Latin America offers pockets of resilience to EM risk aversion

Jeremy Weltman
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ECR experts’ faith in Chile, Mexico, Peru and Uruguay is rewarded as stronger economies linked to fewer political problems survive the rout, but Brazil slides along with Argentina and Venezuela.

The sharp depreciation of currencies for countries most at risk from US tapering and/or China’s slowdown and with large fiscal and external imbalances complicated by domestic political and policymaking problems, has dragged down some but not all LatAm sovereigns in its wake.

Argentina, Brazil, Colombia and Venezuela – those considered most at risk from one or more economic, political or structural problems – saw their risk-scores downgraded last year by economists and other experts taking part in Euromoney’s Country Risk Survey.

The survey’s regular contributors nevertheless kept faith in a few domains, including top-rated Chile, the only country in the region to have made it into the top tier of ECR's five risk categories, containing the world’s safest A-rated borrowers. Mexico, Peru and Uruguay were three more to experience rising scores (that is, diminishing risk) in 2013 and pushing higher in the rankings.

With higher-risk Belize, Guyana and Suriname included, seven of the 20 countries across the region saw their scores upgraded (see chart), with five still climbing during Q4 to leave the average score for LatAm unchanged compared with the start of last year.

Removing Argentina and Venezuela from the equation

Disregarding Argentina and Venezuela – two countries with longstanding problems and notable for their downward spiral through the global rankings in recent years – the region’s risks reduce even further.

Indeed, it is wise to exclude them, as otherwise the arithmetic is biased. Argentina and Venezuela’s woes are, after all, largely home-grown, isolated problems despite the Argentinian peso slide providing the catalyst for wider EM contagion.

Comparing LatAm countries in JPMorgan’s Emerging Markets Bond Index with other sovereigns would suggest on a first impression that they are faring much worse than other EMs.

Of the eight LatAm countries in the index, ECR survey data suggest an average points-score decline of 1.1 for 2013, larger than the 0.6 point fall for the entire JPM EM universe, comprising 18 countries in total, and only a 0.3 point decline when LatAm sovereigns are excluded.

But take out Argentina – which shed 3.5 points last year, and plummeted 24 places through ECR's global rankings to 136th – and Venezuela (downgraded by 4.6 points and falling 26 places to 140th), and the picture is quite different. On that basis LatAm was comparatively safer.

Supported by Mexico and Peru, the region’s underlying score, shown in blue in the chart (above), fell considerably less than its headline measure. Latin America’s comparative safety, moreover, would have been stronger with Chile and Uruguay included, neither of which features in the JPM EMBI – with both soaring higher on a rising score trend.

Countries outside Latin America taking a big hit in ECR’s survey last year were Egypt (rocked by its resurgent turmoil), Morocco, Turkey, South Africa and Ukraine, all with various problems of their own and invariably caught up in the EM shake-out preceded by score declines.

Their combined downgrades outweighed improving scores for Nigeria, Poland, the Philippines and others considered more robust to capital outflows because of healthier macroeconomics and/or lower political risk.

The addition of Indonesia, another country downgraded by experts last year, carried along by the EM currency slide, would increase that gap even further. So too, would Malaysia, Hungary and a whole host of other central and eastern European borrowers, among them Albania, Croatia, Cyprus, Montenegro and Slovenia.

By contrast, Latin America has offered greater security from the turmoil – though country-selection is still a prime consideration as Brazil’s weaknesses highlight. Latin America’s largest country shed 1.3 points and slipped three places to 41st in the rankings last year, one of a fragile five of larger EMs causing concern for investors.

What is driving the relative strengths of other LatAm sovereigns? After all, aren’t they also dependent on the US for liquidity and on China to keep commodity prices bubbling along?

ECR expert and global head of country risk at HSBC, Victoire de Groote, offers two explanations: “First Chile, Mexico, Peru and Uruguay don't have the high financing requirements of others, their current account deficits are rather limited and the financing of these deficits is generally long term.

“Second, these countries have seen strong growth in domestic demand over the past years, and this has been offsetting the weakness of external demand.”

Christiaan van Laecke, country risk analyst at RBS and another ECR survey contributor, adds: “Real effective exchange rates provide a clue. Brazil, especially, has seen significant competitiveness losses over the past decade, whereas Mexico has managed to stay around 2003 levels”.

Herwin Loman, working in the country risk team at Rabobank alongside ECR expert Jeroen van IJzerloo, adds: “Those countries do have large FX stocks and large net FDI inflows, which we both expect to mitigate the impact of tapering and slower Chinese growth.”