In times of high risk aversion and fears of global recession investors tend to overlook the opportunities offered by emerging markets, it is a pity, as this is usually the best time to buy. Recent results may help to put through this thesis. In the year to date the MSCI Latin America stock index is down by 3%, and the JP Morgan Emerging Markets Bond Index (EMBI) for the region is up by 3%, not bad for a year in which the S&P is down by 14%.
One reason to explain this outperformance is that Latin America remains a point of growth in the world. Our growth forecast for the region is 3.3% this year and 4.6% in 2002. This represents a slowdown from last year’s levels, but is still impressive in the current developed world context. Country dispersion is high, ranging from an expected 4.1% GDP growth in Brazil to 1% in Peru, but no country in the region is expected to experience negative growth.
Mexico is expected to show a still robust 3.1% GDP growth, coming down from a whopping 6.9% in the year 2000. Mexico has a problem, common to most other emerging markets, of a very low tax collection. Public sector non oil receipts amount to 11.3% of GDP, compared to 21.5% in US. President Fox’s reforms aim to increase this by 5.2 points. We are extremely confident in the final success. Once the fiscal reform is approved there is a high probability of Mexico obtaining investment grade rating from S&P, it is already Baa3 by Moody´s, paving the way for a dramatic reduction in financing costs.
A big positive for Mexico is OPEC’s new found ability to stabilise oil prices in the $22 to $28 per barrel range. Mexico’s fiscal deficit and balance of payments vary by 0.1% for each dollar change in the barrel price.
The high impact of oil prices is leveraged in the Andean countries. Both Venezuela, where the fiscal impact and the BoP impact of one dollar movement 1% and 0.7%, and Colombia, where impact is 0.2% and 0.2%, are strong beneficiaries of the new oil regime. In Venezuela growth for this year is expected to top 4.5%, after 3.2% in 2000. Investment is expected to increase to 15%, on the back of recovered confidence and public spending. As a result the BoP surplus will be reduced from 12.3% of GDP to 6%. Public spending has been the main engine to reactivate growth. The trend of fiscal balance is not sustainable. Despite posting a 3.2% of GDP surplus in year 2000 due to the very high increase in oil revenues, non oil revenues actually decreased.
Government revenues are usually behind fiscal problems in the region, as expenditures are quite low. In the case of Venezuela government expenditures only amounted to a paltry 8% of GDP in 2000. Venezuela is thus a country highly dependent on a single commodity, oil, and as such it is the country that will most benefit from the current oil regime.
Colombia’s growth in 2000 was 2.8%, despite the troubles caused by the guerrillas, on the back of a 27% increase in private investment. For this year, we expect growth to be 2.5%, increasing to 3.5% in 2001. Colombia is one of the best rated countries in the Andean region, BB/Ba2. However for an upgrade some progress should be seen in structural reform, especially on the pensions front, likely after
the 2002 elections.
Peru’s growth has been sharply reduced by last year political turmoil. The loss of confidence has resulted in very low consumption growth and negative private investment. The recent elections, and the new government, could have a big positive impact on confidence, and be the necessary catalyst to restore growth.
Brazil is the success story of the recent past. After the real devaluation in January 1999, the country has been able to effectively control inflation, 4.8% year on year at the end of March, and increased growth to an impressive 4.2% in 2000. For this year we are expecting a slight reduction to 4.1%, due to the recent tightening of monetary policy by the Central Bank. Primary surplus was increased to 3.5% of GDP, stabilising net total government debt at 49% of GDP. The black spot of the Brazilian story is the BoP, as current account deficit was 4.7% of GDP in 1999 and 4.2% in 2000. FDI has covered more than 100% of these deficits, but clearly the situation is not sustainable. For this year the depreciation of the real and the increase in rates should mean a deterioration in the fiscal deficit, but we do not expect the situation to get out of hand.
The current turmoil in Argentina, in which we have seen three economy ministers in two months, should not veil the fact that Argentina has achieved no mean feat in maintaining a currency peg for the last 10 years, surviving the tequila crisis, the Russian crisis and the Brazilian devaluation. The situation is difficult however as time seems to be running short to reactivate growth, which is Argentina’s real problem. The aftermath of the Brazilian devaluation produced a sharp contraction of GDP in 1999, to minus 3.4% year on year. In 2000 the situation was only partly redressed, as growth was still negative, although only slightly so, minus 0.5%. The problem is that with such a paltry growth, the country has not been able to achieve the primary surplus needed to stabilise public debt. Despite the fact that the government has been able to keep a primary surplus in the last years, debt as a percentage of GDP has increased from 37% in 1998 to 45% last year. However the current Superminister, Cavallo, has, through incredible skilful manoeuvring of the political and financial scene, gained space to try some radical measures to regain growth. Very little is known of the proposed plans, but they may prove to be the confidence catalyst needed by the Argentinean consumers, and more importantly, investors, to start spending again.
Chile, which is rated A-/Baa1 on its foreign debt, is not exactly an emerging economy. Successive reforms have achieved a high degree of macroeconomic stability. The country consistently runs fiscal surplus and low current account deficits. Current account deficit was covered five times by FDI in 2000. GDP growth has averaged 3.9% per year in the last four years. For 2001 we are expecting a 5% growth rate, slightly below last year’s 5.4%.
The hard currency debt of the Latin American countries has proved to be a good way to play the attractive prospects of the region. To put things in perspective, a comparison of the return and volatility of the Emerging Markets Bond Index (EMBI) against some major developed world stock indexes is useful (see table).
As can be seen the extremely high volatility of the hard currency debt has been more than adequately rewarded by very positive returns. Current yield of the index is more than 12%, which represents more than 7% over US Treasuries. This provides a very ample cushion against market turmoil and an extremely attractive return in a time of reduced investment opportunities.
Latin American equity markets performance during 2001 has been remarkably good, especially when compared with the world major equity benchmarks. Latin American equity markets have outperformed all of them.
The most powerful driver of equity performance going forward is, in our view, the result of the radical transformation the region has experienced over the last 10 years. On the political and social front this means public claim for democratically elected governments, with increased accountability, as well as demands for more transparent and better disclosure of administration results and figures.
On the economic front, transformation has included a reduction in inflation levels coupled with free-floating currencies allowing for more normalised interest rates as well as lower fiscal deficits and increased privatisation of state companies helping to reduce the overall debt load. And this driver, namely a “sound foundation”, has been built over a long time, with ups and downs along the road, but in a firm and continuous way. This trend favours equity performance, as a solid base allows for a lower risk premium, and thus, an equity market multiple re-rating process. Some countries are more advanced than others on this transformation path, but we see it spreading and deepening over time. So not to consider Latin American equities could lead to missing one of the greatest convergence stories of the century.
Santiago Rubio is head of fixed income, credit markets and Elena Eyries is head of Latin American equities at Santander Central Hispano Gestion in Madrid