Country Risk: China’s economic slowdown hangs over Andean economies


Matthew Turner
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Weakening demand from China for Latin American commodity exports had a negative impact on country risk survey results for Chile, Peru and Colombia in the third quarter of 2012, as ECR experts revise down their risk-assessment scores on some of the region’s leading economies. However, there was good news for Brazil, which bucked the trend by climbing two places in the ECR rankings and overtook China to become the safest Bric economy.

The Andean economies – Chile, Peru and Colombia – have been subject to closer scrutiny by risk experts in the third quarter results of Euromoney’s Country Risk Survey (ECR). All three economies have had their overall ECR scores downgraded by participating analysts this quarter, amid weakening global demand for Latin American commodity exports.

Peru, presently ranked 50th in the global ECR rankings, was down four places in the survey this quarter. Colombia’s score also fell as economists marked the country down across several indicators, including access to capital markets. Chile’s score slipped marginally during the quarter, although the country remains by far the safest in Latin America, according to economists.

Lower export revenues, coupled with a looming Argentinian default and anti-market policies in Venezuela could weigh noticeably on Latin America’s average risk assessment score over the next quarter.

However, despite a slowdown in commodity exports, there are reasons to remain optimistic in the region’s risk profile. Brazil – Latin America’s largest economy – retains a firm footing in the rankings and is up two places Q/Q, to become the safest economy among the Bric (Brazil, Russia, India and China) nations.

Additionally, the region as a whole has resisted any further decline to its average risk assessment score, which remains unchanged between Q2 and Q3. Venezuela and Argentina, whose scores slipped again in the third quarter, remain key regional underachievers, with both countries rated among the riskiest in the world by economists.

Colombia’s rank stable despite score fall

                                                   source: ECR

Colombia’s rise in the ECR rankings in recent years has been well-documented (The safest and riskiest emerging markets) but concerns are slowly creeping into analysts’ risk perception. Colombia’s decline this quarter follows a 1.1 point decline earlier this year.

Colombia’s access to capital markets indicator fell by one point, to 5.5 in Q3 2012, along with reductions in the country’s regulatory and policy environment indicator, which fell by 0.1 point to 6.2. The country’s economic assessment score saw a marginal improvement of 0.8 in Q3, but this improvement falls on the back of a one-point decline in Q2.

Colombia remains highly dependent on trade with the US and China, its main export partners. Apprehension is growing that weakening demand for Colombian commodity exports, mainly oil and coal, could offset the strong economic growth that has been seen by the country during the past five years.
Capital Economics expects a slowdown of 0.5% next year to 3.5%. Any slowdown in real GDP growth could be seen as a policy challenge for the incumbent administration, as fiscal and monetary policy will need to be adjusted to fit the revised downturn in economic growth.

Julio López, senior economist at BBVA-Colombia, explains that Colombia’s exports revenues will be hampered by a slowdown in the Chinese economy, negatively affecting fiscal revenues.

“The main transmission channel of China’s slowdown has been on the international prices of the two most important Colombia’s export products – oil and (mainly) coal, with coal prices presenting a larger slowdown in recent months,” he says. “This has already affected the growth rate of energy and fuel exports.

“In case that the lower commodity prices become permanent, the main impact would be on lower fiscal revenue, considering that around 12% of the central government’s revenue comes from the oil activity – tax revenue and the dividends of its share on Colombia’s largest oil company. This should affect the recent trend and outlook of fiscal consolidation.

“In the short run, we do not expect additional monetary stimulus, although in the case that the external scenario worsens, the central bank should easily enhance its monetary support. The government also maintains an ambitious infrastructure plan, which would support the economy in the event of deterioration in international conditions.”

                                              source: ECR

Signs of unease in Brazilian economy

Brazil’s overall risk assessment saw a marginal deterioration Q/Q, falling by 0.1 points, to 60.7 between Q2 and Q3. This falls on the back of a sharp decline between Q1 to Q2, after its overall risk assessment fell by two points.

Of most concern to ECR analysts this quarter is the country’s economic assessment, with score downgrades across Brazil’s banking-stability and employment indicators, each of which fell by 0.1 points.

And in Q2, ECR analysts highlighted concerns in the country’s economic-outlook and banking-stability indicators, each falling by 0.4 points and 0.3 points respectively.

Brazil’s economic growth has lowered in the face of lower export-driven manufacturing production and reduced investment rates, weakening its ability to attract capital flows. These factors, coupled with weakening demand from China for Brazilian commodities, mean that Brazil will face growing challenges to sustain economic growth stemming from its traditionally versatile export sector.
An ability to manage the sovereign’s exposures will therefore be dependent on the effectiveness in government fiscal policy to counter the effects of a slowdown in the country’s export sector.

Abelardo Daza, country economist at Andean Development Coporation, explains: “China is Brazil’s main trading partner – the slowdown in the Chinese economy coupled with trade problems with Argentina has negatively affected Brazilian exports during the year, which are down 5% year on year.”

Despite Brazil’s notable downturn this quarter, there are reasons to remain optimistic in the country’s economic outlook. The sovereign retains a firm footing in the rankings and has been among the best-performing emerging markets since 2007(Country risk: The safest and riskiest emerging markets), having climbed 29 places in the ECR rankings since then.

“Brazil has shown a strong fiscal performance in the last five years, they have a primary fiscal surplus of 2.5% of GDP, but the negative environment of the external sector is not impacting that much on the public finances, maybe a reduction of 0.5% of GDP,” says Daza.

In fact, Daza points out that “the main fiscal problem in Brazil is created by the heavy debt service associated with high interest rates”.
Peru’s economic growth remains steadfast

Peru, presently ranked 50th in the global ECR rankings, was down four places in the survey this quarter. ECR analysts have pointed to the same risks seen elsewhere in the region, after the sovereign witnessed a downturn in its political-assessment score by 0.3 points, with downgrades across Peru’s non-repatriation, regulatory/policy environment and government-stability indicators.

A report by Capital Economics states that Peru still enjoys some of the highest growth rates in the region but remains heavily dependent on China’s “commodity intensive investment boom”. This is reflected in ECR data, which shows that Peru’s economic outlook indicator remains the highest in the region in Q3 – on a par with Chile.

The report notes that a slowdown in Chinese investment “will reduce both the demand for, and the price of, Peru’s metals exports, which in turn will take some of the steam out of the economic growth. As it happens, this might actually be a positive development since the economy is showing some signs of overheating.”

Juan Ruiz, an economist at BBVA and a member of ECR’s expert panel, does not expect further downturn in the Chinese economy. “If there is a slowdown, we expect policy in the Latin American economies to kick-in and start a stimulus, which would be a positive for metal and copper exporters, like Peru and Chile, as the stimulus would be concentrated in infrastructure and construction,” he says.

However, Juan warrants a note of caution. “Public finances are very much dependent on commodity prices in Peru and Chile,” he says. “They have a margin for commodity prices to come down and still be resilient in a surplus position.

“But if the economy still comes to a slowdown after a policy stimulus, this would weigh heavily on commodity prices, metals in particular, which would be a huge strain on the public finances.”

                                                 source: ECR

Chile weathers out global slowdown

ECR analysts have become less optimistic about Chile’s country risk outlook in Q3, after the country witnessed a 0.2 point reduction in its overall risk assessment score.

Speaking to the FT on November 16, Chilean president Sebastián Piñera highlighted the country’s dependency on commodity exports to China.

Copper is Chile’s largest export and a downturn in copper prices could offset the economy’s growth trajectory. As reported in the FT: “In Chile, everything is vulnerable to China – it is our largest customer,” said Piñera.”

Yet Chile remains the safest economy in Latin America for another consecutive quarter. With a rank of 16, Chile is now 21 positions ahead of Latin America’s largest economy – Brazil.

Chile’s wider institutional framework is a key element in it withstanding any external shocks and supporting sustainable economic growth – a point raised in a recent ECR article (Chile: The storm beneath the calm?).

This is one reason why Chile has been able to weather out the global financial storm so far, as structural mechanisms in the banking sector and the high levels of reserves has allowed it to withstand any contagion impact from the eurozone or fall in commodity exports.

Camilo Pérez Álvarez, chief economist at Banco de Bogotá and a member of ECR’s expert panel, notes: “In the Lehman crisis, the government was able to tap into the savings accumulated from the stabilization fund, allowing them to give a boost to the economy during the international crisis and this is probably what they will do next year, if growth rates go down further.”

Risk outlook remains bleak for Argentina and Venezuela

Argentina is proving to be one of the region’s worst performers this year and has descended to 110th in the global rankings. Against a backdrop of the nationalization of state oil company YPF and other unorthodox economic policies, including raising tariffs and rationing foreign currency to protect against capital flight, Argentina has dropped into the riskiest of ECR’s five tiers, as economists have lowered their scores for all 15 of its sub-factors.

Argentina has suffered another detrimental setback after legal proceedings against the sovereign demanded it pay out $1.3 billion to hedge fund creditors. Market speculators are already weighing up the impact this decision will have for the country, with a technical default now highly anticipated – a theme Euromoney magazine recently picked up on (Imminent Argentinian default)

Argentina’s points deficit to Venezuela, the riskiest of Latin America’s main economies, was 2.8 at the beginning of 2012, but has since narrowed to just 0.1.

                                           source: ECR

Venezuela’s risk outlook remains bleak, having being downgraded again by ECR analysts for another consecutive quarter. Venezuela now sits in a lowly 112th position with a score of 34.3, alongside other economic and political fraught economies such as Greece, Egypt and Madagascar.

The re-election of president Hugo Chávez in October has sparked new concerns over its future risk outlook, with analysts predicting a worsening in economic policies: those have profited the incumbent regime but remained detrimental to foreign investment.

Miguel Rojas, associate professor of University of Moncton, says: “After 14 years of a strong anti-capitalist stand, it is very unlikely that Chávez could be able to modify perceptions of foreign or domestic investors. It is possible that currency overvaluation that penalizes exports and subsidizes imports will continue, because it seems to profit the operation of the Venezuelan government.”

In comparison to the Latin American average, Argentina and Venezuela now have riskier assessment scores across the economic and political components of the survey and in the Access to Capital Markets (ATCM) indicator, reflective of the marked downturn in both countries’ risk profiles.

Mexico closing in on Brazil

Brazil is now considered the safest investment destinations among the Bric nations, after overtaking China by two positions Q/Q, to rise to 37th position in the global rankings.

Mexico climbed two places in the rankings this quarter to 40. Mexico looks set on becoming a key competitor with Brazil, with Nomura expecting the sovereign to overtake Brazil as Latin America’s largest economy as early as 2022.

Mexico’s strong performance is reflected in ECR data, which points towards a strong improvement across the country’s economic assessment indicators during the last quarter, having improved by 0.5 points to 61 in Q3. This falls on the back of a further 1.9 score increase in Mexico’s economic assessment between Q1 and Q2 in 2012.

                                             source: ECR

This is supported by the fact that Mexico’s fundamentals have been among the best in the Latin American region during the past five years. Mexico outgrew Brazil last year and should again in 2012, according to Nomura. Growth forecasts show that Mexico grew by 3.9% against Brazil’s 2.7% in 2011, while Nomura forecasts Mexico to grow 3.7% by the end of the year, against a 1.9% rate for Brazil.

                                          source: ECR

However, Dalton Gardiman, chief economist at Bradesco Securities, contends that Brazil’s economy should remain resilient. “Brazil will remain stable, an improvement in the economy has been spurred by an increase in real activity, lower rates and fiscal stabilization, while concerns over inflation, reforms and low productivity have eased,” he says.

There are two reasons to remain optimistic in Brazil, according to Dalton. “With the world in a recession, Brazil has very high growth in relative terms as opposed to absolute performance,” he says. “Secondly, it enjoys a robust banking sector through leverage that is controlled, good supervision, no housing excesses and very tight control by the central bank.”

                                              source: ECR

In Mexico, general government gross debt is expected to be 42.85% of GDP this year, compared with 65% in Brazil, according to the IMF, and consensus forecast for inflation in Mexico is 4.2%, compared with 5.1% in Brazil, according to Morgan Stanley.

The new centre-left government, elected in July, has promised to embark on a comprehensive set of reforms across energy, taxation and labour law. Any progress in these areas would be an additional stimulus to the country’s economy and risk profile. This is a point raised in a recent Capital Economics report, after years of policy impasse, that prospects for economic reform in Mexico are improving. Labour market reforms have already been approved in recent months and measures to boost foreign investment could follow once president-elect Enrique Peña Nieto takes office in December.

These developments suggest that Mexico and Brazil’s economies are on a par to converge during the next few years, largely due to the change in growth rates that is being forecast for both countries.

Capital Economics reports: “Over the next two years, however, we expect Mexico to replace Brazil as the fastest-growing of the region’s two largest economies. The report forecasts that the Mexican economy will grow by around 3.2% in 2013 and by 4% in 2014 – well above the average annual growth rate of 2.5% seen since 2004. By contrast, we expect Brazil to grow by 3.5% in 2013 and 3.8% in 2014 – not a disaster, but disappointing by recent standards.”

Rising performers

On the other hand, Uruguay, rated BB+ by Fitch, Baa3 by Moody’s and BBB- by Standard & Poor’s is becoming safer. ECR analysts upgraded the sovereign’s risk assessment by 1.2 points to 52.5 in Q3 – leaving it with a global rank of 61. This falls on the back of a further 1.9 score improvement between Q1 and Q2. Rising confidence in the sovereign is underpinned by strong fundamentals, as noted in a recent ECR article (Latin America’s uneven risks should spur portfolio shifts):

“Uruguay has decoupled from its export-dependency on Argentina, and by diversifying up the value-chain into gourmet food products, in conjunction with a boom in construction and healthy tourism flows, the country continues to record respectable growth rates.”

Bolivia enjoyed the strongest improvement in the rankings this quarter. The sovereign climbed 10 places in the rankings, after its overall assessment score was bolstered by a substantial improvement in the country’s ATCM indicator. This leaves the sovereign lying in tier four in the rankings – on a global rank of 101.

Bolivia’s access to capital markets indicator improved by two points to 2.75 points between Q2 and Q3 2012. This is in line with the improvements seen across its overall ECR score, which improved by 2.3 points to 37.1. Although still low in comparison to Latin America’s average overall risk assessment score, the development highlights the economic and structural reforms being undertaken by the current administration.

                                              source: ECR