After a year of relative stability, Latin America is heading into
uncertain times in 2006.
At best, Latin Americas prospects for this year could be described as mixed. While the economies of countries such as Brazil and Colombia are becoming increasingly prosperous and robust, their neighbors, including Argentina and Venezuela, are anything but stable.
Argentina is among those countries giving investors most cause for concern. In a move that was widely criticized among investors, Argentine president Nestor Kirchner in November replaced Roberto Lavagna as economy minister with Felisa Miceli, the head of state bank Banco de la Nacion Argentina. Although she has been a protg of Lavagna, Miceli is seen as more leftist and market-critical than her predecessor.
The recent change of guard at Argentinas economy ministry has generated growing concern among investors that the South American country, the regions third-largest economy, will expand public expenditure, weaken fiscal discipline and lose its struggle against ever-rising inflation. What worries us is that theres a lack of a concrete macroeconomic reaction to the inflation, says Gustavo Caonero, the Buenos Aires-based chief Latin America economist for Deutsche Bank. Its nothing compared with what we saw in the past, but its a risk we hadnt expected to see.
Until 1991, when the country introduced a so-called convertibility law that pegged the peso to the US dollar, Argentina had experienced years of hyperinflation. The law was scrapped in 2002 in a move that coincided with Argentinas massive debt default. The outlook is one of slow deterioration from today because of a shift to more populist policies with the new minister of [economy], says Paulo Leme, the Miami-based managing director for emerging markets at Goldman Sachs. Instead of taking advantage of a positive external environment and strong local growth to implement further market reforms, the government is going the opposite way, Leme points out.
Our concern is that inflation will rise, and substantially, probably rising to 14% [in 2006], Leme says. While the price controls were expected to help reduce inflation at the end of 2005, prices will probably again pick up in the first quarter of 2006, predicts CSFB analyst Carola Sandy.
However, Caonero believes that apart from the rising inflation, Argentina still has much to brag about. The real economy is still growing strongly, he says, forecasting a GDP growth of around 6% in 2006. By comparison, Latin America as a whole should grow by 3.8% in 2006, the IMF forecasts.
Latin Americas two largest economies, Brazil and Mexico, may also see some turbulence in advance of their presidential elections, scheduled for October and July respectively. There will be some market volatility until the elections [in Brazil]. The political dispute will create uncertainty, but not of the magnitude of the last election, Leme says, referring to the massive capital flight seen in Brazil when Luiz Incio Lula da Silva was heading all polls ahead of the 2002 elections.
Despite overseeing a remarkable turnaround in his countrys economy, Lula might not win reelection. Observers such as Leme are expecting a win for the opposition PSDB, whose likely candidate will be So Paulo mayor Jos Serra, who is popular among investors.
Even if the countrys leadership changes, investors will be unlikely to suffer. You wont see any big changes in Brazil after the elections,Caonero says. He expects continued declines in inflation and interest rates combined with good foreign trade growth to produce a GDP expansion of 3% or more. The economic fundamentals continue to be very favorable, although its fair to say that some election-related news could impact the markets leading up to the polls, he says.
Mexico Braced For Volatile Times
In Mexico, however, the likely outcome of the election is spreading anxiety among investors. That election will also generate substantial market volatility, particularly because it will be a very tight election similar to what weve seen at the gubernatorial level, with margins of less than 2% for some winners, Leme points out. That will generate volatility. As in Brazil in 2002, having as leading candidate a leftist politicianAndrs Manuel Lpez Obradoris generating some concerns. He is unproven, untested, [and] we dont know what policies he will pursue, says Leme.
Many economists in and outside of Mexico have warned of potential negative fallout from a victory by Lpez Obrador. This might play into his hands, of course, as expectations will be low when he takes office. He also would be stepping into the shoes of Vicente Fox, a president who many criticized for being too weak and failing to push through key economic reforms, Caonero comments. In fact, many observers believe the opposition PRI party, which ruled Mexico for 71 years until 2000, is capable of pushing through key reforms if their candidate is elected.
While the election is sowing doubt among investors, few expect a repeat of the 1994 Tequila Crisis, when the peso plunged. According to Leme, Mexicos economy is solid enough and its fiscal policies are robust enough to weather the potential pre- and post-election turmoil. Most analysts expect the currency to weaken but for the countrys economic expansion to continue, posting perhaps 3% growth in 2006. Theres going to be uncertainty [but] overall substantial strength, Leme says.
Elsewhere in the region, similar uncertainty prevails. Caonero sees major improvements in Colombia in 2006. The likely re-election of Alvaro Uribe as the countrys president in May 2006 will result in a significant boost to Colombias economy, which needs to deal with fiscal imbalances and high external account deficits, he says.
Venezuela, another key economy, is causing mixed feelings among economists, however. On the one hand, the countrys massive oil revenues are seen as a boon. On the other hand, the rapid spending of those revenues is seen as a negative. Political uncertainty as president Hugo Chavez increases his power at the expense of independent institutions, coupled with rising attacks against local and foreign investors, is also raising concern.
Under Chavez, we expect Venezuelas credit fundamentals to continue to deteriorate over the long term, owing to intensifying price controls, the public sectors expansion into numerous non-oil sectors, and the weakening of the investment climate, legal framework and transparency, CSFB analyst Cem Karacadag wrote in a recent research report.
Overall, Latin America should see good growth this year, helped by the outlook for the global economy and higher commodity prices. In terms of growth liquidity, in terms of market performance [and] currency debt, its going to be hard to replicate the outstanding performance of 2005, [but] overall there will be positive returns, Leme says. Caonero believes the first half will see the strongest growth, followed by a weaker second half. We see a very favorable development, he concludes.