Latin America also deserves investor attention

By Stéphanie de Torquat, Macro Strategist

When reflecting on the powerful economic turnaround staged by emerging markets over the past 18 months, Asian countries spring to mind, as the most credible with already well-established fundamentals. Latin America (Latam) has – rightly – been viewed as the weak link within the emerging space, because of high political uncertainties, poor fundamentals and an inescapable need for structural reform. While all this remains mostly true, the current environment of stable global growth, commodity prices, US dollar and Chinese dynamics is supportive for Latam also. Time will tell whether the political elite has the drive to lay the ground for sustainable growth. For now, though, we see strong enough near-term prospects to offer interesting investment opportunities.

Brazil’s recovery has been impressive, with currency strength driving down inflation and allowing the Banco Central do Brasil (BCB) to aggressively cut rates. In turn, 2^nd quarter growth was positive for the first time since 2014. Going forward, the cyclical impulse of lower rates may last a few more quarters, but heavy structural adjustments will also be needed. Brazil’s public deficit remains close to 10% of GDP due to a largely loss-making pension system. Unless this deficit can be narrowed, single-digit interest rates will spark new bouts of inflation and force the BCB back into tighter policies. The October 2018 general election and ensuing appetite for reform will thus be key to Brazil’s long-term outlook.

Mexico saw its currency drop more than 20% when President Trump was elected, leading to accelerating inflation and rapid monetary tightening. Conversely, the peso’s recent rebound could pave the way for rate cuts in 2018. North American Free Trade Agreement (NAFTA) renegotiations are a concern, but we do not expect a prolonged breakdown in trade links with the US. Finally, Mexican fundamentals are supportive with favourable demographics (still growing working-age population), a competitive labour force (surpassing China) and a string of reforms over past years (e.g. liberalization of the energy sector).

Argentina’s chances for reform were bolstered by the August legislative primaries – boding well for the ruling coalition’s prospects in the October elections. The twin deficit remains large, but should start to narrow thanks to public subsidies cuts and rising revenues. Inflation has slowed from over 40% a year ago to below 25%. As the effects of the lower utility subsidy fade, the fiscal deficit narrows and expectations become better-anchored, inflation should gradually return to the central bank’s 12-17% target. That said, still high inflation, a significant budget shortfall and recent defaults mean that Argentina remains vulnerable to negative shocks.

A brief review of other Latam countries

In Colombia, recent developments have generally been supportive with the FARC (Revolutionary Armed Forces of Colombia) peace accords making progress and the oil price rebounding. Twin deficits nonetheless remain high, and a new equilibrium of lower growth, higher inflation and a wider external deficit might continue to prevail as compared to the pre-oil shock era. Chile still deserves its status of Latam safe haven, despite a large dependence on copper prices. It boasts a contained current account balance, robust capital inflows and a large stock of foreign reserves. In Peru, one of the least indebted Latam countries, a large fiscal stimulus is expected to support economic activity. Substantial political risks do, however, threaten near-term prospects following the ousting of the entire President’s cabinet by the Peruvian Congress, via a vote of no confidence.