by Ben Miller
After dodging a bullet in 2008’s financial crisis
and subsequently fixing vulnerabilities exposed during that
period, Latin American policymakers feel more prepared than
ever to face future contagion risks. Events in Europe, however,
are being watched with increasing unease amid the realization
that the continent’s debt predicament will
eventually wash upon the region’s shore in some
form or another.
A splashy announcement by euro-zone leaders in late October
sent markets sharply higher, but the plan’s lack
of substance and the difficulties of executing it left many
observers unconvinced that the uncertainty hanging over Europe
had passed, meaning that Latin America will have to live with
the ensuing volatility for quite some time.
"This package is still as opaque as it gets – big
announcements are very different from actual logistics and
implementation," says Robert Abad, a senior analyst at Western
Asset Management, which has $3.6 billion under management in
Each crisis brings its own set of surprises and this one
will be no different. Finding the possible transfer mechanisms
that leave Latin America vulnerable to broader market
volatility – caused in this case by debt problems in
Europe and anemic growth in the US – is a popular
thought experiment conducted among the region’s
policymakers and market participants these days.
In Latin America’s case, this volatility could
manifest itself in several ways. Weakness in the commodity
complex if China’s economy slows, volatility in
the FX rates, and a lengthy lull in capital markets activity
are just some of the areas of susceptibility in the months
But perhaps above all else, bankers are wondering what the
sovereign debt crisis and subsequent recapitalizations will
mean for European banks, many of which have a broad
on-the-ground presence and have been active participants in
Latin America’s loan markets, particularly
For now at least, the immediate horizon looks stormy but
manageable. Expectations for the developed world may be below
2.0% for this year, but JPMorgan and other forecasters see EM
GDP above 6.0% for 2011 and between 5.0% and 6.0% next year.
The shop estimates that LatAm growth should dip to 3.2% in 2012
from 4.0% this year, putting it behind its 3.6% potential, but
not by far.
In the event that worst case scenarios unfold in Europe, it
is thought that Latin American countries will have more staying
power than many others. Learning from prior crises, the region
has won top marks for building the defenses necessary to
protect itself against exogenous shocks.
"The one region that has experienced the most crises and is
the most battle-tested market has always been Latin America,"
says Abad. "For anyone who is positioned defensively or for
normalization, LatAm is where you want to be."
Overall economies remain in healthy shape, albeit with
declining growth expectations. Some can still boast trade and
fiscal surpluses, not to mention substantial firepower thanks
to record reserve levels.
"Needless to say, we will experience some turbulence because
of the interconnectedness of the global financial market, but
we feel our main financial variables will be anchored by the
strong fundamentals," Augustin Carstens, Mexico’s
central bank head and former minister of finance, tells
Though the region is still reliant on foreign capital to
grow, the development of local markets in countries like Mexico
means both sovereigns and corporates now have an important
alternative funding pool. Such efforts have gone a long way
toward tackling the problem of "original sin" – a
termed coined by economists Ricardo Hausmann and Barry
Eichengreen to describe countries’ inability to
borrow abroad or domestically in their own currencies.
However, successes on this front have created their own
challenges at a time when foreign investors have become
increasingly enamored by local currency plays. These often
crowded trades leave countries once again exposed to sudden
movements in international portfolio flows, though this time
borrowers need not fret about currency mismatches.
"A lot of the selloff has been in those countries where the
foreign position has been highest," says Joyce Chang, head of
emerging markets and global credit research at JPMorgan.
Still, corporate Latin America remains an improving credit
story, and in most cases CFOs have more than enough cash on
hand to cover upcoming maturities should capital markets remain
shut indefinitely. They are also now more constrained from
taking the FX derivative bets that caused several corporates to
implode during the last crisis.
Yet the notion that Latin America, or emerging markets overall,
can decouple from events in G3 countries has been broadly
rejected, at least until the region can move beyond its
reliance on commodity in exports, establish stronger domestic
economies, and further reduce its need on foreign capital, say
"Under the current conditions, there is a pretty good
external backdrop for the most part," says Javier Kulesz, chief
economist for Latin America at UBS. "But if we move to a more
hostile environment, LatAm will not decouple."
Balance sheets and reserves might be stronger now than in
2008, but that is not a guarantee that the region is on the
whole better prepared for a downturn, Kulesz says. The last
crisis saw expansionary fiscal moves to soften the blow of the
downturn, but that leaves government with less room for
maneuverability this time around.
"Emerging markets in totality have been, are and always will
be price takers of G3 risk whether it is exchange rates or
interest rates," Abad says. "As awesome as balance sheet
positions in LatAm are, the fact remains that if you see
continued volatility, especially on the FX side, that is
eventually going to crack some of the balance sheet position
because it has really been a deep one way trade for the last
few years into emerging markets."
Aside from FX and interest rate risks, borrowers and bankers
alike have been wondering about the broader implications for
European banks and how much they stand to suffer from a Greek
debt restructuring and more turmoil in the peripheral euro-zone
countries, not to mention higher capitalization requirements
ahead of Basel III.
Cost of funding and banks’ willingness to lend
to Latin American credits in this environment has come under
scrutiny, and borrowers are already feeling the pinch.
"We are finding more and more clients turning to us saying
they can’t count on so and so," says one senior
syndicate official in New York who works on emerging market
Less lending from European banks and moves to shore up
capital are likely to result in a domino effect, with immediate
and longer-term repercussion for Latin America.
Asset sales among European banks would potentially have an
immense impact on credit markets everywhere. European borrowers
that have traditionally been reliant on bank lending may also
push pricing higher as they seek funding alternatives
"If they get forced into the bond market they are all going
to the same investor base [as LatAm issuers]," says a senior
banker at a US institution. "You can’t have that
shift without impacting pricing."
European banks’ heavy involvement in
infrastructure financing is not good news for the
region’s efforts to raise trillions of dollars in
this sector. The glaring absence of French banks in
OSX’s recent $850 million FPSO loan may be a sign
of things to come, and mean even more disintermediation amid
efforts to bring infrastructure deals to the bond markets.
In the medium term, export credit agencies and multilaterals
will likely have to increase their lending role, particularly
when it comes to supporting participation in infrastructure
financing, says Valentino Gallo, global head of export and
agency finance at Citigroup.
A big pullback from European lenders that have been part of
the trade line supply to LatAm would be problematic, though
some see euro-zone banks as less likely to cut trade finance
lines than they were in the 2008-2009 credit crisis.
"This is not as bad as it was three years ago when the
liquidity dried up overnight," says Citi’s Gallo,
"There is a little more confidence that regulators have been
monitoring liquidity levels."
Jaime Rivera, CEO at foreign trade bank Bladex, voices a
similar optimistic view. "It was a problem, but it was resolved
as trade lines were reduced and central banks put in place
credit facilities," he says. "They had the means to do so and
they have more firepower at their disposal now than they had in
Fortunately for Latin America, the region’s own
banking systems are now on a surer footing after having been
the catalyst for many a crisis in the past. Not only are they
highly liquid and well-capitalized, but they have a stable
"Banks by and large are now funding 100% of their loan books
with stable deposits," says Bladex’s Rivera. "So
from that perspective the health of LatAm banks is not going to
be impacted by what is happening in Europe."
In some countries such as Mexico, the banking system remains
a potential vehicle for growth, largely thanks to where it
stands in the credit cycle. It is neither cooling off from an
overheated credit expansion such as in Brazil, nor is its
banking system in the process of cleaning up balance sheets and
strengthening its capital base.
"We are not in either extreme," says Carstens. "So I think
our banking system has the capacity to increase lending and
contribute to growth."
This doesn’t mean that the financial system
can’t act as a contamination channel should the
situation in Europe deteriorate.
"If it keeps going, the risk is that through the financial
channel things in EM might start to suffer," Carstens adds.
The broad presence of European banks, which Fitch says make
up between 10%-20% of assets in Latin America’s
local banking system, could in theory act as Trojan horse for
Latin American economies. But, in reality, such subsidiaries
lack the strong funding links with parent institutions that are
seen in other emerging markets, the agency adds.
Nevertheless, Alejandro Díaz, the
country’s head of public credit, recognizes the
dangers posed to banking systems like Mexico’s
which is largely owned by foreigners including
Spain’s BBVA and Santander. According to Fitch, in
Mexico European subsidiaries take up a 45% market share.
"That could clearly take a dynamic of its own," Díaz
says. "We saw something of that nature in 2008. [But] there
have been regulatory measures put in place to ring-fence this
in a more efficient way."
Commodities Remain Key
Meanwhile, commodities continue to be key for a region,
where, as Chang explains, they represent 50% of exports and
well above that level for major countries like Argentina,
Brazil, Chile, Colombia, Peru and Venezuela.
In that context, what happens to China remains vitally
important for the region, though threats to growth in that
country come less from events in Europe and are driven more by
internal factors such as a possible overheating of the real
estate and credit markets, say analysts.
If China and other countries’ appetite for
commodities wane on the back of a slowdown in global growth
this would unwind some of the terms of trade gains that have
supported consumption and investment in the region, Chang
Furthermore, LatAm’s trade dynamics may not be
as strong as they first appear. Imports are on the rise, and
price effects explain more than 50% of increases in exports,
says Kulesz. "When you have that kind of structure, you are on
weaker footing if the situation turns around," he adds.
That said, Kulesz says his shop does not forecast
significant changes in commodity prices ahead. Crude oil,
copper, and soy should finish 2012 at similar levels to
The prospects of sub-par growth remain a worry for many
policymakers in Latin America and this has clearly been
reflected in the abrupt shift in monetary policy in counties
like Brazil. The Brazilian government has its sights on growth
above 5.0%, and has aggressively pursued such goals through
monetary policy and inflation targeting, says Tony Volpon, head
of emerging markets research for the Americas at Nomura
Securities in New York.
"Even if Asia holds up and even if Europe can avoid a
negative conclusion, there should still be lower growth in
Brazil, as credit growth and labor growth slowdown," Volpon
says. "I don’t think Brazil will grow at the
4.5%-5.0% pace we’ve seen in the last couple of
years. Once we have been through the slowdown, you
won’t see 4.0%-5.0% growth, but 3.5% growth."
This may cause investors to reconsider the Brazilian
domestic growth story that has drawn them to the
region’s largest economy in droves.
Given the uncertainty hanging over the markets, selling the
LatAm story will certainly be a trickier affair for both ECM
and DCM bankers, who say market uncertainty means that issuers
have to be fleet of foot and jump through windows of
opportunity while they can.
"What has changed are the recommendations and the dynamics
of the market," says Gustavo Ferraro, head of Latin American
DCM at Barclays Capital. "Before, you set out your strategy and
you would execute on that strategy. Now, because things are
changing constantly, fine tuning is very relevant. Otherwise,
you can miss out tactically."
Yet many corporates and sovereign are already well
positioned to weather the storm in the short term, and are
often more than content to wait on the sidelines.
"We have the benefits that we have anticipated our
initiatives in capital markets by raising equity while the ECM
was still open," says Leandro Bousquet, CFO of BR Malls. "Now
we have the cash. We won’t change our plans in
terms of our growth plans and investments. We are well
capitalized and well prepared."
The Brazilian shopping mall operator has been a regular user
of the international debt and equity markets in the last few
years, loading up on funds it uses to acquire new assets in
what is still a fragmented industry.
Though it’s impossible to predict how long the
volatility will last, local DCM in Brazil is pretty open,
Bousquet says. BR Malls is not planning any fundraising in the
near future, but bonds, securitizations and bank loans are
available locally to issuers.
"What we have seen in the past, at times of high volatility
like we saw in last quarter of 2008, for good names with good
histories there is always a market, even for equity," Bousquet
If one asset class has learned to live with the volatility
it is equity capital markets, which has only seen intermittent
issuance since July, and only the odd follow-on from top
secondary market performers or better-known names.
Latin American McDonald’s franchisee Arcos
Dorados raised nearly $1 billion in October as its private
equity investors took their planned exit. This followed
Brazilian wireless operator TIM Participações,
whose $925 million sale was supported by parent Telecom Italia
taking two-thirds of the deal.
Colombia’s Ecopetrol raised $1.34 billion in
July, but demonstrated the vulnerability that the
country’s local issuers face as they keep their
books open for a prolonged period with the intention of
attracting retail investors.
"We need to see a reduction in volatility, we need to see a
more healthy IPO market in the US which we aren’t
seeing yet, and we still need to see a reversing of foreign
flows into Brazilian markets," says Fábio Nazari, head
of ECM at BTG Pactual.
Speaking in late September, Nazari says the peak of the
outflows has already happened, adding the region could see
40-50 new equity deals in the next 18 months. However, when
sales resume targeting the local LatAm investor will be key for
many of these stories.
"To get a deal done in Brazil, if the local investor
community is fully engaged you are halfway toward a successful
deal," Nazari says.
Bond issuers also began in October to reopen the markets
after a lull – but only quasi-sovereigns –
aware that a European-induced slide could quickly shut things
"These environments might be less comfortable, but they can
yield some good opportunities," says Luz Padilla, portfolio
manager at DoubleLine Capital, which manages $500 million in
emerging markets. "There are some opportunities opening up.
There are a lot of good credits that have cheapened up, but the
question is can they get cheaper."
While the flight to quality has funds flowing into
high-grade sovereigns and blue-chip names, Wamco’s
Abad is eyeing opportunities in the high double B space, among
names that may be on the cusp of investment grade.
As with 2008-2009, there should be ample opportunity to pick
up solid credits for those who understand the
region’s fundamental strengths and take the view
that growth in LatAm and China will remain reasonable.
"If you take your eye off the ball and are worried about the
top down and getting out, you are going to miss the potential
pickup of some really good value in some credits if you look at
it from the fact that their balance sheet strength is so much
better than some of the US names," Abad says.