Publish in Perspectives - Wednesday, February 19, 2014
Mexican President Enrique Pena Nieto is attracting investor enthusiasm while Brazilian President Dilma Rousseff continues to lose investor favor. (Photo: Ricardo StuckertJr/Brazil President's Office)
The Rousseff administration has responded to Brazil’s poor growth and higher inflation with mostly the same policies that it has pursued over the last three years.
BY JOHN H. WELCH
In Latin America, 2013 marked a year when good and bad economic and market performance were determined by good and bad policy. This separation resulted partially from global stability. There was no large trend upward or downward in commodities prices. The U.S., Japanese and European economies continued on a path of slow recovery, although at different paces, and China's economy stabilized at a lower, but still high, growth rate. Hence, the environment was ripe for a delineation of performance according to types of policies. The prospects for 2014 will fall along the same lines, especially in the face of less monetary accommodation in the United States. Those countries that have pursued responsible policies will weather the increase in interest rates much more robustly than those countries that have not.
Unfortunately, much policy debate since the 2008-09 crisis has centered on ideological mudslinging between the so-called developmentalists and neoliberals. When faced with deteriorating economic performance, policymakers in Argentina, Brazil, Bolivia, Ecuador and Venezuela continued to double down on the very policies that had led to their poor performance, such as increased government intervention, loose fiscal policy, protectionism and loose monetary policy. Brazil is now part of this group of countries because the policies that the government has pursued since 2008 virtually assure a one-notch ratings downgrade and have made a two-notch downgrade, to below investment-grade, significantly more likely.
Contrast these countries' performances with that of the countries that have pursued responsible fiscal, monetary and trade policies, such as Chile, Colombia, Mexico and Peru. Despite the fact that most of these countries have had, or will have, center-left governments, they have stuck to the fiscal straight and narrow, along with continued reform. Good economic performance has followed, with approximately 4.5 percent (unweighted) average growth. These countries are well positioned for even better economic performance in 2014, and market performance should follow.
The overall asset performance in Latin America in the second half of 2013 became hostage to the fears that the U.S. Federal Reserve would "taper" its asset purchases. The first (over) reaction occurred mid-year, when Federal Reserve Bank Chairman Ben Bernanke suggested the possibility of reducing these asset purchases. Images were conjured up of selloffs and blowups in emerging markets following the Fed tightening of 1994-95. Those started with Orange County's default in Q2/1994, and exploded with the Mexican devaluation and float in December of the same year. In June 2013, emerging markets, following their 1994 pattern, sold off and the U.S. dollar strengthened dramatically. As the market became more accustomed to the idea of U.S. Fed tightening, selloffs close to its Federal Open Market Committee (FOMC) meetings became less intense. The Fed then decided not to taper, despite the fact that the market was ready for it to do so. The strong rally in growth markets that followed in this earlier example means that we will likely go through the same process all over again. Now that the market has started to discount a December tapering, value has once again returned to growth markets, credit and currencies.
As in 2013, the relative performance of Latin America's asset markets in 2014 should reflect these policy differences. In the group of Latin American (LATAM) countries in our focus - Brazil, Chile, Colombia, Mexico and Peru - Brazil was the largest underperformer both in credit and in rates, as we had anticipated in our 2013 publication.
GROWTH SLOWS BUT REMAINS ROBUST
The performance of LATAM assets has followed economic performance. (…) Latin American real GDP growth is slowing and that Brazil is a major underperformer. From a market standpoint, (…) Brazil has underperformed the other low volatility countries, Chile, Colombia, Mexico and Peru, as measured by five-year credit default swap (CDS) spreads. (…) High-beta Argentina and Venezuela have underperformed all countries, including their European counterparts. The continued radicalization of economic policy in Argentina, in addition to the recent ruling by the New York courts, which found in favor of the holdout bondholders, has made a technical default a high-probability event. Meanwhile in Venezuela, economic policies have deepened the country's challenges.
And in Brazil, after feigning a change in direction on policy, the Dilma Rousseff administration has responded to poor growth and higher inflation with mostly the same policies that it has pursued over the last three years. Despite clear signs that higher protectionism, government intervention and loosening fiscal policies have hurt growth, the Brazilian government continues to provide demand-side stimulus. One good sign is that the central bank is tightening monetary policy, but loose fiscal and public-sector credit policies make the central bank's task all that much harder. Fiscal looseness has helped erode external accounts by making imports increase unsustainably and has put Brazil on a collision course with at least one downgrade in 2014 and a possible second downgrade if policies do not change significantly. Unfortunately, the 2014 World Cup in June and July and presidential elections in October 2014 substantially reduce the possibility of policy change.
Chile, Colombia, Mexico and Peru in contrast, have continued to pursue prudent monetary, fiscal and trade policies. Peru and Chile are running virtually on autopilot as their openness, overall fiscal surpluses and good growth rates do not require major reform efforts. Colombia has implemented a number of reforms, including tax reform, but further efforts should wait until after the 2014 presidential election. The new administration of Enrique Peña Nieto in Mexico has passed a number of important initiatives including education, labor and media reforms. In addition, the recent energy reform passed by the Mexican Congress opens up energy - that is, oil and electricity - to foreign investment for the first time in more than 80 years. We remain strongly constructive on Mexico's asset markets for 2014.
The prospects for the region for 2014 and 2015 follow directly from the policies put in place over the last few years. And poor performance, at some point, should force a change in policies in those countries that have strayed from the responsible path. That keeps us constructive on the region in the medium-to-long-term. (…)
The recent cycle of commodities boom and consolidation shows conclusively that good policy matters. Those Latin American counties that followed responsible fiscal, trade and monetary policy have fared well in this turbulence, namely Chile, Colombia, Mexico and Peru. Those that have not, however, are suffering despite commodity prices remaining at a high level. And those countries that have gradually moved away from responsibility, namely Brazil, are suffering proportionately. The last three decades, however, show that in the functioning democracies of Latin America, such poor performance at some point creates political pressure to move in a more responsible direction. We expect a convergence of policy and performance to the better for all of Latin America.
H. Welch is executive director and the emerging market
macro strategist for CIBC World Markets in Toronto, Canada. His primary
responsibilities encompass global sovereign and macroeconomic research with
special emphasis on Latin America and Brazil. Prior to joining CIBC, he held
senior positions at Macquarie Capital, Banco Itaú S.A., Bear Stearns, Lehman
Brothers and Barclays Capital BNP Paribas. He served as senior economist with
the Federal Reserve Bank of Dallas.
This column is an excerpt from the Perspectives on the Americas series from the University of Miami’s Center for Hemispheric Policy. Republished with permission.