Latin America offers pockets of resilience to EM risk aversion


Jeremy Weltman
Published on:

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.”

Mexico surfing on its strengths

Indeed, Mexico’s score may have edged downwards in Q4, but it ended the year 2.5 points higher than at the start of it, pushing the sovereign up four places in the rankings to 36th position – which is only two places below and less than four points off the second of ECR’s five tiered categories containing A-rated sovereigns.

Mexico is top B-rated, but stable, according to Fitch, Moody’s and S&P, signalling no near-term prospect of an upgrade.

ECR has looked at the reasons for Mexico's strengths previously, but it is worth reiterating those findings.

None of the country’s five economic indicators were downgraded last year, one in fact rose: the economic/GNP outlook. The IMF predicts that real GDP growth will accelerate to 3% this year, based on improving economies north of the border boosting Nafta trade flows, coupled with government policies geared toward employment creation. Prior to last year’s slowdown Mexico enjoyed a vibrant economy for three uninterrupted years.

Political factors are conducive to its low-risk environment. Five of Mexico’s political risk indicators, especially its regulatory and policy environment, and government stability, improved in 2013 as the government’s structural reforms (including new energy policies) made progress under the new PRI president, Enrique Pena Nieto, who took office at the end of 2012.

“These reforms will be the basis of a more sustainable long-term growth” de Groote notes.

Marijke Zewuster, head of emerging markets research at ABN Amro and another of ECR’s experts, sees the reforms as: “the first important step for private-sector investment in the oil sector as a lack of investments, along with a decline in reserves, has led to a gradual decline in oil production over the last eight years.

“Mexico has huge shale gas and deep-water oil reserves, which could be tapped more easily once the reforms are approved.”

All of this has been achieved without a particularly painful rise in the budget deficit and, critically, by retaining a strong external balance position, with a current account deficit of less than 2% of GDP.

Peru also riding high...

The enthusiasm for Peru is a little harder to explain, but not unjustified. On a score of 52.2 it ranks 40th, four places lower than Mexico, giving rise to a risk premium partially driven by its larger current account deficit, which is seen rising to over 5% of GDP in 2014, three times larger than Mexico’s.

Incidentally, such nuances are not picked up by any of the credit ratings agencies, which award Peru an identical top-B rating.

Its risk factor scores have moved in both directions this year, but on balance government stability, and rising perceptions concerning capital repatriation and the employment situation, with strong real GDP growth continuing at around 5% to 6% endorse its merits. Benefiting also from strong trade links with low-risk Chile, Peru’s total score has improved as a result.

ECR expert, Roberto Cervello-Royo, assistant professor at Universidad Politécnica de Valencia, states: “The Peruvian economy seems to have less external vulnerabilities; it remained mostly unaffected by the termination of the US tapering and it seems to be less exposed to risks related to Chinese demand (in comparison to other LatAm countries).

“Peru is expected to be one of the world's most dynamic economies this year; furthermore, there are great expectations for the Peruvian currency (nuevo sol) performance also vis-a-vis other LatAm countries.”

...along with Uruguay

Uruguay is facing elections this year – as are many of the hard-hit EMs worldwide – and has seen a three-point rise in its risk score in 2013. Unlike Peru, however, where doubts crept in during Q4, its score continued to rise through to year-end.

Uruguay is riskier than Peru, some 10 places higher in the rankings, but it climbed 12 places last year to 50th – a more comfortable mid-tier three position commensurate with BB+ to A- ratings, signalling that its lowest triple-B ratings are negatively biased and overdue a review. 

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