The tapering of the US Federal reserve's quantitative easing programme and a higher interest rates environment are mopping up liquidity from emerging markets, separating the top-in-class from the current-account-bingers. How does Latin America fare?

Emerging markets are going through tumultuous times, as the tapering of the US Federal Reserve's quantitative easing programme has exposed countries that have been overly reliant on portfolio flows – or ‘hot money’ – to fund their current accounts. Lower levels of global liquidity along with better growth prospects and higher interest rates in the developed world have provoked an emerging markets sell-off. The currencies of developing countries have plummeted along with bond prices and stocks. In the two weeks to February 7, 2014, investors removed $12bn from developing country equities, as reported by Bloomberg.

Until early this year, Latin America was represented in a group of countries known as the ‘fragile five’ – so-called because of their exposure to the Fed's tapering – by Brazil (along with India, Indonesia, South Africa and Turkey). Now fresh concerns have added protectionist Argentina as well as Chile, traditionally a poster boy for economic development in the region, to the larger group of eight – which includes Russia too.

Economists have resisted talking of contagion, but the readjustment in currency valuations and to a higher interest rate environment begs the question of which countries are simply re-adjusting, and which are in trouble. So which category do Latin America’s troublesome three fall into?

Argentina: under-achiever

Argentina was at the epicentre of the latest emerging market currency shock. The correlation to other Latin American or international economies should have been limited, or even non-existent, as Argentina has cut itself off from international markets and has been quick to raise trade barriers. Investors’ nerves, however, are easily shaken by unusually wide volatility.

After Argentina’s central bank decided to stop supporting the peso in late January to protect its foreign reserves, the currency dropped 15% against the dollar, shocking the market and causing the currencies of Turkey, Brazil, South Africa, India and Russia to all dive. Furthermore, many feared the move would not be enough to guarantee the government’s solvency on its international obligations. Yields on Argentine sovereign dollar bonds due in 2015 went up to more than 19%, the highest since 2012, according to Bloomberg.

"It’s funny to see that everybody is talking about Argentina,” says Citi’s emerging markets strategist Luis Costa. “Argentina has been a deterioration story for many years. Would I be a buyer now? I don’t think so. [Prices] will need to go way down before I’d be comfortable to go long [and buy Argentine bonds].” Mr Costa adds that Brazil is an example, although not the worst one, of a country with a “chronic current account problem that became fixed-income addicted and sold bonds to the world”.

Alejo Costa, head of strategy at Buenos Aires-based investment bank Puente, also points to Argentina’s longstanding problems. While the country runs a current account deficit that is not much larger than many others ($1.27bn at end of third quarter of 2013) its main problem is the government’s credibility. “After many years of highly expansionary policy in Argentina, both on the fiscal side and the monetary side, the country is now running a small current account deficit compared with other countries,” he says. “The problem is that its [economic] policy and lack of credibility have had an impact on inflows [needed to fund the deficit].”

In a recent paper, HSBC’s head of emerging markets research, Pablo Goldberg, offers his own grouping of developing countries. In this group – ‘the poor economic management club’ – Argentina is joined by Venezuela and Ukraine. The group is characterised by the monetary financing of subsidy-heavy fiscal deficits combined with an unwillingness to depreciate the currency, leading to rapid reserves losses. Argentina has relaxed its currency control, but is still in dire need of a complete overhaul of its macroeconomic framework, says Mr Goldberg.

Chile: the poster boy

Mr Goldberg’s other groups are ‘the high current account deficit and inflation club’, which includes Brazil and the other ‘fragile fives’; ‘the cyclical recovery club’, of which Mexico is a member; and 'the happy depreciation club', which is where the rest of Latin America resides. “These countries do not mind seeing their currencies depreciate as long as the move is orderly, and they eased monetary conditions in 2013. This has happened in Chile, Peru, Thailand and Israel,” says Mr Goldberg.

Chile has traditionally been a best-in-breed among emerging economies, thanks to its open-market policies and credible central bank, which is why some may have been surprised to see it mentioned in the extended list of fragile economies.

One of these lists was put together by investment bank Schroeder and published by the Financial Times. It judged countries’ perceived ability to repay short-term foreign borrowings as tapering takes liquidity away from developing countries, and put Chile just above bottom-placed Turkey. The ratio of foreign exchange reserves to gross external financing requirements as of the second quarter of 2013 was 1 for Chile, against 0.9 for Turkey. Poland (2.1) and Brazil (2) were the best scoring economies of the eight that were analysed.

However, Puente’s Mr Costa views Chile very interestingly. He says that despite its widening current account deficit (the country went from a 2% surplus in 2010 to a 3.5% deficit at the end of 2012), the country has improved productivity over the years, a sign that portfolio flows were directed to activities that have long-lasting positive effects on the economy.

How hot money is used is always hard to assess, admits Mr Costa, but confidence in a country’s government and monetary authorities help. “In past crises, in Argentina, Russia or Greece, for example, you had similar situations: big current account deficits being funded by [capital] inflows," he says. "In the case of Argentina at the end of the 1990s, for example, large chunks of those inflows funded public consumption. For a long time in Argentina, in that period, the government claimed that those inflows were going to increase productivity, but it didn’t happen.

“In the case of Chile, you know that those inflows have been going into the productive sectors. You see the impact on infrastructure; you see the impact on productivity.”

Brazil: the behemoth

Already worrying investors because of its abrupt gross domestic product (GDP) slowdown, Brazil recorded a current account deficit approaching 4% of GDP in 2013 according to some estimates, and it has been on a declining trend since 2008, the last time is showed a surplus in the past decade. The deficit was $8.68bn in December 2013. Furthermore, Brazil recorded its worst ever monthly trade deficit in January this year, of $4.1bn.

While Brazilians kept up demand for imported goods, the depreciation of the real – which has dropped by about 18% over the past year – has not yet translated in a sharp improvement of exports. GDP growth is expected to be less than 2% in 2014 and the country’s growth model is still heavily based on consumption. 

Joaquim Levy, chief executive of São Paulo-based Bradesco Asset Management, however, challenges the poor image that the country suffers among investors. “[In Brazil, volatility] is much more about expectations than the actual deterioration of fundamentals,” he says. “[Brazil’s] external debt hasn’t changed, it is only about $50bn or $60bn. International reserves are still four to six times international debt levels.”

Central bank governor Alexandre Tombini recently stated: “Foreign direct investment covers 79% of the deficit, the economy is rebalancing towards investment and away from consumption… our policy response has been very classical and straightforward. I do not lose any sleep over Brazil’s current account deficit.”

Discordant views on a market are positive, as they offer investors buying opportunities. For example, looking at current account data next to stock market valuations gives an interesting picture. Citi charted a number of countries by these two variables and found that while Brazil and Chile have current accounts larger than Mexico’s, they are significantly cheaper then their northern neighbour.

Argentina, which was not included in Citi’s calculations, undeniably has its idiosyncrasies, but the central bank’s removal of currency controls is a hopeful development. The much-anticipated change of leadership at the next presidential elections in 2015 will be another key development for Argentina. All in all, Latin America’s leading economies face a challenging 2014.


All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker

For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Top 1000 2023

Request a demonstration to The Banker Database

Join our community

The Banker on Twitter