Pandemic reveals Latin America's fiscal cracks
June 30, 2020 |
Government reactions to the pandemic in Latin America have varied, with some launching big fiscal stimulus packages while others have taken more muted approaches. All face the same struggles of fighting a health crisis that renders economic forecasting even more of a guessing game
Many Latin American nations implemented some of the world’s earliest and strictest lockdowns in an effort to contain the spread of the COVID-19 pandemic. However, the results are mixed as infection and death rates vary, no matter what actions were taken. What is universal, however, is the coming economic pain.
Over a half-dozen sovereigns tapped the bond market since March, cognizant that tax collections are sure to plummet with lower economic output. The International Monetary Fund predicts gross domestic product will contract by 9.4% this year in Latin America and the Caribbean, where most countries have very little extra fiscal capacity to tackle the crisis. Only a handful of governments have issued cash payments to help the most vulnerable muddle through social isolation in a region with flimsy social safety nets and high levels of informal employment.
Chile and Guatemala specifically mentioned COVID-19 concerns for shoring up their finances, while vowing to use proceeds to improve their medical responses to the pandemic. The issuances paid an attractive premium versus developed market credits.
“We participated in almost all the sovereign issuances since mid-March, with a few exceptions,” said Bruno Rovai, a New York-based Latin America sovereign strategist with Macquarie Asset Management, a firm with $233.5 billion in assets under management.
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Rovai says the countries best-positioned to weather an ongoing storm are those with low debt and historically responsible management, such as Chile and Peru. Both countries provided large fiscal packages to assist households and businesses, and still have further room to increase. Macquarie cut exposure to credits that are big oil exporters or that are highly dependent on remittances and tourism, such as Ecuador, El Salvador and Costa Rica.
Quasi-sovereigns such as Chile’s national copper company, Codelco, and Colombian oil firm Ecopetrol have also rushed to issue debt during the pandemic, while development bank Corporacion Andina de Fomento (CAF) has tapped the market on multiple occasions. The first five months of 2020 saw $39.3 billion of issuance by sovereigns, state entities and agencies from Latin America and the Caribbean — versus $24.2 billion in the same period of 2019, according to deal tracker Dealogic.
Some countries entered the crisis on shaky footing. Argentina was meandering toward default on $66 billion in foreign debt, while Ecuador’s oil dependent economy was hit by the plunge in crude prices. Investors in 10 different Ecuadorean bonds agreed in April to defer approximately $800 million in interest payments until August.
Francisco Campos-Ortiz, Latin America economist at PGIM Fixed Income in Newark, New Jersey, says the COVID-19 shock struck the region at a “relatively unfavorable juncture” of lackluster growth dynamics, a lingering need to correct macroeconomic imbalances and the ongoing fallout of last year’s social protests. “Against this backdrop, risk premia have risen across the region,” says Campos-Ortiz. PGIM Fixed Income is an active global asset manager with $868 billion of assets under management (AUM).
Anders Faergemann, a London-based portfolio manager for emerging markets sovereigns with PineBridge Investments, a global asset manager with $96.2 billion in AUM, says his firm favors countries where the authorities have sufficient monetary and fiscal buffers to stimulate their economies despite the global contraction.
“Proactive central banks with an ability to promote economic growth will be favored by investors, while financial markets may be reluctant to invest in countries where governments have gone beyond what would be considered appropriate fiscal easing in reaction to an exogenous shock,” said Faergemann.
In contrast to the sovereign sector raising cash with low yielding debt, the private sector is in dire straits. Corporate bankers and lawyers say they have been working double-time to advise clients in Latin America since March. The first task involved arranging standby credit lines with banks, where possible. Supply chains and payments were in disarray, while businesses such as shopping malls, hotels and airlines saw demand vanish overnight.
Helena Radzyminski, head of corporate and investment banking for Latin America at Natixis in New York, says her team is in regular contact with the bank’s strategic clients throughout the region, checking in on their liquidity and other needs. Strategic clients include French multinationals, aviation firms and infrastructure investors.
Corporates have cut capital expenditures to a bare minimum as they try to weather the storm. Banks are now slowly opening up to more loans, as are the capital markets. There’s liquidity, it’s just more expensive. On the horizon are a slew of corporate restructurings and, eventually, mergers and acquisitions.
The first large-scale restructuring came from LATAM Airlines Group, a company that was in a healthy expansion mode before the pandemic. The Santiago-based carrier filed for Chapter 11 protection in the U.S. in May.
For many, Chile’s pandemic response stands out as one of the region’s most prudent. President Sebastián Piñera declared a state of catastrophe on March 19 and announced a series of extraordinary economic relief measures aimed at protecting health, salaries and employment. The country closed borders and required residents to get permits to go to grocery stores, pharmacies and doctors. Piñera’s $12.1 billion emergency economic plan works out to roughly 4.8% of Chile’s gross domestic product. It also included the authorization of up to $4 billion in additional debt issuances this year to help cover $10 billion in costs incurred in 2020.
It helps that Chile entered the pandemic on relatively sound financial footing, despite protests that rocked the capital last year. The sovereign has the highest credit rating in Latin America: an A+ from Standard & Poor’s.
Radzyminski says Natixis is very active financing infrastructure in Chile at the moment. “Sometimes boring is good,” she says. “That’s what investors want at this stage.”
As a region, emerging market analysts see Latin America experiencing a deeper economic downturn than most due to COVID-19. Commodity-dependent nations like Peru will likely undergo more severe, yet quicker fundamental resets. Countries where creditworthiness has been tarnished by policy reactions – think Brazil, where the fiscal deficit has nearly tripled – will face a more difficult economic cycle.
Argentina and Brazil issued emergency cash payments to the poor that some investors worry could become permanent fixtures of federal budgets. There is also talk of establishing a universal basic income in Brazil, and the state of São Paulo floated the idea of raising the tax rate on gifts and inheritances to cover budget shortfalls.
“Brazil has lost its reputation as the darling of Latin America due to the recent excessive fiscal easing,” said Faergemann.
PineBridge sees a handful of Latin American countries - Colombia, Guatemala, Mexico, Paraguay and Uruguay — positioned to weather the economic crisis perhaps as well as rest of the globe.
Faergemann says Mexico offers an “out of consensus opportunity” to buy into a country with declining inflation and relatively high interest rates. Mexico's central bank cut the country’s key interest rate by 50 basis points to a still hefty 5.00% on June 25. Mexican President Andrés Manuel López Obrador has repeated during the pandemic his determination to cut government spending and not increase public debt — while pushing ahead with personal projects such as a train through the Yucatán peninsula that could have a major environmental impact while also raising questions of whether the venture will ever pay for itself. Moody’s downgraded the Mexican sovereign in April saying that policy decisions under the current administration “have materially altered business sentiment” and dampened prospects for economic growth.
Around the globe, there is ongoing concern about the impact of a second wave —or multiple waves— of COVID-19 infections. More illness could lead to additional shutdowns and quarantines, and spell more economic pain.
PGIM’s Campos-Ortiz expects countries that have shown a willingness and ability to implement containment measures while preserving manageable macroeconomic balances — such as Peru, Uruguay, Guatemala or Honduras — to perhaps fare better in an environment of prolonged or even permanent loss of productive capacity and subdued domestic demand.