the right direction.

In Argentina, the turnaround story is unfolding and, unlike most of Latam, the country currently enjoys some degree of certainty on the political front. Indeed, President Macri’s Cambiemos coalition substantially increased its legislative representation following October’s mid-term elections, thus emerging as the country’s most powerful bloc despite remaining in minority in both chambers of congress. As such, while fundamentals still appear fragile (annual inflation rate of 24%, policy rate at 28.75%, and 3% current account deficit, momentum is undeniably supportive and the upside potential significant.

Peru is one of the soundest Latam country from a purely macroeconomic point of view, alongside Chile, with the current environment of rising metal prices also particularly supportive. But it has undergone its share of political turmoil lately as well. Indeed, on September 14, Peru’s congress ousted the entire presidential cabinet via a vote of no confidence, led by the opposition Fuerza Popular. While the President has since named a new cabinet, political tensions and inter-party conflict will resurface with both President Kucynzski and opposition leader Fujimori implicated in a purported graft scandal with Brazilian builder Odebrecht. These allegations will likely weigh on Kucynzski’s support and further inhibit his legislative agenda.

Finally, Colombia is one of the weakest economy in Latin America, but it may have passed an inflection point. Indeed, disinflation, FARC peace accords and higher oil prices are all tailwinds. As such, inflation could stabilize at current lower levels, paving the way for continued accommodative policy. Should the country manage to reduce its high twin deficits (current account and budget deficits both near 4%), we might turn more constructive on the country. The main risk to this scenario relates to the FARC peace accords, since a likely opposition victory in the March 2018 legislative elections could lead to changes in the terms of the deal and delay its implementation. 

While we should not be complacent about the possibility that political risks turn sour, positive outcomes could also trigger increasingly positive investor sentiment and inflows to Latin America. In a context of supportive global growth, accommodative financial conditions and stable-to-rising commodity prices, the region appears well positioned to surprise positively in 2018.