Latin America’s new burden of high expectations

As delegates file into this year’s World Bank/IMF meetings in Prague, the mood with regard to Latin America will be much more positive than in previous years. In 1998, Brazil was about to devalue, and panic was in the air. In September 1999, Ecuador became the first country ever to default on its Brady bonds, right in the middle of the annual meetings. Come 2000, and Ecuador has successfully restructured its debt, Mexico has had its first ever truly democratic election, ending more than 70 years of one-party rule in the process, and the Brazilian success story continues. Moody’s has upgraded Mexico to investment-grade status, and upgrades from Standard & Poor’s in both Mexico and Brazil are seen as inevitable. But challenges remain, Felix Salmon reports

Now that Latin America has got through the crisis years, investors wonder where the region might be headed next. Will the years to come bring improved economic performance, political stability and enhanced credit ratings, or will the old uncertainties continue? With Ecuador, Pakistan and Ukraine having all successfully restructured their debt in recent months, default is no longer the anathema it was a year ago. Argentina seems increasingly embroiled in a Fiscal crisis with no obvious solution bar devaluation or default, and the political situation in the Andes continues to deteriorate.
All this, as Latin America becomes increasingly dependent on the United States for export-driven growth, and therefore provides increasingly less diversification from US assets: historically, one of the main reasons to invest in emerging markets.
Ask Paulo Leme, head of Latin American research at Goldman Sachs, whether it even makes sense to think of the region as a whole any more, and he's quick to say that "the concept of a unified bloc is no longer applicable."
All the same, he says, "there is still a common thread, which is economic structural deficiencies. They are all economies with low savings rates, current-account deficits, and high reliance on commodity prices." Hardly a reason for spooked US investors, who have yet to re-enter emerging markets after being burned in 1998, to go barreling back in.
And those low savings rates set up a self-reinforcing cycle: if foreign investment increases then growth picks up and investment in the region accelerates. On the other hand, without foreign investment, the region stagnates and can Find itself in an ugly deflationary spiral of the sort with which Argentina has been struggling for the past two years - precisely the conditions which make foreign investors stay away.
Even Latin America bulls don't expect sovereign bond spreads to tighten much from their present levels. They talk instead about the coupon income should spreads stay more or less where they are. But if investors have learned anything from the past couple of years, it's that emerging markets crises are all too common. Should anything go wrong - an oil-price collapse, say, precipitating a Venezuelan default - then the losses would be dramatic.
Even amidst success stories, such as that of Mexico, unfortunate investors can still lose out. Moody's upgrade of the country to investment-grade status sparked a wave of euphoria, and much talk of how Mexico had now differentiated itself from the rest of the region and was more or less the 51st state of the USA. Sovereign spreads tightened so far that specialist emerging market investors lost interest in holding the country's bonds.
"The sovereign bonds at the short end of the curve are trading through US corporate bonds that are similarly rated," says Joyce Chang, head of emerging markets research at Chase Securities. "I don't think the pricing makes it very attractive on a relative-value basis."
At the height of the euphoria, in March, a small Mexico City telecommunications company called Maxcom issued $300 million of debt with an equity kicker into the US market through lead manager Warburg Dillon Read. The lead manager made a big deal of the fact that this was very much a US high-yield issue, and not sold to emerging market investors. Bonds of this type were relatively commonplace among US telecoms, but this was the First time an emerging market issuer had managed to get one away.
But the immediate lesson of the placement - that Mexico was no longer an emerging market, and that Mexican companies had the same Financing resources available to them as their US counterparts - did not last long. When the dot com bubble burst in April, the price of Maxcom debt, which had been issued at par, fell through the Floor. Bonds were traded at about 70 cents in the dollar only a couple of months after the issue. Not for the First time, emerging market securities were the First ones dumped when the markets became nervous.
"I don't buy the story that Mexico is no longer a part of Latin America," says Walter Molano, head of research at BCP Securities. "Mexico is still Firmly an emerging market country."
All the same, as long as the US avoids a hard landing, Mexico looks to be the best-positioned of the Latin economies. "You have to give Mexico its due," says Gene Frieda, head of emerging markets research at consultancy 4Cast. "Its exposure to the US is an extreme positive at the moment."
Goldman's Leme agrees, up to a point. "Mexico is in a group of its own, and doing very well thank you," he says. But if investors want to make a play on a continued US expansion, it is easier - and safer - simply to stay in the US.
Leme adds: "In terms of the diversification play, if you were to have a hard landing in the US, Chile would suffer relatively less."
There are also political questions in Mexico, which have largely been brushed aside in the euphoria over the victory of Vicente Fox in the presidential elections. For one thing, no one knows what will happen to the gloriously oxymoronic Institutional Revolutionary Party, or PRI, which ruled Mexico from the 1920s until this year. For another, Fox does not have a majority, and other parties' willingness to form a governing coalition is far from clear.
"The big question in Mexico is the PRI as an opposition force," says Chase's Chang. "Fox is beginning to slow down the pace at which he's going to put reforms in. I think the market is going to turn to looking at the external pressures in terms of the current-account and trade deficits. The focus will turn to the fulfilment of high expectations."
Echoes Goldman's Leme: "The political situation is quite undefined, starting with the PRI itself. Who will Fox establish an alliance with? Which members of the PRI will he invite into his cabinet? I still think it will probably work out well, but it's not a sure thing yet."
Yet good news is on the horizon. It now seems that the only question is when, not whether, Standard&Poor's will Finally give Mexico the investment-grade rating that Moody's bestowed in March. Most analysts seem to think it will happen in the Final quarter of 2000, but others think the agency will wait to see Fox prove himself, and only grant the upgrade at the beginning of 2001.
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