The Monday Edition- Latin America Outlook- Part 1: Brazil & Argentina

Current account surpluses, debt reduction, commodity prices and steady capital remittances remain drivers of exchange rate stability, attracting yield-hungry and aggressive growth investors.

The key countries in Latin America have opted to implement alternative exchange rate regimes, but the majorty have deepened the process of de-dollarization, and occasional interventions in Brazil, Argentina and Peru in times of uncertainty.

** All figures in US$

Brazil:

• Brazil (Real GDP is expected to come in at 4.2%) has embarked on fostering the use of the local currency in international financial transactions and to deepen the process of de-dollarization under way. So much so that they will increase the issuance of real-denominated debt securities in external and local jurisdictions in an effort to complete the buildup of the local currency yield curve.
  
  
• The goal of investment-grade status remains a top priority for Brazilian leaders (External debt as % of GDP and % of Exports of G&S will be reduced (04 to 07, US$): 33 bn to 15 bn and 198 bn to 100 bn, respectively). The country’s export boom (Exports are set to reach 155 bn in 07 from 96 bn in 04) has translated into large trade (47 bn) and current account surpluses (14+ bn) in 07.
  
  
• The outstanding contribution of the Brazilian export sector in the context of excess global liquidity searching for high yielding security investments has created a virtuous cycle in the country’s external finances. The accumulation of FX reserves, soon to reach 150 bn, will remain strong as the central bank continues its precautionary buildup of US dollar-denominated assets.
  
  
• The real has been appreciating since 03; massive capital inflows and impressive trade results have been major drivers of this performance. FDI inflows, so far have exceeded 18 bn, will continue to reflect the bright economic and financial outlook in Brazil. The country’s leaders acknowledge that the most effective shield against exogenous shocks is sustainable low-inflation export-driven (L.I.E.D.) growth.
  
  
• To compliment L.I.E.D. the Banco Central do Brasil (BCB) will maintain its policy of reducing interest rates to bring monetary and inflation trends more in line with economy standards by executing well-timed interest rate cuts; the benchmark overnight SELIC rate will likely hover around 11%, and CPI is likely to increase but to a manageable annual rate of 4% by end of 07.
  

Argentina:

• The economy is gradually shifting onto a slower growth path after a period of rapid expansion. Real GDP is expected to grow by about 7.5% this year, following an average of 9% YoY over the past four years. A very favorable external environment for commodity exporting nations on the back of strong Asian demand and a sharp recovery in local consumption (following the 00-02 depression) has allowed the economy to record high economic growth.
  
  
• Argentina’s external debt stands at about 109 bn, 51% of GDP, down from 112% in 04. The sharp reduction in public sector external debt servicing obligations coupled with the robust post-recession recovery also led the economy to record fiscal and current account surpluses, which limited the country’s need to access external sources of financing.
  
  
• However, the fiscal outlook is gradually deteriorating on the back of widening provincial deficits and rising indebtedness, especially thanks to energy. Strong growth and price controls are increasing domestic energy demand, making it imperative to obtain access to foreign sources of energy. Adjustments to the price of Bolivian natural gas, together with supply cuts to Chile, also hint at pending problems on the energy front.
  
  
• Public debt may be adversely affected by rising inflation, as a large portion of tradable government securities is indexed to inflation. The Argentine economic and political authorities have voiced their willingness to restructure debt obligations owed to government creditors grouped under the Paris Club (the latter requires a programme endorsed by the IMF).

Risks

• A comprehensive cycle of presidential elections will be completed at the end of October when Argentines go to the polls. The quality of governance remains poor, fuelling the rise of authoritarian governments across Latin America.
  
  
• Recent events in the US sub-prime market, the spike in energy prices as a result of heightened tensions in the Middle East and the risk of unwinding of yen-funded carrytrade investments are all reminders of the inherent risks associated with emerging market investments.
  
  
• The US attempt to re-engage with key countries through a high-profile presidential tour of the region has failed and deepened divisions amongst countries.