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Latin America and the global financial turmoil: A remake of 2008 ?

Florent Michel, Managing Partner at Latina Finance & Co is providing us with his views on the potential impact on Latin America of the on-going financial turmoil in the US and Europe.

Michel Florent
Michel Florent
Latin America is looking at Europe and at the US with mixed feelings of worry and “déjà vu” remembering the 2008 crisis. Only spectators of the game that is being played in Europe they already know that this economic contraction will cost them in terms of growth. Some of them have already started to take measures anticipating the impact. How deep is this crisis and how is it going to affect the region? This is still unknown territory. Is it a remake of the 2008 crisis which ended up in a strong regional rebound in 2010 driven by increasing Foreign Direct Investments (FDIs), continuous surge in commodity prices and renewed access to long term financing, or is it something different, deeper and more permanent ? As of today Latin America still seems to be insulated, but can this last? Internationally integrated countries of the region as well as those with weak economic fundamentals should suffer more, this is certain.

Impact of a potential European credit and liquidity crunch

The reduction of credit availability and tighter liquidity in Europe (and the US) should impact Latin America in various ways. European banks have a large presence in many Latin America countries with even dominant positions in some cases such as Panama (HSBC) or Chile (Santander) . The three largest European banks in the region (Santander, HSBC and BBVA) account for a good chunk of local claims even thought as a whole Latin America credit base is still 60% with domestic banks and this should serve as a good buffer.

Given balance sheet constraints, European bank should be gradually reducing their interbank lines with banks in the region and especially Brazilian banks. This definitely will put additional pressure on Brazilian banks balance sheet to maintain on-going credit availability.

Banks in the region, given that their activity is predominantly domestic, should remain, as in 2008, relatively protected and immune from the financial institutions crisis in Europe and the US. They should remain sound providers of liquidity to Latin American economies. It is also to be noted that while pure domestic players will be in a relatively better situation, the four large key international players including BBVA, Citi, HSBC and Santander, will certainly reduce their credit exposure and provide less new money.

Some of the Latin American economies are very integrated internationally; this is the case for Panama and Chile and to a lesser extent for Peru, Brazil or Mexico (USA). The more integrated those economies are the more impacted they should be. This being said some of them such as Chile have other positive macro economic and financial strengths which should help them better weather the storm.

Another aspect to also take into consideration for Brazil in particular is the need of credit lines for the hedging of long term currency positions. In the last three years the Brazilian corporate bond market has flourished. Large Brazilian corporate issuers will be looking for long term hedges but they might fall short of finding credit and liquidity providers. Derivatives market in the region could also be impacted with difficulties to roll over positions and book new deals.

Trade financing should be hurt too as European banks are large providers of trade lines to the continent and this could adversely impact on going trade growth across the region. Notably this should translate into an erosion of trade surpluses of Mexico and Brazil for instance.

Overall a reduction in credit availability and reduced liquidity will put pressure on balance of payments as well as weakening exchange rates of Latin American countries.

Increasing pressure on current account balance of payments

Key economic drivers of the region have not fundamentally changed in the last five years. To the exception of Mexico, more than 70 % of the region’s revenues still derive from the exports of commodities whether soft or hard. The only real change has been the destination of those exports with more diversification (some would say dependence) towards China and Europe and to some extent increased intra regional sales (especially true between Argentina and Brazil).

Quasi all Latin American countries cannot rely solely on their domestic market yet to fuel high single digit GDP growth. Even if less than before, they still remain dependent on exports of commodities and imports of manufactured items, machinery, equipments and technology. Foreign currency inflow remains a “must have” to sustain the unprecedent growth that the region has experienced in the last five years. Where are those foreign currencies coming from? Simple, four main sources: Exports (commodity driven but to a lesser extent for Mexico and Brazil), Foreign Direct Investments (still coming for the bulk of it from the US and Europe), Foreign workers remittances in the case of Central America (coming mostly from the US and Europe- Spain-) and finally Tourism (there again US and Europe). No need to be a rocket scientist to understand that the present financial turmoil in Europe and the US will have a strong impact on Latin American current accounts as a whole in 2011 and 2012.

There is also a risk that foreign investors and multinationals will look at repatriating more rapidly earnings and cash balances hold in countries. This would have an additional negative impact on current balances.

Early warning signs

The last six months have been quite interesting to follow with a number of early warning signs across the region. Between April and September 2011 , Braziliean, Argentinean, Chilean, Mexican and Colombian stock exchanges have drop respectively by 21, 20, 15, 9, and 7 % illustrating investors nervousness. Moreover, at the same time in the last months most of the Latin American currencies have started to fall against the USD with Brazilian Real and Mexican Peso respectively down 10 and 13 % in September 2011. On interest rates, while most of the countries have progressively increased them since the beginning of the year (Brazil, Colombia, Chile, Peru) some of them are reverting to wait and see mode while others have already taken action (Brazil CELIC down 0,5 % in Sept 2011). The trend is that we should see some reduction in interest rates level in most of the countries of the region before year end, maybe to the exception of Venezuela and Argentina. Some commodity prices have also continued to fall including crude and copper (crude down to USD 80 per barrel and copper at its lowest in 12 months on Sept 2011). For their part soft commodities have been more resilient in the last months including Corn, Wheat and Soya but Chinese imports in particular could decelerate at a point and those should ultimately be impacted too.

Other worrying signs in September include investors accelerated withdrawals of funds from emerging market bonds and equity funds shifting to US treasuries.

Domestic consumption however seem to be maintaining itself at good level across the region for the moment. One must bear in mind that local consumption continues to be also supported by an unprecedented growth in consumer finance and hire purchase provided by banks eager to earn higher yields on their short term liquidity. But will they be able to sustain this in the context of increasing balance sheet pressure? For sure consumer finance is certainly an area to look at closely in the coming months.

Brazil to be certainly the most resilient and resistant

Brazil (and also Chile) will be certainly the country that should the best resist in this adverse environment as its overall economic situation has improved so much in the last decade it should put it in a favorable corner. While geographically diversified its exports goes for nearly 50 % to China, US and Europe with China for more than 15% (its number one export customer). Even if exports does not represent a major component of the economy, a drop in exports should have some impact on the GDP growth which is now forecasted to be in the 4 % range in 2011 (against 7,5% in 2010).
At the same time the country has built strong foreign currency reserves standing at about US$ 350 billion in mid 2011. If the recent rally of the USD against the Real continues it should also positively counterbalance some export slowdown.

Brazilian banks have also grown their balances sheet wisely and the financial system appears to be strong and sane. This being said the country will be definitely affected.

Latam should once again better resist, but are we talking about a remake of 2008?
Turbulences in Europe and the US will have (and already has) some negative impact Latin American economies. Will it only be a temporary reduction of GDP growth down to acceptable levels as in 2008 or will it be deeper? Hard to say. Morgan Stanley’s recently revised its growth forecast for the region at 3, 6 % for 2011 against 6, 3 % last year…

One should not forget that, even if most of the Latin American countries survived the 2008 crisis better than the rest of the world, it has not been without any pain. Among others things (a) FDIs went down 40% (b) imports and exports were down 24 and 25% respectively and (c) the region experienced a negative GDP growth of 2,5 % ( 7% in Mexico).

Even if some of the macro environment has changed, the 2008 crisis remains and interesting proxy. Countries mostly affected by the crisis in terms of GDP growth were Mexico (but that was to a great extent linked to the US economic contraction) and Venezuela. Otherwise Argentina, Costa Rica and Peru suffered the most, followed by Panama. Chile, Colombia and Brazil were less hurt. It is most likely that the scenario will repeat itself for Argentina and Venezuela as there have not been any major changes in their economic drivers since then.

On the one hand, there are reasons to believe that the region should be once again little less impacted than the rest of the world given (a) lower debt level, (b) reasonable current deficits (c) improved fiscal deficits and finally far stronger foreign exchange reserves built over the last four years (especially in Brazil, Mexico, Chile, Peru and Colombia) which should serve as a good cushion. On the other hand the pressure on foreign currency inflow as well as contraction of the domestic economies (lower consumption, and reduction in production output) could jeopardize GDP growth to the point of a recession. Countries with important or excessive public spending budgets and big reliance on imports such as Venezuela, Ecuador, and Argentina should be more impacted.

The spontaneous offer for help from Brazil to Europe in late September is a good sign that there is an understood common interest and political willingness to see Europe weather the storm. What can be said is that as in 2008, Latin American economies appear once again better armed and have definitely gained in terms of financial management and public finance discipline. The creation of macro stabilization funds illustrates that trend. Prices of commodities as well as maintaining sound and rigorous fiscal policies with good anticipation will be essential in the coming months. Clearly a new challenge for emerging Latin America…

Florent Michel
Founder and Managing Partner - Latina Finance & Co
Florent Michel is the founder and managing partner of Latina Finance & Co, a firm specialised in consulting and advisory for corporate, banks and financial institutions in the area of treasury and debt in Latin America. Prior to this, he spent 15 years at Citigroup where he was managing director and senior credit officer after seven years in treasury and financing with various corporates and banks. Michel's product skills ranges from international treasury and cash management to bank, capital market and structured debt including a strong export and infrastructure project financing practice. He has an extensive knowledge of Latin American markets in the area of cash management and treasury servicing large multinationals needs but also in the field of corporate and project financing. Michel regularly writes articles and studies for various publications and provides treasury training in Latin America. He is also one of the co-founders, and director general o f the Latin American Treasury Association.

Latina Finance & Co
Latina Finance & Co (www.latinafinance.net) is a firm based in Uruguay and specialised in corporate finance advisory and consulting in Latin America primarily serving multinationals, banks, financial institutions and financial technology vendors. Practices include regional treasury and cash management performance audit on processes and controls, performance measurement, benchmarking, cost saving. Latina Finance & Co also provides debt and funding advisory and treasury training in Latin America. Latina Finance & Co has a team of trustworthy professional experts in the key Latin American markets. This team is united through their culture of efficiency, integrity, pragmatism and professionalism and has long-term corporate finance experience in the region, combining corporate and banking backgrounds. Email: contact@latinafinance.net

Mardi 4 Octobre 2011

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