Elections spread uncertainty across Latin America

Elections spread uncertainty across Latin America

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The markets do not decide elections, but they do have a say. Nowadays, as commodity prices remain far below the supercycle highs of 2011, governments in Latin America are again relying heavily on the international financial markets to raise billions of dollars in funding. This reliance could appear to lend an outsized voice to Wall Street in Latin America’s presidential elections, but it also ensures that the region’s economies do not stray far from the economic orthodoxy of fiscal responsibility espoused by investors around the world.

“In Latin America, you finance yourself with the markets,” said Luisa Palacios, the head of Latin America at the macroeconomic policy research firm Medley Global Advisor. “You cannot completely derail [everything] with a very leftist platform if you need international financing and local financing.”

Left-of-center governments in Latin America, including Brazil, Chile and Venezuela, placed a lower priority on international financing when commodity prices were riding high less than 10 years ago. They ran current account surpluses and paid for what they needed with cash from the sales of oil, copper and other raw materials. But those commodities no longer command the same high prices, and now governments in Latin America, especially those on the left, face more constraints from the market.

“Now every candidate has to have a market platform,” Palacios said at a panel discussion hosted by the Americas Society/Council of the Americas (AS/COA) in New York. Foreign bondholders own around 60% of Mexico’s peso-denominated bonds, 50% of Peru’s local notes, roughly 25% of Colombia’s local notes and around 20% of Brazil’s local notes, she added.

Market friendly leaders are popping up all over Latin America. President Mauricio Macri led the way in Argentina, bringing the country back from default and returning to the cross-border bond market in April 2016. Brazilian President Michel Temer assumed office in August 2016, stepping in after the impeachment of Dilma Rousseff, and set about trying to reform Brazil’s labor laws and social security system. More recently, Sebastián Piñera won a decisive victory in Chile’s presidential race, after pledging to boost investments by an average of at least 6% per year over the next four years and present social security reforms in the first half of 2018.

While Argentina and Brazil have abandoned the leftist economic policies of recent years, the outlook for other parts of the region remains less clear. But people are clearly frustrated with the sluggish performance of many of Latin America’s economies, that much is clear. From top to bottom in Latin America, after years of economic inertia, exacerbated by endemic corruption charges that have multiplied across the region, voters have become more receptive to upstart presidential candidates.

“The common narrative is anti-whoever is in power,” Gerardo Rodríguez, a portfolio manager for the emerging markets group at BlackRock, said at the AS/COA event.

Outsiders take the inside track
Colombian voters go to polls to pick a new president on May 27. President Juan Manuel Santos is on his way out of the presidential palace after failing to push through a peace agreement with the FARC guerrillas in a 2016 referendum. He later earned a Nobel Peace Prize for his efforts. (The Colombian congress ratified a revised peace deal with the FARC in November 2016 and ended the conflict after more than 50 years.)

Santos’ former vice president, the right-leaning Germán Vargas Lleras, is stuck in fourth place in the latest polls with 8%. Gustavo Petro, the former mayor of Bogotá and once a member of the M-19 guerrilla movement, is in the lead with 22%, while Sergio Fajardo, who has been the mayor of Medellín and the governor of Antioquia, and Iván Duque, who has the support of the rightwing former President Álvaro Uribe, are effectively tied for second with roughly 15% each. But perhaps more tellingly, some 20% of voters have indicated that they plan to leave their ballots blank.

In Mexico, where general elections take place on July 1, the left-wing candidate Andrés Manuel López Obrador holds a commanding lead in the polls with around 40%. A more business friendly candidate, Ricardo Anaya from the conservative National Action Party, or PAN, heads a broad coalition with the leftist Democratic Revolution Party, or PRD, and follows López Obrador in the polls with roughly 31%. But the establishment candidate, José Antonio Meade, who served in three cabinet positions for the outgoing president, Enrique Peña Nieto, trails the other two candidates with 19%.

Brazil, Latin America’s largest country, holds general elections on October 7, with a runoff between the top two finishers scheduled for October 28 if the first round does not decide an outright winner. Luiz Inácio Lula da Silva, president from 2003 to 2011, was found guilty of corruption charges in an uncharacteristically speedy trial in Brazil last year and barred from running in the election. Lula has said that he is confident that the Supreme Court will overturn his conviction and that his name will again appear on the ballot. But in Lula’s absence, the far-right candidate Jair Bolsonaro is running neck-and -neck with the more centrist Geraldo Alckmin, at least in the state of São Paulo. After that, almost 17% of poll respondents have picked “no one” before the center-left candidates Marina Silva with 13% and Ciro Gomes with 7%.

Elsewhere, voters in Paraguay choose between Efraín Alegre, head of the centrist Authentic Radical Liberal Party, and Mario Abdo Benítez, the pick of the ruling Colorado Party and the son of former dictator Alfredo Stroessner’s private secretary, on April 22. Cuba and Venezuela are also scheduled to hold presidential elections this year, but the outcomes appear to be headed to forgone conclusions. Miguel Díaz-Canel is poised to take over for Cuban President Raúl Castro in April, and Nicolás Maduro is set to face limited opposition at the polls in May.

Colombian idiosyncrasies
Even by local standards, the presidential election in Colombia promises to be wildly unpredictable. The political spectrum has extended to the left with the FARC guerrilla army recast as a political party and, in a crowded field, half a dozen candidates hold plausible ambitions of sitting in the Casa de Nariño at the end of the year. But one key issue divides the diverse candidates into two groups.

“This election is a replay of the plebiscite,” says Sergio Guzmán, the principal analyst for Colombia at the consulting firm Control Risks. “Most candidates have yet to formulate their economic or social policies, but they will appeal to voters on the basis of their support or opposition to the peace deal.”

Voters rejected the peace accord by less than half a percentage point in October 2016. Weeks later, after some minor revisions, the agreement unanimously passed both houses of Congress, as legislators loyal to Uribe abstained from the votes, claiming the government had granted too many concessions to the FARC.

The struggle over the peace agreement could extend to the presidential elections in May, and from an investor’s perspective, there are risks on both side of the divide.

The candidates that supported the Yes campaign during the referendum include Humberto de la Calle, the 71-year-old former minister who led the government’s negotiations during talks with the FARC in Havana, and Fajardo, who oversaw Medellín’s transformation from the grips of violent narcotraffickers to a thriving tourist destination and hub of innovation.

The FARC’s own candidate, Rodrigo Londoño, perhaps better known by his nom de guerre Timochenko, is not expected to fair well at the polls, but Petro, the other former guerrilla in the race, is running from the front.

“Petro’s polling numbers are up,” says Carlos Fradique-Méndez, a partner at the Bogotá-based law firm Brigard Urrutia. Petro supports a Venezuelan model “with adjustments” and his administration would increase taxes and review “the private property regime,” Fradique-Méndez says.

But an anti-Petro campaign in Colombia’s rightwing press, together with a recent spate of bombings by ELN rebels, could push voters towards one of several candidates who want to review some of the concessions made to the FARC in the peace deal, including Vargas Lleras, once a target of guerrilla attacks himself, and Duque.

The rightist candidates in Colombia’s elections promise pro-business, market friendly policies but they might take several years to implement their plans if one of them is elected president, Guzmán says. Any effort to renege on the terms of the peace agreement would undoubtedly trigger long-running legal battles, and foreign investors would be far from impressed.

“As far the world is concerned, the peace deal was extremely positive,” says Jan Dehn, the head of research at the emerging markets investor Ashmore Group. “Investors would see a return to armed conflict — a real risk if the peace agreement is called into question — as idiotic.”

Attempts to undo part of the peace agreement could strike a significant blow to the economy just as the outlook brightening after years of slow growth and fiscal difficulties aggravated by low oil prices. Colombia’s GDP is expected to register a 2% increase in 2017, but the OECD forecasts stronger 3% growth in 2018 and 2019.

If a pro-peace candidate wins, which is still the likeliest scenario, the economy could enjoy a sharp revival. “As long as there is no freak result, I think we could see a significant upturn in the second half of 2018 as a stable oil price, low inflation and increased investment in infrastructure spending kick in,” says Rupert Stebbings, the head of equity investments at Bancolombia.

The markets have all taken Colombia’s political uncertainty into account, so pent-up investments are likely to return after the election. “The economy has performed subpar for a while, so investors are not heavily exposed,” Dehn says. “The odds are that any selloff prior the election will be shallow, while the upside after the election could be substantial, especially if whoever wins commits not to renegotiate the FARC peace treaty.”

Mexican exception
As López Obrador consolidates his lead ahead of the elections, he has stepped back from some of his more contentious economic views and made some concessions to voters in the center. He has toned down his opposition to the 2013 energy reforms, but the market is now not sure where he stands.

López Obrador’s top economic advisors have said the candidate will not dramatically reverse the energy reforms if elected, but his pick for energy secretary, Rocío Nahle, has criticized the reforms and also has been quoted as saying she would halt future oil auctions to evaluate how the first round plays out.

The candidate, often referred to by his initials AMLO, has not said explicitly what he plans to do with energy policy, other than vow to stop privatizations and not allow Mexico’s oil reserves to fall into the hands of foreign corporations.

With that in mind, AMLO could block future auctions and delay progress on Mexico’s energy reforms, Marcelo Carvalho, the head of emerging market research for Latin America at the French bank BNP Paribas, said in a February report.

For BlackRock’s Rodríguez, AMLO’s economic views belong firmly in the 1950s or 1960s, with “government intervention to pick winners and losers in industries.” The candidate says he is fiscally conservative, but his ideas have been tested in the past with disastrous results, according to Rodríguez.

“If he were to win and implement all these bad ideas with a bad economic team, it’s not going to be good for Mexico,” Rodríguez says.

But voters may not see it that way. AMLO draws strong support from young, urban voters, while Anaya attracts middle-aged voters and Meade appeals to voters over the age of 50. In Rodríguez’s views, Mexico’s younger voters have not lived through a financial crisis, and any attacks against AMLO’s macroeconomic policies may not resonate with them.

“In Mexico, you cannot take the public debt from… 50% to 80% of GDP without having a major crisis. I’m not sure that people, especially young voters, understand this,” he said.

Medley’s Palacios, however, sees less cause for concern, due to the constraints in the international financial markets. Also, the Peña Nieto administration will draft the 2019 budget and Mexico’s next president will likely face a divided Congress, meaning AMLO cannot spend too freely in his first year in office if he wins, she says.

“I think López Obrador understands that the central bank has to have independence and that he has to fiscally conservative,” she says. Still, an AMLO administration could go on an irresponsible spending spree if his cabinet does not keep him in check, she adds

AMLO has tipped Carlos Urzúa Macías to be his finance minister. With a PhD in economics from the University of Wisconsin, Urzúa, who served as the finance secretary for the Mexico City government when AMLO was mayor, has defended spending caps at all levels of government, pushed efforts to reduce tax evasion and supported social program to reduce poverty, according to Carvalho.

S&P Global Ratings has said that AMLO could slow down the opening of Mexico’s energy industry to private investors, but it doubts he will enact “substantial change” to fiscal or monetary policy if he wins the election.

AMLO “presents less certainty” than Anaya or Meade, S&P said, but undoing the energy reform would require support from two thirds of Congress and a majority of 32 state governors, something the winner of the July election is unlikely to find.

“The strong participation of foreign and local private companies in the recent oil and gas auctions indicated the private sector’s confidence in the continuation of the new energy policies,” S&P said in a report.

If AMLO does not win the election, S&P said that Anaya or Meade will likely carry on with the government’s current economic policies “to a large extent.” S&P also said it expects Mexico’s GDP to rise 2% in 2018, followed by similar rates of growth through 2021, if the US economy keeps growing, the government upholds its key economic policies and private investments maintain a gradual increase in the energy sector.

Brazilian dilemma
Brazil’s campaign season has a long way to run before the first round in early October. Lula’s case is still going through the courts, but Roberto Simon, the lead analyst for Latin America at the business advisory firm FTI Consulting, does not think the former president will be able to run.

Perhaps more telling, Lula’s political party, the leftist Workers’ Party, or PT, has remained in disarray since the Lava Jato corruption investigation began in 2014. In the municipal elections in 2016, for example, the PT fielded just half the candidates it had presented in previous contests, Simon says. And the PT candidates that did run were punished at the polls.

“What we are seeing is a hugely fragmented election because a bomb called Lava Jato has exploded, weakening parties and changing the rationale behind coalition building,” Simon says.

The field is not entirely set in the Brazilian elections, but the left will certainly put forth a candidate, possibly Gomes, the former governor of the state of Ceará who has served as a cabinet member for Lula and Itamar Franco, or Silva, who ran for president in 2014 and was previously in Lula’s cabinet.

The extreme right has an advocate in Bolsonaro, and the center right has Alckmin, but Simon says the overriding question is which candidate can carry the underdeveloped North and Northeast regions that Lula and Dilma both took in their drive to the Palácio do Planalto.

During the Temer administration, the finance ministry and the central bank have pleased the markets, Simon says. They have reined in inflation, lowered interest rates and put the country back on the path of economic growth. And in April last year, Temer appeared to have the votes in Congress to pass a contentious social security reform bill, but then he was caught on tape talking about bribes with Wesley Batista, the former boss of Brazilian meatpacking company JBS.

After that, the administration went into survival mode, and Congress declined to vote on cutting social security spending. The failure to pass social security reform caused S&P to downgrade Brazil’s credit ratings to three notches below investment grade.

Downgrades aside, BNP’s Carvalho is optimistic that pragmatism will prevail and that the markets will eventually calm down. And regardless of who wins, the next administration will likely pursue Temer’s proposed changes to social security because Brazil’s fiscal challenges will remain the same.

“The fact that there is some uncertainty in the financial markets due to elections is quite natural,” Carvalho says. “The thing is, the economy is growing again with some vigor, while inflation in quite low, which has allowed the central bank to cut rates and probably leave them at a low level for quite a long time.”

But even if an anti-establishment candidate wins, Carvalho does not see a reason for the markets to overreact. In 2002, after Lula won for the first time, the markets panicked, afraid that the former union leader would enact hard-left economic policies. Brazil’s risk premium increased, and the real plummeted against the dollar. “But what we eventually got was a pragmatic government. This is what appears to be the most likely scenario for next year,” Carvalho says.

Zena Latif, the head economist at the investment management company XP Investimentos, expects a subdued market reaction to the elections, unless the winner does not implement a strong reform agenda quickly. “The new administration will not enjoy a grace period,” she says.

Despite the current fiscal challenges, Brazil is better positioned now than it has been in the past. The government has made important changes to the country’s labor laws, and legislators have discussed the proposed social security reform for months. “The issue is whether the next president will be strong enough to pass more ambitious, tougher reforms,” Latif says.

Alckmin can be counted on to continue what Temer started and pursue more business-friendly policies. But the market is less sure about Bolsonaro. The candidate previously espoused more nationalistic views on the economy, but he has since adopted a more libertarian tone. He has said he supports social security reform, but not as deep as Temer’s proposal. He has said the central bank could cut its benchmark lending to 2% from the current 6.75%. He has also said he could consider privatizing state-owned companies in all sectors, including the energy company Petrobras, to cut down on corruption and that he favors increased trade with the United States over China.

Paraguayan predictions
Voters in Paraguay will elect a new president on April 22, but many of the key political battles were fought in 2017, after protesters set fire to Congress in March and convinced President Horacio Cartes to abandon his efforts to amend the constitution to allow him to run for reelection.

Cartes’ disappointment was compounded in December when his chosen successor, the former finance minister Santiago Peña, lost the Colorado Party’s presidential primary to Abdo in December.

On the other side, the Liberal Party’s Alegre took the mantle for the opposition from the more leftist Guasú Front. But Alegre will have his work cut out for him: the Colorado Party has had a hold on the presidency for all but five years since 1954.

“The market is already operating on the assumption of an Abdo win,” says Juan Manuel Pazos, head strategist for the Argentine financial services firm Puente. “That would mean the continuation of existing pro-investment policies and an easy transition.”

The International Monetary Fund (IMF) predicts Paraguay’s GDP will grow 4% in 2018, one of the highest rates in South America alongside Bolivia. However, foreign direct investment — much of which going to agribusiness — stood at just $273 million in 2016, less than half of the $697 million recorded in 2012.
   
If Alegre pulls an upset, he will have to unite Paraguay’s fractious left and hope the divisions in the Colorado Party, evident during the primaries, reemerge, says Carlos Gómez Florentin, professor of politics and history at the Universidad Católica in Asunción. 

One potential area of division in the Colorado Party is tax reform. While Paraguay runs one of the tightest fiscal ships in the region, ending 2017 with a fiscal deficit of 1.5% of GDP, foreign debt has doubled to $5.5 billion over the last five years. “Any future government will have to raise taxes to meet external obligations,” Gómez says, “but while Alegre is open to the necessity, Abdo has spoken about raising taxes on tobacco, which would bring him into conflict with Cartes, who will remain an important figure in government.”

In an economy dominated by soybean farming and hydroelectric power, prosperity often depends more on the climate than the president. On that score things are looking up for 2018. “The range of options available to the next president are limited due to the country’s dependency on agro-industry,” Pazos says. “In 2017 we experienced droughts, but in 2018 we expect the situation to normalize, meaning bigger harvests and more hydro energy for export.” LF

With additional reporting by Thierry Ogier in São Paulo