Latin America (LatAm), has been identified as one of the better performing emerging markets following the region's resilience in enduring the global financial crisis. In response to global economic activity slowdown and increased global downside risks, their historically outstanding growth has somewhat softened. The two major downside risks dampening growth in the region and by extension, the world, are the European debt crisis and the looming "fiscal cliff" in the United States.
However, the Latin American sphere has reaped the benefits of sound macroeconomic policies, low levels of indebtedness and an increasing demand for the region's export commodities. This has resulted in higher growth rates than most developed countries. The International Monetary Fund (IMF) projects that the region's economy will slow to 3.20 per cent in 2012 down from 4.50 per cent in 2011. Figure 1 depicts the recovery in select Latin American countries after 2009. In this article, we will review the opportunities in these key Latin American nations: Brazil, Mexico and Venezuela.
Brazil
Over the past decade, Brazil has emerged as the region's largest economy. The nation's economic expansion is sustained by strong domestic demand, low debt to gross domestic product ratios and high international reserves levels. However, in 2011, the economy of the South American giant cooled as growth declined to 2.70 per cent on a year-on-year (y-o-y) basis from 7.50 per cent in 2010.
The slowdown observed in the latter half of 2011 was largely attributable to the effects of monetary and fiscal tightening, which included the increasing of the benchmark rate, the Selic, five times during the period of January to July 2011 from 10.75 per cent to 12.50 per cent. According to IMF forecasts, Brazil's economy is expected to shrink further to 1.50 per cent in 2012, then to expand to 4.0 per cent in 2013.
The country has been struggling with inflationary pressure over the years with an inflation rate of 6.60 per cent in 2011, up from 5.0 per cent recorded in 2010. The fiscal tightening has had the desired effect of reducing inflation to 5.24 per cent in August 2012, which was above their target rate of 4.50 per cent. The fiscal tightening also resulted in a undesired effect of reducing investment spending as the outlook for commodities, Brazil's key sector, waned.
In light of a worsening world economy, the central bank began reversing its monetary and fiscal policies by reducing the Selic rate, which today stands at an all-time low of 7.25 per cent. Also, Brazil's hosting of the World Cup in 2014 and Olympics in 2016, is expected to positively impact on the country's growth process. Despite Brazil's economic challenges, it is a popular investor destination and Standard and Poor (S&P) affirms its BBB foreign currency long term rating, with a stable outlook.
Mexico
Mexico is the second largest economy in the LatAm. It relies heavily on oil exports and trade with the US (major export market and prime source of foreign direct investment). As a result of its economic ties and heavy dependence on the US, the nation was hit the hardest by the global financial crisis experiencing a drastic fall in economic activity. However, like Brazil, the economy rebounded quickly, with growth supported by strong domestic demand.
In the face of the Euro zone crisis and the softening of the US economy, Mexico's growth rate declined in 2011 to 3.94 per cent from a high of 5.56 per cent recorded in 2010, according to latest records from the IMF. The IMF also projects the Mexican economy to grow at rate of 3.78 per cent this year and 3.46 per cent in 2013. These low projections are in light of the risks coming from the US, in particular, the looming fiscal cliff and upcoming elections early next month.
The inflation rate remained relatively subdued at 3.40 per cent in 2011, which was relatively on par with its target inflation rate of 3.0 per cent. Despite slow growth in the US, investment houses like Credit Suisse remain positive about the outlook for the Mexican economy.
This optimism stems mainly from the high performance expectations from the new president who will be inaugurated on December 1st 2012 and the view that industrial production in the US will gradually pickup in the 4Q 2012. Moody's maintains a Baa1 rating of the world's number seven oil producer with a stable outlook, on account of its moderate government and external debt ratios, solid international reserve position and a flexible exchange rate regime.
Venezuela
Venezuela, the fifth largest economy in the LatAm, has been the worst performer in terms of gross domestic product per capita growth during the last decade. As illustrated in Figure 1, the nation did not show positive growth until 2011, two years after the financial crisis. Thus, in 2011, when the economies of Brazil and Mexico experienced a slowdown in their economic growth, Venezuela grew significantly by approximately to 4.20 per cent.
However, this communist nation has one of the highest inflation rates in the region of 26 per cent in 2011, down from 28 per cent recorded in 2010. Apart from Venezuela's exorbitant inflation rate, the economy lacks diversification and relies heavily on oil revenue. Latest records show that revenue from oil accounts for more than 90 per cent of the country's foreign currency inflows.
In their recent presidential elections, Hugo Chavez maintained his position as president for another six-year term. The IMF projects Venezuela's economy to grow at 5.75 per cent this year and to ease to 3.25 per cent in 2013. Additionally, S&P maintains a stable outlook for Venezuela at a B+ rating. Their stable outlook and speculative grade rating reflect the risks associated with interventionist government policies, uncertainties regarding Chavez's health and the government's negative impact on investment and growth prospects.
Recommendations
Figure 2 illustrates the yields to maturity (YTM) of bonds due to mature within the five-seven-year range. ELEBRA 2019 (Centrais Electricas Brasileiras) is a quasi-sovereign bond issued from the utilities sector of Brazil which currently yields 3.70 per cent. Pemex 2019 (Petroleos Mexicanos) is also a quasi-sovereign bond from the energy sector of Mexico that currently yields 2.60 per cent.
These two bonds are of investment grade. The vast difference in the YTM of the Venezuelan bond (PDVSA 2017) is due to the fact that this quasi-sovereign bond is of speculative grade and thus the high yield (11 per cent) compensates for the increased risk.
Though the above mentioned bond yields are relatively low, it still surpasses the returns an investor would gain in the local USD money market which ranges between 1.00-1.60 per cent. Thus investors seeking new opportunities could gain a decent yield pick-up by extending their horizon to the short and medium term and considering sovereign and quasi-sovereign bonds of Brazil and Mexico.
For the more aggressive investor, Venezuelan sovereigns are worth considering for their attractive yields. It is recommended that investors adopt a hold-to-maturity stance in order to mitigate risks from price volatility. As usual, we recommend that investors seek consultation from a qualified investment adviser, such as Bourse, before making any investment decisions.
