July 5, 2017    7 minute read

Why Is Almost No One Paying Attention To Latin America?

Testing Your Risk Appetite    July 5, 2017    7 minute read

Why Is Almost No One Paying Attention To Latin America?

Mentions of Latin America are often met with silence as many are not familiar with what is happening in the region. Some may, however, make vague statements regarding revolution, political instability and economic recession in reference to countries such as Cuba, Chile, Colombia, Mexico, and Argentina. But South America is also viewed as the continent of opportunities (Andean countries), tourism (Brazil), and wild nature (Costa Rica).

Overall, Latin America poses mostly a country risk for the rest of the world. This is because both the banking industry and trading centres are not significant enough to cause a major contagion risk to the rest of the world. However, what sadly unites those countries is the fact that these economies are not very diversified and are mostly driven by commodities (be it mining, farming, and oil).

Other weaknesses are the absentee government structures (given the falling tax revenues and onerous debt service) as well as widespread corruption and tax evasion. Furthermore, one issue causing headaches is the transnational organised crime epidemic, particularly in Central America which acts as a major transit platform for hard drugs, fueling extremely high levels of violence.

The Regional Debt Problem

The two largest economies in the region are Brazil and Argentina, but they are both suffering from weak economic growth and face challenging public finances, the former on the brink of bankruptcy (remember the default of Argentinean debt) and the latter facing massive fiscal deficits and political chaos.

Notwithstanding the fact that current debt levels are relatively lower than their counterparts in Europe and the US, negative budget balances and increasing debt ratios restrict the use of creative policy options for many of the region’s countries.

And notwithstanding feverish economic growth in many of these countries, the local authorities remain limited in their capacity to launch or ease any monetary policy as a result of rising interest rates around the globe and panicky capital flows.

Low Commodity Demand

Subsequently, these phenomena hinder growth and make the debt service more onerous. Apparently, despite a more optimistic economic environment in the US and Europe, overall demand for Latin American commodity products remains subdued, depressing any hope for an economic revival in the region.

The countries in Latin America that warrant the most attention on the radar screen are Argentina, Bolivia, Brazil, Colombia, Ecuador, Mexico, and Venezuela, as they are all facing deep political instability and collapsing commodity prices.

While Argentina was for a while the ugly duckling of the region, that title now belongs to Brazil and Venezuela. Brazil is facing endless corruption scandals, preventing the country from focusing on reforming public finances and the economy, thus wasting too much time on self-preservation. Brazilian economic growth remains negative at -0.4%, and fiscal deficit is at -8.9% as of Q1 2017.

Venezuela’s Political Turbulence

Venezuela is in an even worse state as the country under the rule of Maduro – in power since the death of Chavez – is in chaos. Its economy faces a bloody contraction as GDP is -18.6% per end Q1 2017  and inflation is at a crazy 741%.

As a result, ordinary people are facing massive unemployment with no easy access to food nor medical care, and openly taking up arms against the government on the streets. Bearing in mind the latter, combined with the fact that the Maduro government is spending more than 90% of the Venezuelan oil export revenues for paying off interest and principal, there is very high likelihood that the government debt will face a default.

Venezuela is, together with Ecuador and Bolivia, a typical example of a government that has bet all of its money on commodities trading (in this case energy – oil and gas) without any plan B in the unfortunate event that this commodity-driven economy falls apart.

Caracas, La Paz, and Quito had put in place socialist governments that were labelled as the new socialism of the 21st Century, focused on bringing more equality among their citizens. But this was done by spending way more than what the government was collecting in taxes – a recipe for failure.

The leaders of these three Latin American countries, namely Hugo Chavez, Rafael Correa, and Evo Morales (but also Luis Inacio Lula da Silva from Brazil), wanted to put in place a revised Marxism but failed as the current state of their economies is showing.

Argentina’s Debt Woes

As for Argentina, the country hit the news headlines in the early 2000s as a result of the country’s default on external debt back in December 2001. Foreign capital flows almost left Argentina entirely during the period 2001 – 2003; inflation went over 40%, and real GDP fell by more than 10%.

A substantial debt restructuring was necessary as debt reached close to 180% of GDP. Early 2016 negotiations came to a fruitful outcome as the first debt repayment was made. Today, the economy remains anaemic (even though active at 0.3% per end Q1 2017), price inflation remains at a staggering 24% as of May 2017, and domestic politics are in disarray.

Colombian Civil War

Colombia, after a civil war that killed tens of thousands of people, was able to secure a peace agreement with the FARC (but only up until 2018). However, the fighting against the ELN (National Liberation Army) fails to mention the war on the drug cartels.

Furthermore, it is a public secret that as soon a longer lasting peace deal with the FARC is secured (after 2018), splinter groups will certainly proliferate, presenting a huge threat to the Ecopetrol operations. While the country is a not a major producer of oil, the latter represents the largest source of export for the country, accounting for almost 20% of government revenues.

Mexico’s Drug Problem

The last country that is on the blacklist is Mexico. Granted, ever since the 1994 tequila crisis, consecutive Mexican administrations have been improving the country’s economic fundamentals, resulting in low inflation, reduced reliance on oil revenues, and macroeconomic stability – thanks also to the positive effect of NAFTA).

Notwithstanding those impressive achievements, the country is facing two lethal challenges: the drag that low oil prices represent for the Pemex oil activities, combined with the costs for waging an escalating war on the drug cartels.

One needs to keep in mind that Mexico is a major transit platform for hard drugs, fuelling extremely high levels of violence. Close to 45% of the people in Mexico live under the poverty line, and the country displays the second highest degree of economic inequality between the very poor and very rich – these two factors are a dangerous breeding ground for the gangs.

Mexico being the immediate neighbour to the United States, with Trump now in power in Washington DC, the country is vulnerable to a potential change in US trade policies. This causes unwanted uncertainty in turn representing a drag on both investments and economic growth for 2017 and 2018.

While these countries are not making the headline news from a risk management perspective, this so-called black list of Latin American countries warrants a very close monitoring by the international investors as they are all facing political instability to various degrees, deepening fiscal deficits (in turn feeding higher debts), shrinking government revenues due to weak economic growth, widespread corruption, and informal economies becoming larger by the day bringing to life dangerous crime groups. Tragically political self-preservation and entrenched economic interests prevent reforms and hence a long-term view.

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