By Jorge O. Mariscal, regional chief investment officer of emerging markets at UBS
EXTERNAL CONDITIONS present challenges and opportunities for Latin America in 2014. On the bright side, the strong pick-up in growth in the United States and a moderate recovery in Europe, as well as expected robust levels of activity in China, augur well for the region.
On the other hand, international funding conditions will likely become less favorable considering that the U.S. Federal Reserve will continue to retire monetary accommodation gradually, though Europe and Japan are expected to maintain their loose policy stance. Lower commodity prices will most likely weigh on the region’s economic performance as the commodities super-cycle is undergoing a pause that is expected to last another two years.
Overall, we still forecast growth in Latin America to accelerate moderately to 2.9 percent in 2014, from 2.4 percent in 2013, but the risks are clearly biased to the downside.
Major differences, however, remain within Latin America on how countries respond to their respective challenges. Policy choices in Mexico and the Andean countries lean toward market mechanisms. Argentina and Venezuela have thus far preferred to rely on government intervention, crony capitalism and populist policies. Brazil stands somewhere in between the two groups, but has certainly, under President Dilma Rousseff’s administration, moved closer to the latter than to the former.
MEXICO: Market momentum
In Mexico, the stars have realigned on the back of a cyclical re-acceleration paired with encouraging structural reforms. With a positive view on the Mexican sovereign, it is expected that the country will receive a credit rating upgrade in the next 12 months on top of the one recently granted by Moody’s, which drew some skepticism of not being fully priced in. A rerating of Mexican equities is also justified as the energy sector’s new regulations were positively surprising, allowing for broad private participation, and thus higher potential long-term gross domestic product growth. Mexico’s equity market valuation premium is explained by a more defensive sector composition with less exposure to commodities than many of its Latin American peers. The Mexican peso is also among the preferred currencies in emerging markets.
CHILE, COLOMBIA and PERU: Stable but slower
As a consequence of the moderate deterioration of terms of trade in the Andean countries, growth in Chile, Colombia and Peru is expected to stabilize at levels lower than those witnessed in the decade before the financial crisis. No major macroeconomic troubles, however, are expected in a region characterized by healthy public finances, safe levels of international reserves, anchored inflation expectations, moderate current account deficits funded by foreign direct investment flows and floating exchange rate systems.
BRAZIL: Uncertainty and underperformance
Brazil’s economic underperformance in the past three years is closely related to the exhaustion of the consumption-driven model and to low investment levels. Output is set to remain below structural potential in the medium term as political uncertainty related to the October 2014 presidential election and stronger government intervention weighs on the economy. Structural imbalances and weak fundamentals remain a concern for the currency. Over the medium to longer term, therefore, the Brazilian real will continue its depreciation trend, at least as elevated inflation rates erode recent improvements in competitiveness.
VENEZUELA and ARGENTINA: Decline and distress
In Venezuela and Argentina, fundamentals are deteriorating rapidly. Governments have pursued policies focusing heavily on fiscal expenditures, subsidies, price and foreign exchange controls, nationalizations and non-independent central banks. The political dividend of staying power these policies initially paid their rulers is collapsing economically: The peso and the bolivar are under pressure, foreign exchange reserves are shrinking, inflation is soaring, and economic activity is contracting. As a result, social tensions have been increasing in both countries. Necessity is the mother of invention, and since social unrest has spiked, authorities have shown signs of more pragmatic policy making. In particular, they have introduced measures to liberalize the foreign exchange markets. These are steps in the right direction but they are not enough.
Like-minded countries have also clustered into two distinct clubs. Mexico, Colombia, Chile and Peru are strengthening their economic links through the Pacific Alliance. Argentina, Venezuela and Brazil, on the other hand, belong to Mercosur, a failed trade zone where group exports as a percentage of total exports of member countries has decreased since 2000.
This seems to indicate that although the continental divide will be reflected in this year’s economic performance, the diverging path followed by these two country groups may extend well beyond 2014. That is, unless Brazil, Argentina and Venezuela finally stop postponing the decision to tackle their structural problems and allow the markets to play a larger role in the economy.
Jorge O. Mariscal, regional chief investment officer of emerging markets at UBS, leads the development of wealth management investment views on emerging markets across different asset classes and geographical regions. Prior to joining UBS, Mariscal was a partner and chief investment strategist at The Rohatyn Group, a multibillion dollar, New York-based asset manager focused exclusively on the global emerging markets. Mariscal was a managing director at Goldman Sachs, where he coordinated the firm’s emerging markets investment research products and served as chief equity strategist for Latin America. He earned a bachelor of arts in economics from UAM University Mexico City and a doctorate in development economics and international finance from New York University. Mariscal also teaches emerging financial markets at the School of International and Public Affairs at Columbia University in New York.
This story is from the May 2014 issue of Ignite magazine, YPO’s exclusive member publication. Members, read the magazine online and explore YPO’s partnership with UBS.
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