Key Themes For 2014: Progress Report
In December 2013, we identified seven key themes we expected to play out in Latin America and the Caribbean throughout 2014 ( see 'Our Key Themes For 2014', December 11 2013). Now, a little more than halfway through the year, we believe that five of these themes have played out or are currently playing out, one is still likely to come to the fore this year, and two are unlikely to play out before year-end. Below we assess where we stand at present.
Key Themes Currently Playing Out
Economic Rebalancing Has Further To Run: Beginning in 2013, slowing Chinese metals demand and falling industrial metals prices saw significant exchange rate depreciation and external account deterioration in a number of Latin American economies. We expected these dynamics to continue playing out this year, as major regional metals exporters such as Brazil, Chile, and Peru adjusted to a lower demand environment.
Slowing Chinese metals demand and falling industrial metals prices have had the most prominent impact on the Chilean economy in the year-to-date. The Chilean peso remains among the worst-performing major Latin American currencies in spot return terms so far this year, and we foresee further depreciation in the coming months. A weaker peso will drive a contraction in goods imports this year, while bolstering the competitiveness of the country's manufactured goods exports, underpinning our forecast for the country's current account deficit to narrow from 3.4% of GDP in 2013 to 1.8% in 2014 and 1.1% in 2015 ( see 'C/A Deficit To Narrow As Economic Rebalancing Takes Hold', June 30).
|Chilean Rebalancing Under Way, Brazil Stalled For Now|
|Latin America - LCY/USD Spot FX Returns & Exchange Rates, Dec 31 2013=100|
In contrast, Brazil has seen relatively limited progress on economic rebalancing this year. The exchange rate has gained 6.3% in spot return terms in the year-to-date, bolstered in part by an aggressive monetary tightening cycle between April 2013 and April 2014. While we expect currency weakness to be limited in the near term, as the central bank remains wary of the inflationary impact of FX depreciation, poor balance of payments dynamics will help drive further depreciation over a multi-quarter period ( see 'BRL: Depreciatory Trend To Persist', July 8). With demand for Brazil's iron ore exports to remain more moderate and manufactured goods exports unable to pick up the slack, we forecast Brazil's goods trade balance flipping into deficit for the first time in over a decade in 2014, and the current account shortfall to widen from 3.6% of GDP in 2013 to 3.7% in 2014 and 3.9% in 2015 ( see 'External Account Set For Further Deterioration', July 2).
A More Challenging Policy Environment: Slowing growth, reduced purchasing power, and concern about the redistribution of resources from the commodity boom have remained a catalyst for protests in recent months. Moreover, with easing cycles in a number of regional economies having run their course, we believe fiscal policy will remain the tool of choice to address many of these issues. However, with increasing competition for investment within Latin America, we believe that governments will be challenged to meet the demands of domestic constituents and foreign investors.
While protests in Brazil during the World Cup were primarily related to the high level of spending on the tournament itself, we believe that public concerns about the poor quality of public services and government transparency will remain drivers of demonstrations in the coming months. Rolezinhos, large public gatherings of urban (often poor) youths, have also heightened tensions between social classes, bringing the country's income gap into focus once again. In Peru and Chile, still significant income inequality, reduced purchasing power and slowing growth will continue driving social instability ( see 'Mining Sector Tensions And Rising Disapproval To Increase Political Risk', May 22).
Shifting To More Pragmatic Economic Policies: The prospect of lower export revenues and greater competition for investment will continue to drive more pragmatic economic policies in a number of Latin American countries. The Pacific Alliance trade bloc, which comprises Peru, Mexico, Chile and Colombia, has already made considerable progress on breaking down tariff and non-tariff barriers, and we expect the bloc to remain a major driver of pragmatic economic policies in Latin America ( see 'Pacific Alliance: Integration Paves The Way For Enhanced Competitiveness', March 12). In addition, Ecuador re-entered capital markets this year for the first time since the country's 2008 default, in line with our long-held view. We expect the government to continue inching in a more investor-friendly direction, as declining revenues from oil exports and a widening budget balance necessitate increased external funding in the coming years ( see 'Public Policy To Inch In An Investor-Friendly Direction', June 18). Paraguay is another country that has seen a continued move in an investor-friendly direction in recent months, under the leadership of new President Horacio Cartes, whose fiscal reforms have helped to make the country's sovereign debt a strong performer in the year to date ( see 'Sustained Fiscal Improvements To Narrow Budget Shortfall', May 13).
Argentina May Have Reached An Inflection Point: The Argentine government has taken a number of steps in recent months that reinforce our view that a policy pivot is under way. These include a move towards reporting more accurate inflation statistics, a deal with the Paris Club group of lender countries to repay USD9.7bn of debt in the next five years, and sustained improvements to the business environment for oil and gas companies ( see 'Paris Club Deal Reinforces Policy Pivot', June 2). The most significant risk to this view remains the ongoing negotiations between Argentina and holdout investors regarding payments on the country's restructured debt, as a court ruling now forces the government to pay all bondholders or none. We believe that a negotiated settlement with holdout investors remains the most likely outcome ( see 'Debt Deal Likely, But Default Risk Substantial', July 28). However, with the deadline for a settlement - July 30 - imminent, we cannot rule out the possibility of negotiations failing and the Argentine government entering technical default.
Still Likely To Play Out
Additional Credit Events In The Caribbean: This theme has yet to play out this year, but with little improvement in the balance of payments positions or growth outlooks for a number of small Caribbean economies, we continue to see an elevated risk of credit events in the latter half of this year. We have previously highlighted Dominica as highly vulnerable given its wide twin deficits - the budget balance was 8.3% of GDP in 2013 and the current account shortfall was 14.5% of GDP. With growth set to remain tepid in the coming years, an economic shock could tip the balance for the country. Similar dynamics continue to impact Montserrat, which is set to run double-digit current account and fiscal deficits this year. We believe that the risks of a credit event in Barbados have receded in recent months. This is due to the implementation of fiscal austerity measures and our expectation that the current account deficit will narrow this year, driven by slower import growth and an uptick in tourist arrivals ( see 'Reserves To Stabilise in 2014, Increase In 2015', July 9 and 'Debt Rally Sustainable On Fiscal Austerity Measures', May 1). However, with the country's current account and fiscal shortfalls set to remain substantial, we cannot discount the possibility of a credit event.
|Still Highly Vulnerable|
|Caribbean - 2014 BMI Fiscal & Current Account Balance Forecasts|
Unlikely To Play Out
Venezuela's Commitment To Debt Payments In Doubt: We believe it is unlikely that the Venezuelan government will renege on its commitment to bondholders this year, as the government's introduction of two weaker exchange rates (Sicad 1 and Sicad 2) has reduced some of the pressure on its fiscal accounts in recent months ( see 'FX Policy To Relieve Some Fiscal Pressure', July 3). This has allowed the government to exchange US dollars earned from oil exports into local currency at a more favourable rate, increasing the spending power of the government at home. However, we do not believe that the government has made significant progress on addressing fundamental economic imbalances, which we expect to constrain real GDP growth in the coming quarters ( see' GDP Growth Constrained On Multiple Fronts', July 8). Moreover, we see little change in the government's antagonistic tone towards the private sector.
A Period Of Household Deleveraging Lies Ahead: This is unlikely to play out in a big way in 2014. Economic activity has remained weaker than expected in a number of Latin American economies, reducing the prospect of rate hikes, and a soft patch for the US economy in Q114 has tempered capital outflows from emerging markets. However, we continue to see potential for household deleveraging in countries such as Brazil and Chile in the next few years following a period of above-trend credit growth ( see 'Credit Cycle Analyst: Starting To Look Overextended', November 13 2013). Brazil remains particularly vulnerable to deleveraging owing to a significant increase in credit from public sector banks. Many of these loans have been offered at subsidised interest rates and have been the result of government pressure to boost lending and private consumption. While we believe that the central bank's rate hiking cycle topped out at 375 basis points in April, we expect the Selic rate to remain relatively high in the coming quarters, at 11.00% through to end-2014, before dropping to 10.00% by end-2015. This means that borrowers will have only moderate relief from high interest rates in the coming quarters, and given our view for weak real GDP growth, we cannot rule out deterioration in asset quality.