Latin America Polls Rehearse Decade Gloom Chorus
Latin America’s heavy 2021-22 election cycle has already delivered surprises to investors as they assess Covid-19’s devastating impact throughout the region and debate if another “lost decade” has begun. Positive news came with the surprise election of banker Guillermo Lasso as President of Ecuador in the second-round run-off. In stark contrast with his challenger Andres Arauz, the leftist candidate endorsed by exiled former President Correa, he has promised to maintain the country’s USD 6.5 billion IMF program, although it is likely to be tweaked, and to honor last year’s bond restructuring agreement.
The election immediately sent the recently restructured bonds sharply higher on Lasso’s promises of free market reform. Following the election, he promised to revive the economy, eliminate the fiscal deficit within four years and propose new risk-sharing contracts with private oil companies to boost production. While welcoming his pledge to respect current oil company contracts, investors are skeptical that the deficit can be slashed absent higher taxes which the IMF is recommending. In addition to dealing with the IMF, Lasso will also be challenged by the left-leaning Congress that may seek to block planned reform such as formal central bank independence now under debate. After GDP contracted 7.5% in 2020 and government debt/GDP topped 60%, the economy is expected to grow only 3.1% this year, according to the central bank.
In stark contrast, the outcome of the first-round presidential election in Peru stunned investors holding more than half of local government bonds. Trade unionist and schoolteacher Pedro Castillo – who did not make the top ten of 18 candidates in any pre-election polls – will challenge right-wing populist Keiko Fujimori, daughter of the imprisoned former president who is facing corruption allegations. During the campaign Castillo promised to draft a new constitution and proposed nationalizing companies in “key” sectors, notably mining and oil. Fujimori has campaigned on re-opening the battered economy – which contracted 11% in 2020 – and creating two million jobs by expanding infrastructure and investing in health and education, but has a checkered past including implication in the notorious construction firm Odebrecht scandal..
Peru has in recent years been viewed by many analysts as “ungovernable” with five presidents the past five years. In addition to the first-round presidential election, Peruvians elected 130 legislators to congress from 20 parties. Populists who dominate the body have been responsible for the destruction of the private pension fund scheme. The latest withdrawal law passed in Congress at end-March and expected to be approved next week will allow citizens to withdraw up to USD 12 billion, about the size of the previous two schemes combined. While the AFP withdrawals may boost the economy in the short-term, future governments will likely need to establish a public pension scheme for a replacement retirement safety net.
With Peru’s run-off election scheduled for June 6, investors also face a rocky ride in Mexico’s mid-term elections then as the ruling Morena party is unlikely to do well. In contrast with other large emerging markets, Mexico stuck to “austerity” during the pandemic, spending just 1.1% of GDP, as AMLO upped state intervention which along with the pandemic dragged investment/GDP to a 25-year low as debt/GDP reached 60%. While the IMF is predicting the economy to expand by 5% this year after last year’s devastating 8.2% contraction, recovery will be export-based, benefiting from US stimulus. Despite out of control infections and erratic government policy, the Mexican Stock Exchange is up 6.5% in USD terms on the MSCI Index.
Chile heads for general elections in November after delaying by a month the April Constitutional Assembly election due to the sharp rise in Covid cases. Investors are already on edge about Brazil’s general election in October 2022. After losing 30% against the USD last year, the BRL is again among the worst performing currencies so far this year down 9%, while on the MSCI Index stocks has fallen 10%. With the pandemic still raging, growing government intervention and reshuffles are ahead after President Bolsonaro replaced the head of Petrobras and top military officials. Asset managers fear the prospect of an extreme political split with a right-wing, virus-denying head of state competing with leftist former President Lula as debt and deficits soar and the economy struggles to recover. GDP contracted “only” 4.1% last year largely due to the 8% of GDP pandemic spending, largely cash transfers to the poor. The IMF is projecting expansion of 3.7% this year, but private analysts believe growth will be much slower particularly as inflation ticks up, the central bank hikes rates, and debt hits 100% of GDP.
Latin America has been the hardest hit region by the pandemic and this month reported more Covid-19 cases and deaths than at any time since the global outbreak. IMF data shows the region contracted 7.7% last year versus an average 2.2% slump for emerging markets as a whole, and this year’s projected growth rate at 4.6% is below the EM average of 6.7%. Elections and uneven policymaking – both around the pandemic and more broadly – will continue to weigh on investor sentiment this year and next. While commodity prices may bolster some markets, domestic demand is expected to remain anemic for years, in that sense at least for most of another lost decade.