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Finance ministry scorecard: Standing out

Mar 1, 2013

The past year has cemented the status of a fresh crop of small, nimble economies as the region’s most dynamic – and resilient. When it comes to economic management, Chile leads the way

By Mariana Santibáñez and Taimur Ahmad

Latin America’s economic temperament in 2012 could hardly have struck more of a contrast with the developed world, crippled under the weight of debt burdens and facing lackluster growth. The newfound vigor of the former, in the face of severe economic headwinds, has proved an immense boon for a region that, not so long ago, was a byword for financial turmoil.

This strength is reflected in LatinFinance’s annual finance ministry scorecard. Our ranking incorporates the views of economists, analysts, investors and independent experts on the adeptness of economic management in the region. It considers the institutional strength of finance ministries, the soundness of public finance management as well as success in advancing policies that encourage economic development. We also evaluate institutions in light of countries’ overall macroeconomic performance in the preceding calendar year.

Growth in the region’s largest economy, Brazil, trailed off sharply last year, amid fears that a more widespread slowdown in the world’s large emerging economies, led by China, could cast a shadow over Latin America. Yet if anything, the past year has cemented the status of a fresh crop of small, nimble economies as the region’s most dynamic – and resilient.

Top of this year’s ranking is no stranger to praise for its economic management. Chile shows a commitment to fiscal rectitude that has long served as a model for emerging economies. The past year, under the stewardship of Felipe Larraín, its finance minister, has been no exception.

"Chile’s economy is doing well, and that is attributed to very sound policymaking and a large part belongs to the finance ministry," says Nick Chamie, global head of emerging markets research at RBC Capital.

The government has made significant progress in addressing growing social demands from the country’s emerging middle class. In September, lawmakers passed a tax reform to finance an overhaul of the Chilean education system – a central plea of protests that had rocked the country since 2011.

Under the new rules, Chile’s businesses face a tax rate of 20%, up from 18.5%, and fewer loopholes to avoid them. The tax overhaul will boost revenues by roughly $1 billion per year.

"We did what is responsible in terms of fiscal policy," Larraín tells LatinFinance in an interview. "We wanted to step up the spending in education but we did it in a way that we did not compromise our commitment to achieve a structural deficit of 1% of GDP."

The tax reform, as Larraín puts it, was "moderate" – raising 0.35% of GDP in net terms – and was part of a "more complex package" that also provided incentives for reinvestment, making it easier for small and medium sized companies to operate. The reform has also helped private investment become the main driver of growth.

Some observers have suggested that further tax rises will be needed as the population demands better state services. But Larraín rejects the suggestion outright: "There’s no reason to increase taxes any further," he says. "A higher tax rate would kill that capacity of this economy to grow."

Foreign investment into Chile reached $28 billion in 2012. "This is a record in our history," says Larraín, who adds that the sovereign’s return to international capital markets under his watch has helped reduce the cost of capital for public and private companies.

"This is a very significant aspect of what we’re doing here," he says. Last October the sovereign issued a 10-year, $1.5 billion bond at 2.38%, the lowest yield achieved by any emerging market sovereign. "Only developed countries have achieved lower rates," Larraín says.

Amid increasing concerns among Chilean exporters over a strong peso, Larraín has raised public spending and increased a local debt program to curb upward pressure on the exchange rate.

"We are helping with fiscal policy to prevent overheating," Larraín says. Chile’s government plans to include peso-denominated bonds as part of the $5 billion it expects to raise locally.

The sovereign has been upgraded by all the major credit ratings agencies in recent years, most recently in February when Dominion Bond Rating Service (DBRS) notched Chile’s rating up to AA from A. "This is the first time in the country’s history that we’ve had four consecutive upgrades from the four prominent credit rating agencies," Larraín says.

Standard & Poor’s upgraded Chile in December, as did Fitch a year earlier and Moody’s in 2010. The main macro imbalance facing the Chilean economy is the increase in its current account deficit. Inflows of foreign direct investment (FDI) particularly towards the mining industry are expected to largely finance that, however.  


Peru defies expectations

Peru came a close second, ceding ground to its southern neighbor largely because of Chile’s successful tax reform. Peru is roundly praised for its solid fiscal performance, robust growth and prudent economic strategy. The economy expanded by 6% in 2012, which, while a slight cooling on the 6.9% growth a year earlier, was the highest in South America. GDP is expected to grow by 6% in 2013.

President Ollanta Humala surprised observers after his election in 2011 by seeking continuity in macroeconomic policy. Under finance minister Luis Miguel Castilla, the economy has benefited from solid fiscal and macroeconomic management.

Castilla says that while 6% growth rates can be maintained over the medium term, the government must press ahead with reforms. Those include addressing competitiveness, natural resource use, institution building and inequality.

It will attempt to do so having cemented its credentials for sound economic management. "Peru is the only country in the region that continued to post fiscal surpluses in 2011 and 2012," says Shelly Shetty, sovereign analyst at Fitch. The country has used windfalls from high copper prices prudently while building its fiscal stabilization fund, Shetty says.

This year Peru plans to spend at least $4 billion on paying back loans to multilateral creditors.  "Our focus is on prepaying expensive debt and on feeding the fiscal stabilization fund," Castilla tells LatinFinance.

Peru’s stabilization fund has accumulated foreign exchange reserves worth 4% of GDP, a threshold Castilla says warrants the state to think about investing internationally.

Like many other emerging market export-based countries, Peru has faced a strong local currency versus the dollar, which is hurting exporters. Castilla has ruled out capital controls to stem the rise of Peru’s currency. But he says the country is considering other measures, including taxes on foreign investment, raising the ceiling on what pension funds can buy internationally, and hastening the set-up of a sovereign wealth fund to invest dollar reserves overseas.

The central bank has also intervened heavily to temper the appreciation of the sol, buying $13.2 billion last year.

Peru’s external debt is one of the lowest in Latin America. Government debt was 20% of GDP in 2012. Analysts expect that to fall in 2013 and 2014, provided fiscal targets are met.

Colombia reforms taxes

Colombian finance minister Mauricio Cárdenas cut income tax for foreign debt investors in December as part of a broader revenue-neutral reform to spur the labor market and make the tax code more progressive.

"Colombia has made efforts to develop the local markets and reduce taxes for foreign portfolio investors which should aid in inflows of foreign investment and in turn enhance the domestic capital markets," says Fitch’s Shetty.

The change reduces tax paid by foreigners on portfolio investments to 14%, from 33%. For investors domiciled in tax havens, it is reduced to 25%. 

Market observers applaud the country’s continued good management of public finances, though last year’s GDP numbers were neither robust nor showing signs of outright weakness.

Colombia’s growth slipped from 5.9% in 2011. JPMorgan analysts forecast 4.3% full-year 2012 growth, followed by 4.5% growth in 2013. Nevertheless, it has brought the fiscal deficit down to 2% of GDP.

"Growth in the country has been disappointing, but Colombia has reasonably good finance statistics for its overall debt load," says Chamie. "The country is opening up the oil sector, and with an improved security situation and strong FDI flows, it suggests Colombia is well on its way for economic success."

'Right signals’ in Mexico

Consistency in policymaking has made it easier for analysts to forecast Mexico’s fortunes. The economy benefits from moderate government deficits, low debt, and an investment grade rating.

Analysts say Mexico deserves credit not only for policy continuity in a transition year, but also for having set the stage for a sweeping economic reform agenda.

"[Mexican finance minister Luis] Videgaray is sending the right signals to the market on energy, fiscal, competitive reform and the Pacto por México which could make a difference in the future growth of the country," says Bulltick Capital Market’s head of research Alberto Bernal-León.  

In November, lawmakers passed a labor bill, which allows employers to hire workers on trial and to pay hourly wages. It also limits the amount of back-pay workers can collect in employment disputes. Lawmakers hope the bill will increase productivity and create thousands of new jobs. Education reform followed in December, with a new system for hiring, evaluating and promoting teachers. There is growing expectation that reforms in fiscal policy, energy and competition, under the Pacto por México, will proceed this year.

Uruguay’s inflation hurdle

Uruguay earned its second investment grade rating in July, when Moody’s upgraded the sovereign, citing its economic fundamentals, fiscal metrics and enviable government balance sheet.

By the end of the year, however, its budget surplus of 2% of GDP in 2011 had turned to a 0.2% deficit – a deterioration the government attributes to a number of factors including higher energy costs, funding a national health scheme and other "extraordinary payments."

Economy minister Fernando Lorenzo has pledged to remedy the fiscal slippage and says the budget should return to a healthy surplus this year. He expects 4% GDP growth in 2012.

Analysts, meanwhile, continue to praise the commitment to sound economic management. But another pressing task faces policymakers: addressing inflation. JPMorgan says the inflation rate will remain at roughly 7.5% this year, before moderating to 6.5% in 2014.

Some analysts are calling for a revision of the way wages are adjusted, a factor adding to inflationary pressures. Lorenzo says the government is taking a cautious line on public sector salary increases to tackle inflation. It has not ruled out measures to temper spikes in the peso.

"In line with the majority of other emerging markets, Uruguay has seen strong capital inflows, caused by low rates in developed economies and the good investment opportunities that our country offers," Lorenzo tells LatinFinance.

"The government respects the fundamentals that allow the currency to move in a balanced trajectory over the longer term. At the same time we apply measures to avoid excessive volatility in that trajectory." LF

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