12 July 2012
Latin America has of late been able to bask under the sun with optimism and resilience. Economies are roaring, and leaders are displaying more confidence in regional and international affairs. However, behind the excitement, serious issues, ranging from benign to malignant, could alter the region’s outlook. Similar to Europe, Latin America cannot be painted with a single brush, and certainly, one country’s problems could certainly permeate territorial borders.
Venezuela, to everybody’s surprise, boasts one of 2012's best performing stock markets. At the time of writing, the Caracas Stock Exchange Stock Market Index (IVBC) has produced overall gains at an impressive 116 percent year-to-date (YTD). More outrageous is the yearly gains from June 20, 2011 to June 20, 2012--the stock market grew 214 percent!
To give these numbers some perspective, compare the general U.S. benchmark index, the S&P 500. The S&P 500 index averages 10 to 11 percent per year; in the last 10 years, the S&P has averaged an underwhelming 4 percetn. The difference, however, is that the U.S. is governed by democratic political system with credible checks and balances. Venezuela, on the other hand, is ruled by semi-authoritarian leader President Hugo Chavez, fueled by anti-Americanism, and mired in arcane socialistic dogma that regresses the once-stable country.
How then can we explain the Venezuelan stock market surge? It appears that investors are anticipating a possible transfer of leadership in Caracas. Since last year, President Hugo Chavez has been battling cancer, receiving treatment in Cuba, thus fanning rumors and intense speculation that either Hugo Chavez will be too ill to serve another 6-year term (assuming he wins the next election on October 7th), despite his recent "cured" diagnosis. If Mr. Chavez is not fit to lead the country, the economy can unravel even while being led by a chosen successor. Also investors are always looking for a maximum gain, the theoretical objective of investing. Markets in the U.S., EU, and China are currently underperforming; therefore the low-risk averse investors look at Venezuela as an attractive alternative. Other Latin America stock markets have not been faring as well in 2012. Argentina and Brazil are currently down in the red, respectively at 14 percent and 6.9 percent. Thus, without a doubt, the main driver behind the Venezuelan stock market’s upward trend though is the potential departure of Mr. Chavez, a massive factor that excites Venezuelan markets.
The reality is not as optimistic as investors are. According to a reputable local polling firm Datanalisis, Chavez is currently leading with 43 percent of the vote, while the opposition, led by Henrique Capriles Radonski, is struggling to gain new momentum with only 26 percent of the vote. Economically, Venezuela is a mess. Inflation is in the range of 25 to 30 percent, and it employs an economy that has overwhelmingly underperformed due to Chavez’s tinkering and ferocious attack against free enterprise. Also, the government is heavily indebted. President Chavez has misused most of the oil revenues to fund his social polices. In the past 3 years, the money owed to foreign creditors has almost doubled, reaching US$96.7 billion at the end of 2011. Venezuela's currency--the Bolívar--employs three exchange rates. The first conversion rate is 4.3 bolivares per U.S. dollar, given to companies that are importing “priority goods." The second rate is 5.3 bolivares per U.S. dollar, and the third, which is a black market rate, is approximately 9 bolivares per U.S. dollar.
At the very least, having a conversation about President Chavez possibly losing the upcoming elections is good news; this notion was inconceivable just a few years ago. In an ideal world, if Chavez were to lose, Venezuelan markets would open up, attracting local and foreign investment. In the U.S., there is an old adage among stock traders that the U.S. stock market is six months ahead of the general economy. Perhaps at the risk of being overly optimistic, but it would be sensational for the Latin American region if the old U.S. adage were to come to fruition in Venezuela.
The darling of Latin America, Brazil, is trying to cope with an economy that is showing concerning signs of fragility. The 1st quarter numbers came with disappointment: a meager GDP growth rate of 0.2 percent, the slowest pace in more than two years. Economists are predicting that Brazil will continue to grow at a rate less than 3 percent for the second consecutive year. The magic number for Brazil is a 4 percent growth rate, a target that seems unlikely for 2012. Brazil, the second largest developing economy after China, is losing its stardom as an exemplary emerging market, a matter of concern not only for Brazil, but also for all of Latin America.
The diagnosis is simple: Brazil is heavily reliant on their commodities. They are not yet suffering from Dutch Disease, but they do tend to flirt with its symptoms. Their largest commodity buyer happens to be China, and the Middle Kingdom has announced that their growth rate may dip below 8 percent for the first time since 1998. To make matters worse, the European Crisis and the subdued global outlook are affecting Brazil as well, giving credence to the notion that the world is flat when dealing with economics and finance. Brazil’s troubles become more alarming while commodity prices continue to fall, making the situation even harder to navigate.
In the last few years, Brazil loosened credit to create a consumer-led economy attached to the commodity boom. Brazilians were able to leverage borrowed money on purchasing goods and services. Now, locals feel over-indebted and have scaled back on consumption, similar to the scenario in the U.S. economy.
Moreover, Brazilian exports (not including commodities) have never flourished because the Brazilian real was too strong in value compared to emerging markets.
Brazil should be worried about their economic state; luckily, the situation is not catastrophic. Already Brazil’s central bank has cut interest rates to a record low 8.5 percent. President Rouseff is planning to further stimulate the economy by offering tax incentive for businesses, and trimming bureaucratic red tape. A much-needed increase in infrastructure investment is in the works, and cutting the interest rate further remains an option. In short, a struggling Brazil is bad for the Latin American region, but the long-term prospects are still bright, as long as they effectively address their current deficiencies.
The situation in Argentina is becoming more comical by the day. Inflation, similar to Venezuela, is running rampant and speculated to be around 24 percent annually, despite Argentina’s stubbornness in claiming it is approximately 9 percent annually. The nationalization of Repsol YPF did not the industry do any favors in attracting foreign investment. Although nationalization of industries does have a notorious history in Latin America, Argentina’s method of implementing this strategy seemed more political than economical. The Argentine economy had been performing strongly the last 8 years, due to the world commodities boom and Chinese demand, but the good times are quickly coming to end. According to the World Bank, the economy is projected to grow only 2.2 percent this year, a significant drop-off from last year’s 9 percent. In fact, some economists are projecting that a recession is feasible.
Unfortunately, both former President Nestor Kirchner and current President Cristina Kirchner de Fernandez have used the revenues from the commodities boom frivolously, not saving the much-needed dollars for economic declines, something Chile strategically accomplishes via its copper fund.
Argentina is now dealing with a new ill--their grossly overvalued currency, the peso. President Cristina Fernández de Kirchner is managing the country with both a low supply of dollar reserves and a declining economy, forcing the government to impose restrictions on foreign currency transactions. Argentine companies that import goods must also export goods to supposedly offset the purchases of dollars by receiving dollars from their exports. For instance, companies that import auto parts must export wine grapes in order to comply with the law. Argentina, without any reservations, discards the law of comparative advantage when dealing with trade and commerce. To be fair, the restrictions have succeeded in negating capital flight; only $1.6 billion left the country during the 1st quarter of 2012, compared to $8.4 billion in the 3rd quarter of 2011.
However, locals are obviously aware of the true value of the Argentine peso, and are opting to horde dollars to preserve the value of their savings and investments. According to The Economist, anywhere between $10-$40 million dollars are exchanged daily in the black market. The Argentine administration does not take too kindly to its citizens preferring dollars instead of pesos. In the pursuit of limiting capital flight, and propelling the peso, President Fernández de Kirchner has enacted a policy of prosecuting people who buy U.S. dollars legally and then reselling them in the black market. Dollars have become so scarce, that it is now more difficult to exchange pesos for dollars than to be financed for a peso-denominated mortgage loan. The mood is that President Kirchner is going to continue to print more pesos, doubling down on peso-fying the market and increasing government subsidies, raising the possibility of Argentina running out of money and falling into the trap it faced in their 2003 economic debacle. As the cliché states, history has a way of repeating itself.
The first half of 2012 has been mixed for Latin America. Without a doubt, the outlook could be better, but when compared to historical standards, it could definitely be much worse. The challenge for a Latin America is to simultaneously think locally, regionally, and internationally. As long as Latin America stays on course, the future remains positive, despite their current difficulties.