An Emerging Roller Coaster Ride In Latin America
Traditionally, Latin America's financial community looks to Wall Street for cues. But since Hong Kong's market tumbled in October, Asia has taken center stage in the morning conferences at Latin investment banks and brokerages. From Mexico City to Santiago, edgy traders who, only months ago, didn't know the Korean won from the Thai baht, now wake in the middle of the night to check developments on the other side of the globe. "We've had to start studying countries we never looked at before," says Marcio Verri, head of trading at BankBoston's Sao Paulo subsidiary.
With good reason. In the three weeks after the Hong Kong crisis erupted, Brazil's stock exchange plunged 40% in dollar terms, triggering heavy losses throughout the region. The Latin debt market dried up, though it began to crawl back in early December. For 1998, most equity analysts are cautiously bullish, taking Mexico as their top pick and regarding Brazil as the biggest mystery. But market volatility will be high as long as Asia's woes--and those in Russia, as well--continue to unnerve investors in emerging markets.
FIRMER GROUND. It's a strange twist that Asia's plight should threaten Latin economies--which are healthier than they were when Mexico's peso devaluation rocked their markets in 1994. The peso crisis prompted Mexico and Argentina to get their fiscal balances and financial institutions into better shape. Now they are reaping the benefits. With current account and budget deficits below 3% of gross domestic product, both countries appear well-positioned to prevent any speculative run on their currencies. Both economies are expected to grow by at least 5% in 1998.
But it is Brazil that will set the tone for the rest of the region. Analysts are encouraged by moves from President Fernando Henrique Cardoso and Congress to put the economy on firmer ground. Legislators approved the bulk of Cardoso's plan to raise $18 billion with tax increases and budget cuts and are finally advancing the President's long-stalled proposals to allow more flexibility in firing public-sector workers and to overhaul the social security system. Those reforms could become law by March. In recent weeks, says Lawrence Krohn, chief Latin America economist for UBS Securities in New York, "Brazil has done all the right things."
With their long-term perspective, multinational manufacturers have already given Brazil a vote of confidence. Companies from Siemens to Coca-Cola to Ericsson have restated their long-term Brazilian investment plans. On Dec. 11, Mercedes-Benz announced that it would spend $1 billion in Brazil by 2000 to expand operations, including the opening of an auto plant in 1998. A day earlier, BMW said it would build a $150 million factory in Sao Paulo state to produce Land Rovers.
But mutual-fund and pension-fund investors have more immediate concerns that may prompt them to pull out. Chief among them: how quickly Brazil's interest rates--currently around 40%--will be reduced. After spending $9 billion in hard-currency reserves to protect the real in late October, the central bank doubled rates to discourage speculators. So far, the real has withstood the storm. But the cost is steep. Gross domestic product, which had been expected to grow more than 4% in 1998, is now likely to rise barely 1% under the pressure of high rates. Unemployment, now 16% in the country's industrial center of greater Sao Paulo, will increase.
But if inflation stays near the expected 4%, the pro-business Cardoso, who is up for reelection in October, will probably hold onto his job for another four years. The good news is that this year's $9 billion trade deficit will fall to about $5 billion in 1998. That will help cut the current accounts deficit from 4.4% of GDP to 3.5%.
GOOD CALLS. High yields on fixed-income instruments are keeping investors away from equities. The Sao Paulo stock market--up 21% in dollars for 1997--is now 30% below its 52-week high. If the central bank lowers rates faster than expected, stocks could rally and the economy would snap back quickly. For now, stock-pickers are cautious. They like Telebras and its regional subsidiaries, Telesp and Telerj, as the government prepares the phone companies for privatization next year.
Banco Bozano analyst Alexandre Gartner estimates that Telebras and Telesp could rise as much as 40% and 25%, respectively, in the next year. Electric utilities also offer "compelling value" because they are less sensitive to the economic downturn, says Jorge O. Mariscal, chief Latin America investment strategist at Goldman, Sachs & Co. in New York. One of his favorites is Cemig, the electric utility of Minas Gerais state.
In contrast to Brazil, Mexico has emerged as Latin America's star. After the devaluation, Mexico kept a tight rein on monetary policy, which helped restore confidence. The Mexico City stock index is up 46% in dollar terms in 1997, tops among the region's major economies.
In addition to solid 5% GDP growth, Mexico will gain from lower inflation, which should fall from 17% this year to 12% in 1998. Interest rates are likely to edge downward from their current 21%, and the peso looks stable. In addition, profits are expected to rise more than 20%, fueled by investment growth that could again reach 20% in 1998.
The leading beneficiaries will be the construction and banking sectors, which, thanks to the domestic recovery, have room to gain. Krohn of UBS is picking financial groups Banamex-Accival and Bancomer. And Lars Schonander, director of research for Santander Investment in Mexico City, is enthusiastic about construction group Empresas ICA and steel-pipe producer Tamsa.
Still, Asian storm clouds loom on Mexico's horizon. Jorge Suarez Velez, president of Afin Securities International Ltd. in New York, worries that the Asian slowdown will have a greater effect on the U.S. than expected. If there is turmoil in the U.S. market, nervous American investors could seek safe havens and pull their money out of emerging markets. The issue of Brazil's stability is another big question. And some analysts worry that Mexico might be growing too fast. The strong peso and buoyant economy are expected to turn a $1.4 billion trade surplus into a deficit as high as $2.6 billion in 1998.
Argentina, too, is waiting to see how Brazil fares. Its close trade ties to its neighbor have prompted analysts to lower 1998 GDP growth estimates from 7% to about 5%. But if Brazil can avoid a major devaluation, Argentina could shine. Goldman Sachs' Mariscal is bullish on YPF, the big oil company, which he believes was unfairly punished in the post-Hong Kong sell-off.
Smaller markets in Latin America appear riskier. Chile, which sends 35% of its exports to Asia, will be hit by reduced Korean and Japanese demand for Chilean copper. Peru's economy should grow by about 5%, but President Alberto Fujimori's political maneuvers to win a third term in 2000 could unnerve the market. And political uncertainty might be a market factor in Venezuela and Colombia, both of which hold presidential elections in 1998. More instability is just what Latin investors don't want to see. If they're lucky, Mexico will continue to shine. But elsewhere, they'll have to be fleet of foot to avoid getting tripped up in 1998.