Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
AmericasMarch 1 2016

Latin America enters a new age of pragmatism

Economic difficulties and low commodity prices are forcing Latin America into a new age of pragmatism, as populist policies fall out of favour amid stagnant living standards, and worries emerge about the region's reliance on Chinese investment.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Latin America enters a new age of pragmatism
GET-LatamChina_700p

Latin America’s ample natural resources have been both a blessing and a curse. They have invigorated commodities exporters during the good times, but had a torpid effect on many governments’ reform agendas. And, over the past decade, the commodities-fuelled economic boom experienced in the region has helped bring about a new era of populist rhetoric that has failed to permanently tackle the regime’s social inequality.

Now that oil prices have dived and global demand for raw material is languishing, governments’ balance sheets are struggling to attract the international capital they need. Discontent with political leaders is also palpable. From the result of Argentina’s presidential election and its new pro-market agenda, to Venezuela’s angry turn against the ‘Chavista’ government whose policies led to a 720% inflation rate, to Brazilians’ indignation at the widespread corruption scandal that has brought the country to a standstill, Latin America appears to be at a turning point, with its most troubled economies attempting to build a sustainable way out of this crisis. 

“When you look at the anti-Washington Consensus crowd, those countries that opposed neo-liberal economic policies, the results speak for themselves: weak or failed economic policies, the political backlash against those policies, the market access consequences of those policies,” says Jay Collins, Citi’s vice-chairman of global banking. “The best example is the enormity of the change in Argentina as a representation of not only the failures of the past but also the enormous potential of what that means, not just for Argentina but for the region.” 

Budget strains

Many Latin American economies rely on exports of natural resources. In Brazil, according to official statistics, oil represents about 13% of the country’s gross domestic product, while raw material exports account for just under half of cross-border sales. The corruption scandal that has paralysed the country is centred on oil; it originated from endemic bribery related to state-owned oil giant Petrobras.

In Venezuela, oil makes up 95% of exports. With crude prices stalling at $30 per barrel, falling revenues are further straining budgets. The country owes as much as $10bn in foreign bond payments this year and markets are anticipating a default – prices for many of its bonds due after this year were trading at distressed prices, between 32 cents to 37 cents on the dollar in mid-February.

But it is not just commodities that are affecting the region’s economic health. International finance is as crucial to Latin America as international trade. While investment banks easily raised funds for the resource-rich sovereigns during the commodities boom, this task is set to become much more difficult this year and beyond. The absence of these deals is an indication of sovereigns’ reduced appeal. 

“Be it capital markets or lenders, I don’t see the external, international banking system doubling down in the region in this environment. I see prudent, cautious behaviour, opportunistically jumping in where policy measures and market opportunities are clear; but this is definitely a cautious environment. I can count four sovereign deals so far this year, so there isn’t a lot getting done,” says Mr Collins.

China’s influence

At the same time, funds made available by other sources, such as China, are plentiful. This can be both a cause for celebration and a concern. China is widely perceived to have a different perspective on foreign investment and arguably looser requirements than the international community when it comes to governance and social and environmental impact. Given the position Latin America finds itself in, both economically and politically, this risks creating a vicious cycle.

“Certainly China has facilitated, particularly in Venezuela, prolonged unfortunate policy-making and has potentially prolonged [president Nicolás] Maduro’s ability to stay in power,” says Margaret Myers, China and Latin America programme director at think-tank Inter-American Dialogue. “Who knows what would have happened without Chinese finance?” 

In 2015, Latin American and Caribbean sovereigns raised a total of $33.4bn in the capital markets and some $786m from bank syndicated loans. In the same year, China’s government banks lent $29.1bn to the region’s governments, according to data from the Inter-American Dialogue. This is more than the combined loans to the region by the World Bank and the Inter-American Development Bank. Furthermore, China has recently announced the creation of $35bn-worth of funds that Beijing intends to dedicate to Latin American infrastructure and other projects.

Since records began in 2005, China has lent a total of $65bn to Venezuela. One-third of last year’s Latin America-bound funds went to the country, with about the same amount flowing to Brazil. 

While capital markets reward governments that undertake orthodox macroeconomic practices, thus creating a virtuous cycle by allowing those countries to invest further in their well-managed economies, this is not necessarily the case when China is the lender.

The list

Ms Myers flags this as a concern. Some Latin American governments solicit financing by presenting a list of projects to China. The worry, says Ms Myers, who has seen one such list, is about the lack of scrutiny of the feasibility, utility or even environmental impact of such investments to the local economy by those governments. “There is a sense that there is a high degree of corruption involved in even selecting some of these [projects] for financing,” she says.

While a traditional investor or investment bank is likely to shy away from projects where reputational risks are too high, China may take other considerations into account. A Chinese government-sponsored investor confirms that the ‘list’ is a preferred way to work with the region. “Our activity depends on government bilateral [relationships]. Two governments talk, they produce a list, each side puts up some projects it is interested in, and then we [the investors] will select from that list. We can get deals from the market or we can select projects from governments’ [lists],” says the investor, adding, with specific reference to Petrobras: “In Brazil, now is a good time for us to get good bargains.” 

In Argentina, under former president Cristina Fernández de Kirchner, the government signed a bilateral agreement on economic co-operation and investment with China, which was approved by Argentina’s congress in March 2015. According to the agreement, Chinese corporations need not bid publicly for infrastructure projects if Chinese banks offer project financing. Furthermore, the governments of the two countries can sign additional agreements to launch public works projects without Argentina’s congressional approval. 

Ms Myers says: “We had a big meeting [at the Inter-American Dialogue earlier this year] to try to understand China’s effects on regional standards on a country-by-country basis and on regulation and policy-making. The one country that featured more prominently in that discussion was Argentina.”

On the other hand, anecdotally, when China has approached more orthodoxly governed countries, such as Chile and Peru, its investors were surprised to find that no ‘list’ existed, according to Ms Myers. With a new, market-oriented government, the tune might change in Argentina too.

However significant Beijing’s involvement with Latin America has been, it may not leave a lasting impact. “[China] has some influence as a lending partner, clearly it has helped Venezuela. In fact, it continues to assist Argentina. But it is not clear to me that it moves the needle that much,” says Gabriel Torres, a senior analyst at Moody’s. “The biggest way that China influences Latin America is in the way it influences the price of commodities.” 

Political change

The year ahead looks set to be characterised by yet more low economic growth, both in Latin America and globally. However, new policies may emerge that could have very long-lasting effects on Latin America’s development.

Political populism is common in Latin America. It has been used by both left-wing and right-wing parties for decades, and has largely played on the region’s acute levels of inequality, which although improving remain the world’s highest, according to the International Monetary Fund. Populism had found particularly fertile ground in countries awash with natural resources, where, in good times, export revenues have delivered on the promises of populist politicians.

Latin America and the Caribbean will complete their latest election cycle this year, with presidential elections taking place in Peru, the Dominican Republic and Nicaragua, at a time when commodity and oil prices remain depressed. None of these countries have a recent history of appointing populist leaders.

More importantly, however, the first half of 2016 will be crucial for a number of other economies. In Brazil, president Dilma Roussef may face impeachment in connection with the Petrobras scandal; her approval ratings have been plummeting since she began her second term one year ago. In Argentina, Mauricio Macri’s administration will have to deliver on its front-loaded adjustment programme and, crucially, on a resolution with the holdout creditors from the country’s 2002 sovereign debt default – until then Argentina is effectively cut off from international markets. And in Venezuela, there will likely be clashes between President Maduro and the country’s opposition, which now, for the first time in 16 years, controls congress.

“Governing [a Latin American country] in the past decade was relatively easy; now governments face much more complex situations,” says Daniel Zovatto, non-resident fellow at US think tank Brookings Institution and regional director for Latin America and the Caribbean at the International Institute for Democracy and Electoral Assistance. “[But this] can also create opportunities. The decreasing popularity of presidents helps avoid succumbing to the pathological deviance of Latin America, the ‘hiper-presidentes’.” ‘Hiper-presidentes’ are heads of state who succeed in repeatedly winning elections and, in some cases, influence legislative as well as judicial powers. Venezuela is a prime example of this.

Thus the ability of the region’s presidents to retain voters’ support while taking pragmatic and sometimes tough decisions will be tested this year.

The pink tide 

Recent election headlines in Latin America have a very different tone from those printed a decade ago. Then, talk was about the revival of populism and the rise of the so-called ‘pink tide’ – a term borrowed from a natural phenomenon of a type of red algae that colours sea shores and which hints at a watered-down communist red. In 2006, Bolivia’s Evo Morales and Nicaragua’s Daniel Ortega joined Venezuela’s Hugo Chávez, Argentina’s Nestor Kirchner and Brazil’s Luis Inácio Lula da Silva in what was perceived to be Latin America’s shift to leftist ideology. But as there were differences among left-wing governments a decade ago, there still are today. 

“In 2006 we had this pink tide, but if you look at the actual policies, the only two countries that had very market-unfriendly approaches were Venezuela and Argentina. Ecuador, Nicaragua and Bolivia did not,” says Mr Torres. “They had different approaches, not all necessarily 100% orthodox, but if you look at how Bolivia is ending the commodity boom, it has a lot of savings, never let inflation get out of hand and has been running fiscal surpluses.” All the same, Bolivian voters rejected in a February referendum to allow Mr Morales to run for a fourth term.

Initial market fears over Mr Lula’s re-election in Brazil in 2006 were also misplaced as he adopted a far more pragmatic rule than his role as founder of the Partido dos Trabalhadores left-wing party would have suggested, and he maintained some of the market-friendly reforms introduced by his predecessor, Fernando Henrique Cardoso.

Although the message of the pink tide was essentially a protest against the Washington consensus, left-wing ideology did not always completely disregard mainstream macroeconomic policy. On the other hand, the countries that engaged in lax fiscal and inflation management, that controlled interest rates and exchange rates, enacted nationalistic policies and strengthened a broad-based system of subsidies instead of targeting investment programmes, are now struggling to stay afloat. Venezuela’s Mr Maduro is continuing to use the same rhetoric as the country’s late president and populist supremo Hugo Chávez, and some fear that his economy may be the first to collapse.

“There is a perfect storm in certain countries: economic slowdown, corruption scandals, presidents with lower popularity levels, which mean lower political capital and higher social conflict,” says the Brookings Institution’s Mr Zovatto.

This social conflict has the potential to see the army become the arbiter – or barometer – of the situation. Late last year in Brazil, the armed forces warned about civil unrest, while the outcome of the Venezuelan economic crisis may depend on whether the army will be willing to repress street protests or not, according to Kevin Casas-Zamora, the Inter-American Dialogue’s director of its Peter D Bell Rule of Law Programme and former secretary for political affairs at the Organisation of American States. “If [the Venezuelan army] refuses to engage in repression, that would be a very powerful signal that its support for the government – a very solid assumption so far – is not that solid any more. That would be a game-changer,” he says. 

Argentina turns right

Further south in the region, the game has already changed. In a historic vote in October 2015, Argentinians replaced populism with pragmatism at the polls. The former mayor of Buenos Aires, Mr Macri is the first centre-right leader in Argentina for 12 years and only the third leader since the end of military rule in 1983 not to come from the populist Peronist party.

One of Mr Macri’s most acclaimed decisions was the appointment of an all-star economic cabinet led by Alfonso Prat-Gay, a former JPMorgan executive and central bank governor. But to reinvigorate the economy, which has been racked by double-digit inflation and heavy-handed state intervention, they will need as much political ability as technical skill, because of Mr Macri’s fragile majority in congress. 

Before even attempting to kick-start growth, the government will have to settle the long-standing and high-octane dispute with the holdout creditors from Argentina’s defaulted debt in 2002. In February, things moved a step closer to resolution when Argentina resumed negotiations and offered a $6.5bn deal to holdouts.

The new government will also need to face the opposition’s request to devolve additional state funds to the more powerful provinces while also reining in public spending and dealing with an 8% fiscal deficit. It has already reduced subsidies and relaxed state intervention in financial markets.

“This is arguably the best economic cabinet in Latin America or even in emerging markets over the past decade,” says Edwin Gutierrez, the head of emerging market sovereign debt at Aberdeen Asset Management. “[But Mr] Macri knows he has a very fragile majority. If the economy does not revive in one year, the honeymoon period, the luna de miel, is over and the Peronistas will come out.” 

International lenders have made their approval known for Argentina’s new regime. At the end of January, HSBC, JPMorgan, Santander and other banks granted a bridge loan to Argentina’s central bank, which replenished its foreign exchange reserves to more than $30bn. The claims of the holdout creditors are estimated to be about $20bn. 

The new government is also to the liking of the local banking community, which sees the restrictions imposed on it as more reasonable. Banco Galicia’s chairman, Sergio Grinenco, points out that although certain interest rates are still capped, limits were revised and other measures muted. “The new objectives are pretty much in line with where the system is today,” he says.

No quick fix

It will not be easy to adjust the economy to more orthodox rules and bring back Argentina from the edge of economic catastrophe, however. “It takes time to tackle a situation like the one this government has inherited,” says Mr Grinenco. “The economy had not been growing for the past four years, with no generation of employment by the private sector, only by the government, and a high fiscal deficit [that] was financed through the central bank. Fiscal and monetary conditions were very difficult.”

So while in the past decade political ideology had dictated the economic fate of many countries in Latin America, it is now worrying economic figures that are forcing political change. Tolerance for the abuse of power and corruption has significantly reduced. The current global environment of low oil and commodity prices may be forcing a painful lesson on those countries that had not prepared for harder times, but they may emerge as much more solid states at the end of it.

As the president of the Inter-American Development Bank, Luis Moreno, says: “We Latin Americans perhaps are better at managing crises than we are at managing prosperity, and it is in times of crisis that Latin America has always turned itself around.” 

Was this article helpful?

Thank you for your feedback!

Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
Read more articles from this author