The banking challenges for Latin America in 2020

Juan Pablo Espinosa

After a turbulent 2019, 2020 is looking shaky at best for the Latin America and the Caribbean region. Overall economic growth remains sluggish, coupled with policy uncertainty and societal tensions in a number of countries. Even in Brazil, which finally delivered a hard-won pension reform, the pace of further change may disappoint. The Banker has polled a number of well-placed economists about the region’s future. 

Q: When will economic growth return to Latin America and the Caribbean?

Ernesto Revilla: The good news is that Latin America should accelerate in 2020. The bad news is that this is mostly a consequence of how bad 2019 was for the region. It will be a subdued expansion, and well below the growth rates of the [early] 2000s. Most countries in the region will accelerate this year, with Ecuador a notable exception, as a consequence of stronger domestic demand.

However, risks are biased to the downside given China’s growth forecast downgrades after the coronavirus, and downward revisions to commodity prices. The medium-term growth outlook for Latin America is also challenging. This is a consequence of a low-savings trap that keeps the region below its potential. Latin America does not grow much given low investment and productivity ratios. Investment is low because savings, both public and private, are low. And there is not much scope or appetite for increasing savings because governments are being [pressured, through] social protests and unrest, to spend more, not less. Similarly, given years of low growth, the population does not want to reduce consumption to increase savings.

This keeps Latin America in a low-growth equilibrium. Strategies for strong, sustainable and inclusive growth are still lacking in the region. Hopefully they will come soon.

Mario Mesquita: Latin America still faces a complex external scenario, most recently with the coronavirus outbreak. In addition, many countries are facing important domestic uncertainties regarding reforms and economic policy direction. Fortunately, inflation is under control almost everywhere, allowing central banks to cut interest rates and therefore provide some support for the economy. So while we are not expecting strong growth in the region for 2020, the two largest economies of the region – Mexico and Brazil – will likely perform better than they did last year.

In Mexico, besides lower interest rates, the approval of the USMCA [the new trade deal between Mexico, the US and Canada] and better fiscal execution will also help growth. Whereas in Brazil, besides the stimulative interest rate, the continuity of the reform agenda – especially [efforts] focused on efficiency and fiscal consolidation, such as revising the government mandatory expenses in order to consolidate a scenario of a gradual return to primary surpluses that are compatible with structural stabilisation in public debt – will be key to supporting growth in the coming years.

Juan Pablo Espinosa: Both multilateral institutions and analysts predict that 2020 will be a better year for Latin American economies, with an expected aggregate growth rate of about 1.5%. 

With no evident global tailwinds in sight, this change in trend will be driven by private investment and consumption, which will particularly benefit from better financing conditions after various central banks took a more expansionary approach in 2019.

However, we should bear in mind that Latin America displays sharp contrasts. As such, the positive average growth rate that we forecast for 2020 conceals heterogenous stories. For instance, due to ongoing political and social challenges, Venezuela and Argentina will again trail the rest of the region. 

In the case of the countries in which Grupo Bancolombia operates, the prospects for economic activity in 2020 are encouraging. Private demand, particularly household consumption and private investment, will continue to be key drivers for growth in Colombia, El Salvador and Guatemala. Moreover, we expect activity to accelerate in Panama due to the consolidation of mining activities and a rebound in construction. 

Charles Seville: Fitch expects a mild economic recovery for Latin America in 2020, but growth will remain well below potential for several countries. While the phase one trade deal between the US and China bodes well for global sentiment, the recent outbreak of the coronavirus has introduced another source of uncertainty. We believe global growth is stabilising in 2020, but downside risks remain.

In Latin America, structural reforms are needed to address both growth challenges and fiscal pressures. Low domestic saving and investment rates, deficiencies in infrastructure and human capital and a difficult business environment continue to weigh on the region’s potential growth. Several countries have eased monetary policy against a more accommodative global monetary policy backdrop amid moderate inflation and anchored expectations. However, fiscal space to provide stimulus to boost economic activity is quite limited across the region given relatively high deficits and debt burdens that have increased in several countries in recent years.

Antonio Cortina: Growth has been distorted in the past few years by [unexpected developments] in a number of countries. As a result it is not easy to view a region as diverse as Latin America as a uniform set. 

In any case, we expect Latin America to grow above 2% in 2020, with a gradual acceleration throughout the year, creating a good base for 2021. The most recent data, ongoing expansionary policies, the reforms undertaken in some countries, global financial conditions, the stabilisation of world growth and the commercial truce between China and the US all create a favourable context.

Q: Public policy uncertainty and social unrest have tested investor confidence across the region, from Mexico to Chile. Will the picture become clearer in 2020?

Mr Revilla: Maybe not, as the problems are complex and solutions will take time. On the social unrest front, we have argued that the main problem is not current conditions – the structural development gap that Latin America has in many indicators – but the downgrade of future growth expectations. With a growing middle class in the region, which demands more and better quality public services, and a reduction in future growth prospects, given that Chinese growth and commodity prices will not return to the halcyon 2000s, there is increased unrest and calls for [wealth] redistribution. Governments have reacted, but the structural problem will not be solved soon.

Regarding policy uncertainty, it will continue in Mexico and Argentina, weakening current investment and putting into doubt their medium-term prospects. In other countries, such as Brazil, Colombia, Chile and Peru, macro policy continues to be strong, credible and consistent, and this will continue to differentiate these countries in the minds of investors.

Policy uncertainty is not exclusive to Latin America. It has afflicted advanced economies too. This will continue to create volatility for emerging markets at times, emphasising the need for countries in Latin America to strengthen their fundamentals and buffers, while conditions remain favourable.

Mr Mesquita: In Chile and Colombia, protests have lost momentum. However, in Chile the constitutional process will be an important source of uncertainty in 2020, dragging confidence and investment, despite expansionary fiscal and monetary policies. In Colombia, protests were lighter than in Chile but they [made the] approval of necessary fiscal consolidation measures, such as privatisation and tax increases, more challenging. While we did not reduce our growth forecasts for Colombia after the protests, as we did for Chile, risks are tilted to the downside.

Mr Espinosa: Social unrest in Latin America has many roots, but perhaps one common factor is the middle-income trap. 

The sharp improvement in economic standards that brought the boom in commodity prices led many households to experience a rise in income that promoted social mobility. However, when the bubble burst, this process came to an end. In fact, the sluggish economic performance during the past few years has left these households at risk of returning to poverty. Because of fiscal consolidation measures, they now receive a more restricted supply of public goods and services. In addition, slow economic activity has affected the labour market, which has translated into fewer job opportunities.

Despite the cyclical recovery that we foresee for 2020, these dynamics will hardly reverse anytime soon. Hence, Latin America needs a more inclusive and sustainable growth model, which can be best summarised in the UN's 17 Sustainable Development Goals. Though it is urgent to start materialising this agenda now, it will take time to get tangible results. This, combined with the pervasive use of social media and a more active citizenship, makes new episodes of social unrest likely. Thus, authorities and the private sector will need to signal their commitment to inclusive growth and reigniting social mobility. 

Mr Cortina: Social tensions are not the exclusive patrimony of countries in Latin America. We have seen similar problems elsewhere. They are always difficult to predict. In the case of Chile, the government has taken a series of profound measures, which are expected to achieve results and stabilise the situation. In Mexico, we hope that the economic improvement, supported by the expansive measures of the government and a stabilisation of growth in the US, particularly in the manufacturing sector, will help improve the outlook. The government is committed to facing the social situation and improving the economic climate.

Mr Seville: Uncertainty is likely to persist in 2020, and idiosyncratic country-specific risks from policy uncertainty, reform disappointment and social unrest cannot be ruled out. Sluggish growth, persistent income inequality and the perceived lack of progress to adequately address these issues could increase political, social stability and governability risks.

In Mexico, policy uncertainty is likely to remain as the administration balances a commitment to fiscal prudence with ongoing weak economic performance. The resolution of Chile’s social grievances is far from over, and the process to revise the country’s constitution is complex and will drag on throughout 2020. Bolivia faces uncertain elections and a difficult political transition.

Finally, despite the favourable external financing conditions, specific countries could still be vulnerable to shifts in investor confidence. Argentina’s likely debt restructuring and the renegotiation with the International Monetary Fund [IMF] will be important milestones. Similarly, Ecuador’s adherence to its IMF programme will be key for it to meet its large financing needs.

Q: After finally passing the badly needed pension reform at the end of 2019, Brazil has promised to tackle its cumbersome tax system. Will it deliver?

Mr Mesquita: We believe that a proposal to simplify the tax system can garner the necessary support for approval in Congress given its potential to increase competitiveness in the Brazilian economy. However, we recognise that very comprehensive reform proposals, [although] praiseworthy, have lower chances of being approved in Congress. This view comes from the complexity of negotiating with different sectors and sub-national entities, from the wide range of existing proposals and the limited room in the congressional calendar, because 2020 may have a shorter working year due to municipal elections.

In this context, we understand that a phased approach, such as the one that has been signalled by the government, can have a better chance of approval. Naturally, it would not generate all the gains of a more comprehensive reform, but it would create a precedent and even the demand for new initiatives.

Mr Revilla: It looks increasingly likely. Brazil is enjoying fantastic momentum given that economic recovery is finally taking hold and the strength of its reform agenda. Pension reform was a tipping point in how to think about Brazil, showing the world that reforms can be tackled even in a difficult political environment. With the pension reform behind us, a stronger medium-term fiscal position, continued compromises to reduce the fiscal deficit and monetary policy support, few in the market expected more to happen in 2020, especially given that local elections late in the year would complicate the political outlook. And yet, it seems that Brazil will indeed be able to deliver on the emergency fiscal plan, the revision of public funds and probably even the tax reform.

There is significant political willingness by many players in Brazil to continue delivering on the reform agenda. This would solidify the virtuous cycle of lower rates, stronger growth and the compression of risk premiums that is benefiting Brazilian assets. 

Mr Cortina: With the approval of the pension reform the Brazilian Congress has demonstrated its firm commitment to structural reforms and fiscal sustainability. The highest priority for Congress now is the approval of the fiscal adjustment measures that comprise two constitutional reforms that, if approved, will limit increases in public spending. The government is also expected to send a proposal for administrative reform to Congress in the coming weeks. In this regard, Congress is considering a profound reform agenda and is demonstrating that it has the necessary support to move it forward. And since the tax reform is one of the most important, we think it will take it forward, although later than those mentioned previously.

Q: Recession, new inflation highs and IMF debt repayments weigh on Argentina. What will be the new government’s next move?

Mr Revilla: It is hard to know, and I suspect any answer will not last long given the speed of the policy cycle in Argentina these days. Of course, the problem in Argentina is squaring the circle of many different and competing policy objectives. On the one hand, the government was elected on a mandate of delivering growth. This would call for expansive fiscal and monetary policies, which unfortunately might not be sustainable given the constraints and diminished buffers of the Argentinean economy. On the other hand, the Argentinean government needs to present a credible and consistent macroeconomic strategy to debt holders and the IMF in order to restructure the debt and regain access to markets. This would call for prudent fiscal and monetary policies.

There are still many uncertainties regarding the main policy choices and objectives of president Alberto Fernández’s administration, and the market will continue to discount a relatively bad scenario until more clarity is delivered. The debt negotiations will take the better part of this year, and it will be a little longer until the patient can be discharged from the intensive care unit.

Mr Mesquita: The [new government’s] first measures included further exchange rate controls, taxes on exports, consumer price controls, a temporary pause on pension adjustments, wage increases and a new postponement of local law dollar-denominated bills. The government plans to offer a debt restructuring proposal to foreign law bondholders by mid-March. The offer would make use of the collective action clauses which allow a special majority of bondholders to change the financial conditions of the obligations. If successful, the government will likely apply unilaterally the new terms to the local law debt.

Argentina also tries to streamline the heavy schedule of payments to the IMF but will likely need a new programme with conditions, a situation the new administration may be unwilling to accept. The risk of failing to service debt before a deal is reached is high, given the low level of reserves and unwillingness to tighten fiscal policy significantly. 

Bringing inflation down permanently is another big challenge. Price controls, especially on the exchange rate, are leading to real official exchange rate appreciation and a wider spread in the parallel market for dollars. Frozen tariffs will likely pressure fiscal accounts.

Mr Cortina: The government of Argentina has a complex task ahead, with three priority objectives: to resume economic growth, control inflation and reach an agreement with creditors to reschedule their external debt. These goals are compatible and we are confident that they will get them through.

The recently approved package of measures is a step forward, with measures to boost spending but also the potential for others that promote fiscal convergence. Additionally, it has sent a bill to Congress that it calls 'the law of sustainability of external debt', which will advance the design of its proposals to creditors. The aim is for this to close in the first quarter of 2020. We believe that there is goodwill on both sides and that an agreement will be reached within the framework of an economic programme that seeks to stabilise the economy. 

Q: Banking remains a largely profitable and non-competitive sector across the Latin America and Caribbean region. Is this set to change any time soon, and, if so, where?

Mr Espinosa: Even though profitability in the Latin American banking industry is higher than in other emerging regions, the competitive landscape is changing rapidly. In many countries competition has surged in past years due to several factors: greater penetration of financial products, digitalisation and a deeper integration in global financial markets, among others. This has translated into a reduction of lending interest rates, as well as lower commissions and transaction costs, all of which has benefited clients. These structural transformations will continue to unfold over the next few years, which will mean that Latin American banks will become more competitive and efficient. 

Mr Mesquita: As in any sector, technology-driven innovations will continue to be an important driver for customer-centric firms, not only in Latin America but worldwide. Open banking initiatives, for example, can already be seen in Mexico and Brazil, and aim to enhance the efficiency in credit and payments markets, while preserving the security of the financial system and ensuring consumer protection. More broadly, measures to decrease asymmetric information and improve guarantees in lending can prove to be important to enhance the efficiency of the financial sector in Latin America and elsewhere.

Mr Cortina: The situation of the countries in the region is heterogeneous. The nature of the banking business in Argentina, Mexico, Brazil and other smaller Latin American economies are very different. In some cases, such as Brazil, for example, the efficiency and competence of the banking system is very high.