Latin America - Ghosts of the past haunt new dawn

Take your pick: Latin America is a basket case doomed to a constant cycle of spurts of short-lived growth followed by economic collapse; Latin America is a continent transformed, with a healthy respect for economic freedom, a burgeoning middle class and an economy on course for convergence with the developed world. Michael Peterson reports.

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Hugo Chávez: gambling on the oil price

For bond investors trying to figure out which is the real Latin America, this year has brought some confusing signals. Ecuador's government is showing an ability to mismanage its economy that would put many populist Latin American regimes of the 1970s to shame. Last month the central bank doubled its interest rates to 160% in an attempt to shore up the currency. The country has defaulted on its Eurobonds, some of its Brady bonds and will probably also have to renege on its $3 billion of domestic obligations, further impoverishing its own population. If all this wasn't bad enough, an unnamed terrorist group last month blew up the country's most important oil pipeline and the volcano overlooking the capital threatened to erupt at any moment. Nothing any Ecuadoran government can do now will prevent years of economic stagnation and isolation from international capital.

Fortunately for the rest of Latin America, Ecuador is small. Venezuela, however, is a bigger fish. Its populist president, Hugo Chávez, seems determined to set it on a course that the rest of Latin America abandoned long ago. Chávez has pushed aside the country's parliament, dreamt up a new constitution that includes generous entitlements to the public purse, and promised to spend heavily next year to boost the economy.

For a while, the country might be able to deliver on the spending its new budget promises using the money flowing into the government's coffers as a result of high oil prices. "Venezuela is idiot-proof next year thanks to oil prices," says Michael Gavin, Latin American economist at Warburg Dillon Read. "As long as the oil price stays around its present level Venezuela can't run out of money. No-one can spend money that fast. If the government spends as it says it intends to spend then the economy will recover next year. But that recovery will be unsustainable. We are told there is little chance of oil prices falling next year, but the government is setting Venezuela up for another crash the instant oil prices change course."

In August and September Venezuela was believed to be lining up a jumbo international bond. Nothing of the sort ever materialized, partly no doubt because the rise in oil prices eased the government's funding problems. But Venezuela would be hard pressed to access the markets at the moment in any size. The government recently decided against launching a much smaller euro-denominated bond of some €200 million, presumably in response to lack of demand.

Latin American bond spreads for much of this year suggest that investors view the region as an unreformed disaster area. A smaller Latin American sovereign wishing to access the dollar Eurobond market this year has generally had to pay at least five percentage points more than treasuries. Colombia, a country with a reputation for solid government finances and monetary stability, managed to raise $500 million in April at a 495 basis point spread over treasuries. But on the two other occasions it issued in 1999, it paid well over 500bp and at times its bonds have traded at 700bp over. Three years ago it was paying less than 200bp.

The economies that really matter in Latin America are the three giants: Brazil, Mexico and Argentina. And these countries are a world away from the political chaos and economic uncertainty of Quito and Caracas. In presidential elections in October Argentine voters roundly rejected the candidate of the ruling Justicialist party who had suggested the country might get away with not meeting its international debt obligations. Instead they plumped for the dull but orthodox Fernando de la Rua of the opposition Alliance.

Argentina has some formidable economic problems. Its fixed exchange rate means it lacks the ability to makes its exports more competitive through devaluation. As a result, it has a large balance of payments deficit and has suffered deep recession this year. It has the heaviest external debt burden, on a per capita basis, of any of the large Latin American economies. But it remains Latin America's most clued-up borrower in the opinion of many bankers. It has been one of the boldest in developing a base of European investors this year to balance its natural US market. And it has worked hard to develop alternative ways of raising the funding it needs. It has, for example, made great strides in developing a deep domestic bond market and issued a bond with a guarantee from the World Bank and an investment grade rating in October.

Even before it took office on December 10, the new government had already bolstered investors' confidence in Argentina, in spite of a scare over the health of de la Rua, who had to be rushed into hospital shortly after winning the election. But the country's economic prospects rely, in the main, on factors outside the government's control. Growth will depend on recovery in Brazil, the biggest market for Argentina's manufactured goods, and a halt to the fall in the value of the real, which has left Argentine products severely overpriced in the rest of the Mercosur trading bloc. Argentina is also at the mercy of commodity prices. A weaker dollar would be the most likely trigger for an increase in Argentina's revenue from commodities.

A successful issuer

Brazil is a much larger and more self-contained economy and most observers expect it to recover strongly next year. The growing confidence that the country has put the problems of its enforced devaluation in January behind it can be seen in the government's success in raising funds in longer maturities. In October, for example, it was able to extend its new euro yield curve out to seven years, with a €700 million offering led by Credit Suisse First Boston and Deutsche Bank.

While Brazil and Argentina are inspiring growing confidence after a difficult 12 months, Mexico has been the star of Latin America this year. Spreads on its outstanding long-term benchmark bonds are around 350bp above treasuries. That compares with some 550bp for Argentina, which is rated B1 by Moody's, only three notches below Mexico (Standard & Poor's rates both Mexico and Argentina at BB). Single-B-rated Brazil's long bonds, by comparison, trade at levels significantly tighter than earlier this year, but were still more than 600bp outside treasuries last month.

Costly but still buoyant

Although Latin American bonds are trading much wider than they were before the emerging markets crisis began, bankers are quick to point out that the volume of new Latin issuance this year has held up well. In the first three quarters of 1999, $25.5 billion-worth of Latin American bonds were issued internationally. Most professionals expect that by the end of the year volumes will be a little higher than the $36 billion issued last year. That is much better than many had predicted at the start of the year.

But the overall volume figures do not give the full picture of the difficulties many Latin American borrowers have faced this year. Sovereigns have accounted for the vast majority of borrowing in 1999. Corporates and banks made up less than 30% of all issuance in the first three quarters of this year. "The volume of new bond issuance in 1999 wasn't materially smaller than it was in 1998," says Brian O'Neill, Chase's top executive for Latin America. "But the composition has changed a lot. By and large corporates have been chased out of the market all year. Almost all new issuance has been by sovereigns and near sovereigns. Corporates have had to rely almost entirely on the loan market."

Several large deals in which pure sovereign bonds were offered in exchange for Brady bonds have boosted the volumes of sovereign issuance. Governments have calculated that collateralized Brady debt is a relatively expensive way for them to fund themselves and have made swaps attractive for Brady bond holders. In October, for example, Brazil offered new bonds in exchange for $2 billion-worth of Bradys. But it had to pull the $500 million cash issue it had planned to carry out at the same time as the exchange.

And even the biggest sovereigns have had to work hard to borrow in the international markets this year. For much of the time between April and October the dollar market, the traditional source of financing for Latin governments, was effectively closed to even the biggest borrowers.

They were saved by the emergence of a new source of funding for Latin America: Europe. Latin borrowers took to the new European currency with enthusiasm in 1999. It accounted for over one-third of all issuance in the first three quarters of 1999, most of which was by sovereigns.

Both Argentina and Brazil have made a concerted effort to build a yield curve in euros. Argentina has issued in a variety of maturities between 18 months and 10 years in a series of small offerings designed to appeal to European retail investors. Brazil has taken a less opportunistic approach, with three relatively large, generously priced offerings providing maturities of three, five and seven years. It then sneaked in with a more tightly priced two-year deal last month.

Given their efforts to tap the market at different points on the yield curve, there seems little doubt both countries see Europe as a valuable source of long-term funding for governments and corporates, rather than as simply a fallback when the dollar market is inaccessible. "Europe has consistently absorbed a range of maturities and credits," says Paul Tregidgo, head of emerging debt capital markets at Credit Suisse First Boston. "It is clearly a very significant financing source for Latin America. That is now proven beyond any doubt."

Only a handful of Latin American corporates have so far issued in euros. Those that have, such as Telecom Argentina and Compañía de Telecomunicaciones de Chile (CTC), have tended to have large European companies as significant shareholders - Telecom Italia and Telefónica respectively - and therefore benefit from investor familiarity with those names.

For most Latin American corporates, the opportunities for issuance have been few and the terms available poor. In addition to the large former monopoly telephone companies such as CTC and Telmex, there have been a sprinkling of telecom deals with appeal to high-yield investors. Argentine media company Multicanal, for example, issued a $175 million deal through BankBoston and CSFB in April; the bond had the 10-year maturity typical of a US high-yield issue. Rival CableVisión followed suit later in the month with a $275 million issue led by Chase.

"The deals for Multicanal and CableVisión, two large Argentine pay-TV companies, were both very successful," points out O'Neill at Chase. "They appealed to a combination of traditional emerging-market investors and US high-yield buyers who tend to be very focused on media companies."

In May Mexican telecoms company Alestra issued one of the largest corporate deals from Latin America this year and another issue with appeal to US high-yield buyers. The $570 million seven-year and 10-year offering was led by Nationsbanc Montgomery and Morgan Stanley. But the poor performance of the US high-yield market has often made it difficult for Latin America's growth companies to tap that source of finance.

Corporates still squeezed

Outside the telecoms sector, corporate issuance has been limited to the small group of Latin American blue chips. The notable example was Cemex, which was able to raise some $2 billion of funds this year by tapping a variety of markets, including a syndicated loan issued by its Spanish subsidiary Valenciana.

The need to open the markets for corporates was the reason for a rare appearance in international bond markets of Latin America's best-rated sovereign, the republic of Chile, in April. The sovereign wanted to set a new benchmark that Chilean companies could follow, and so issued a $500 million 10-year deal on which Chase and Merrill Lynch werebookrunners. The attempt was only partly successful. The deal, priced at 175bp over treasuries, did lead to a tightening of secondary market spreads on some Chilean corporate bonds. But only one corporate deal followed the sovereign: later the same month Codelco raised $300 million in a deal led by Morgan Stanley.

One technique that has been used this year by both Petróleos de Venezuela (PDVSA) and Pemex to raise funds is securitization, using dollar oil receivables to back large bond issues. Several bankers believe that such deals are not simply a response to the difficulties of getting straight bond deals done. "Securitization will continue to grow in importance in Latin America," says Steve Cunningham, head of Latin American investment banking at Morgan Stanley. "It reflects an increased sophistication on the part of issuers. It can give borrowers a way to access a broader investor base and often reduces their cost of borrowing."

A rolling guarantee

Another way to get improved pricing in difficult markets is the use of guarantees, although so far the use of insurance cover has not taken off (see box). In October Argentina became the first Latin American borrower to make use of a World Bank guarantee when it issued a string of zero-coupon dollar bonds with a combined face value of $1.5 billion. The supranational body guarantees repayment of the first of six zero-coupon bonds, gaining that $250 million tranche a triple-A rating. If the guarantee is not used on that bond, it will roll over to the next, and so on, giving each of the following five $250 million bonds a triple-B rating.

This was a structure that allowed the sovereign to re-enter the dollar market at favourable levels. According to Michael Schoen, head of emerging markets syndicate at JP Morgan, which acted as bookrunner on the deal jointly with Goldman Sachs, the World Bank rolling guarantee brought in many investors who would normally shun Latin American debt. Some 70% of the issue was sold to non-emerging market investors attracted by the bond's investment grade rating.

Copycat deals could follow this Argentine success. That will depend on the World Bank's willingness to use its balance sheet in this way. But Schoen at JP Morgan believes structure with guarantees by the World Bank and similar agencies, perhaps the IDB, have a great deal of potential. "I would be surprised if we didn't see more of that in future," he says.

If some bankers are to be believed, there will be little need for guarantees to get deals completed at a reasonable price next year. Most are quietly optimistic that there will be a strong start to 2000 and some see signs of the sort of new money flowing into Latin America that has eluded it for much of the past two years.

Counting on recovery

An improvement in sentiment will depend on good news on the economic front. Though some worry that Mexico's economy could be harmed by a downturn in the US economy or a US stock market correction, it is Brazil that is the main barometer of Latin America's fortunes. Gavin at Warburg Dillon Read says: "In the near and medium term Brazil should recover strongly." The main worry, he says, is that the central bank might raise interest rates.

If Brazil does well, the rest of Latin America, notably Argentina, should recover too. Once a clear recovery starts, the high absolute returns on Latin securities should bring a surge in investment. O'Neill predicts: "After a year of zero GDP growth or contraction in most Latin American countries except Mexico we can expect economic growth to bounce back. On the strength of those fundamentals, corporates should regain access to the markets."

Some see Mexico's main problem as one of success. "Mexican spreads have improved so much already that I have a slight concern that there is no further tightening to come," says one banker. But others are bullish on both primary and secondary Mexican bonds. "Mexico continues to look good," says O'Neill. "That will help not just the sovereign but also corporates. In addition the banking system is slowly but surely recapitalizing and the largest banks such as Bancomer and Banamex are putting their problems behind them and should be able to issue."

With no nasty surprises, Latin borrowers should be able to issue in greater numbers and at more reasonable prices than this year. "We see quite a substantial recovery next year based on good growth prospects, low inflation and currency stability combined with a generally positive outlook internationally," says Cunningham at Morgan Stanley. "We can expect much greater access to the markets next year across a broader range of countries and industries."

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