Emerging Market Debt: Beyond Brazil
Martin Steward talks with Jorge Unda of BBVA Asset Management, who warns that Latin America's biggest economy is heading in the wrong direction if it wants to keep up with its more successful neighbours
Investors could be forgiven for assuming that the biggest threat to Latin America's economies today is the global arrest of demand for raw materials from Asia. In fact, external demand is less important than one might think for most of the region, and the real issue is the extent to which domestic consumption can be maintained or stimulated. On this and many other counts, Jorge Unda, BBVA Asset Management's chief investment officer for Latin America, scores Brazil lower than many of its neighbours - with important implications for bond portfolio allocations in the region.
"Growth in aggregate external demand is very important for Chile, but for the rest of the region it is not as great a proportion of GDP growth as one might expect it to be," says Unda.
Commodities account for 74.8% of Chile's exports and almost 30% of its total GDP. Oil constitutes more than 97% of exports in Hugo Chávez's Venezuela, and 27.3% of GDP. But for Argentina and Colombia, raw materials account for little more than 10% of GDP, and for Brazil and Mexico the figure is less than 7%.
While some governments lean on commodities for budget revenues - Mexico gets 34% of its budget from Pemex, for example, and Chile receives 20% of its revenue from Codelco and other mining groups - they have also tended to be the ones that have managed these natural bounties most responsibly. Moreover, price assumptions are conservative: Mexico's budget balances with oil at $60/bbl.
The key for the resilience of Latin American economies through the global downturn may therefore depend more on the robustness of their domestic consumer markets. Colombia, Mexico and Peru get the highest proportion of their GDP from consumption and Brazil the lowest. At just 40%, the share for Brazil is not much greater than that in China. Of course, that leaves a long way for it to grow, but right now people are more focused keeping debt under control than spending. Brazilians tend towards short-term rolling credit - mortgage take-up is low - and Unda has seen little sign of either re-leveraging or de-leveraging.
"Around 25% of disposable income is used for financial payments," says Unda. "Moreover, the lower-income segment of the population is the most leveraged, and the economic impact of their spending is very high."
Government has introduced special loan rates for durable goods and automobiles, but that has merely crowded out commercial banks, which have been happy to avoid exposure to the over-extended consumer.
Full employment and easy credit within a closed and highly subsidised economy go a long way to explain Brazil's loss of competitiveness against its neighbours. Mexico's open and non-subsidised economy sucks in almost six times as many dollars from industrial exports, for example.
"When you take the Brazilian route you usually expect the industrial sector to take the time that it's been given by the government subsidies to really increase productivity and investment," says Unda. "But in Latin America, companies have tended to assume that this protectionism is going to last forever."
While BBVA sees Chile and Colombia in particular pushing ahead with fiscal and labour reforms, it expects Brazil to be a laggard. Those special loan rates for auto purchases are an example of growing protectionism, as well as the central bank's exchange-rate interventions. While the monetary authorities in Mexico and Peru have intervened openly, both accept the long-term appreciation story and intervene only to reduce short-term volatility. Brazil's moves against the US dollar, by contrast, are much more like Switzerland's action against the euro in their objective of depreciation.
"Countries should be more worried about increasing productivity instead of worrying about appreciation," says Unda.
All of this informs BBVA's views on fixed-income allocation in the region, particularly local currency. Brazil is certainly not a busted flush, especially for euro or sterling-based investors. Yields on its longer-term bonds are twice as high as those of other emerging markets, and investors can be fairly comfortable that this is not about pricing-in the new direction in monetary policy: structural inflation is high, the lack of mortgage financing removes any incentive to keep long-term rates down and pension funds with 6% real-return targets help put a floor in, too.
"For an investor with a long time horizon, that means a lot of value," says Unda. "But for currency appreciation we see a lot of short-term opportunity in Mexico, Chile and Colombia and, long term, we see opportunity in Peru. We expect only modest appreciation in Brazil. In both hard and local currency we think the Andean region is very attractive. That's about 12% of the benchmark, but we are at almost 20% - an overweight financed especially from an underweight in Brazil.
"In Latin America, generally, we see structural reforms, a long-term growth conviction, fiscal stability, central bank stability, improving productivity - and it is the countries that best demonstrate these qualities that will benefit the most. Chile is pushing fiscal and labour reform, but perhaps the most impressive goals for reform are Colombia's, so I am very optimistic about appreciation there. Brazil is the one considering the least difficult reforms - as a result it will be OK, but not as impressive as the rest of the region."