Latin America's Great Economic Divide
There’s a rift in Latin America that is neatly defined by two oceans. According to the International Monetary Fund’s latest economic forecasts, the Atlantic-facing countries of Venezuela, Brazil, and Argentina, the largest members of the Mercosur customs union, will grow at an average rate of 0.6 percent this year; while Chile, Peru, Colombia, and Mexico—which make up the Pacific Alliance—will expand by 4.2 percent.
The divide has little to do with western Latin America’s orientation toward a dynamic Asia or the eastern countries’ exposure to a stagnant Europe. Blessed with abundant natural resources and an almost 200-million-strong consumer market, Brazil remains the regional economic giant. And Venezuela commands some of the largest petroleum reserves in the world. Yet at the end of a decade-long boom driven by cheap money and strong commodity prices, growth in both countries is lagging behind that of many of their neighbors. The standouts are those that, despite a more challenging global environment, have not reverted to the age-old “isms” (think statism and protectionism). “Some countries partied and splurged during the boom years; others did their homework,” says Ramón Aracena, chief Latin America economist at the Washington-based Institute of International Finance. “Latin America is no longer a unified bloc with a synchronized business cycle.”
Atlantic countries spent more while saving less. In Brazil, government spending averaged 40 percent of gross domestic product from 2010 to 2013, compared with an average of 27.5 percent for Chile, Colombia, Mexico, and Peru, according to an April report by Goldman Sachs. Domestic savings are 16.4 percent of GDP in Brazil, compared with an average of 20.8 percent in the Pacific nations.
Debt-rating companies are taking note. Moody’s Investors Service raised Mexico’s credit rating to Aaa in February, four levels above junk. A month later, Standard & Poor’s downgraded Brazil to BBB-, the lowest investment grade. Mexico’s economy will expand 3 percent this year, according to IMF forecasts, outpacing Brazil’s 1.8 percent. “Money follows growth,” says Ricardo Espírito Santo, president of the Brazilian unit of Espírito Santo Investment Bank. The Portuguese lender is interested in financing projects in Mexico, which is in the process of opening its energy industry to foreign investment. That country “is doing well,” Espírito Santo says, “so we’re focusing our activities there.”
Among the Atlantic countries, there’s no shortage of examples of heavy-handed government intervention squeezing company profits, discouraging investment, and curbing demand. Argentina, which defaulted on its international debt at the end of 2001, returned to growth with a mix of statist and restrictive trade policies under the late President Néstor Kirchner. The economy is now sputtering, and his successor and widow, Cristina Fernández de Kirchner, has had to cope with a severe drain on foreign exchange reserves. In December she slapped a 50 percent tax on foreign autos with a pretax value of more than 210,000 pesos ($25,944). As a result, car sales fell 40 percent in April from a year earlier, according to the Argentine Automakers Association. “This month we haven’t sold anything, and last month we sold very little,” says Tomas Herrera, owner of a dealership in Buenos Aires that specialized in luxury cars but now handles cheaper models. In the meantime, a 19 percent devaluation of the peso in January caused consumer prices to surge, further damping the economy—although it’s helped stabilize international reserves.
In Venezuela, which is still dealing with the legacy of the late Hugo Chávez, government expropriations, coupled with price controls, have depressed private investment, crimping capacity in a variety of industries including food processing and electricity. The resulting shortages have fueled the world’s highest rate of inflation—59.3 percent in the 12 months ended in March—and helped spark violent protests that have led to the deaths of at least 42 people since February. In an April 24 report, the IMF cited “distortionary” policies as one reason Venezuela’s oil-rich economy will stagnate this year.
Brazil, once touted as one of the world’s most dynamic emerging markets, alongside Russia, India, and China, this year placed 116th out of 189 countries in the World Bank’s latest ease-of-doing-business rankings. According to the report, companies have to spend 2,600 hours per year to deal with taxes in Brazil, vs. an average of 369 hours in the rest of Latin America. President Dilma Rousseff has espoused a philosophy of big government, enacting capital controls while capping fuel and electricity prices. Her administration “is seen by business as excessively interventionist,” says Carlos Kawall, chief economist at São Paulo-based Banco J. Safra. “There is no trust or confidence.”
In contrast, economic prospects on the Pacific are bright. Peru’s leftist president, Ollanta Humala, has surprised investors with his embrace of free-market principles. Under his watch, the Andean nation has awarded $12 billion in contracts to lay power lines, build new highways, and upgrade port facilities, with an eye to increasing exports. The country has concluded free-trade agreements with the U.S., China, and the European Union in the past five years. “Peru is pretty entrepreneurial at the moment,” says Gerard van den Heuvel, who heads the local unit of Dubai’s DP World, which handles more than 70 percent of Peru’s container shipments.
In Mexico, companies are positioning themselves to profit from the end of the government’s 76-year oil monopoly. Congress approved constitutional changes last year, and legislation defining the scope of private-sector involvement in energy projects may come to a vote in June. Bank of America estimates Mexico could receive as much as $20 billion a year in additional foreign investment as a result of the reforms. Factor in an anticipated overhaul of the country’s byzantine labor and tax laws, and its potential growth rate could rise to 5.5 percent by 2016, says Gabriel Casillas, chief economist at Grupo Financiero Banorte. “We’re optimistic about Mexico.”
Trade is at the root of the Latin American divide. The members of the three-year-old Pacific Alliance have sought to become more competitive and increase trade by lowering tariffs and chasing new export markets. Mercosur, the 23-year-old customs union comprising Argentina, Brazil, Paraguay, Uruguay, and Venezuela, has been moving in the opposite direction. “Mercosur nations have adopted a string of protectionist measures,” says David Rees, an analyst at Capital Economics in London. Trade averages 54.4 percent of GDP in the Pacific Alliance nations, compared with 41.3 percent in Venezuela, 40.1 percent in Argentina, and 24 percent in Brazil.
The outward-looking and market-oriented nature of the Pacific Alliance is paying dividends for companies such as Modamar. The Bogotá-based swimwear maker says that, compared with its Brazilian rivals, its shipments to the U.S. and Europe clear customs faster, thanks to bilateral and regional trade agreements. It also pays lower duties on the Lycra it imports. “We’re more competitive, and Colombia is gaining that fame that Brazil used to have for these kind of products worldwide,” says co-founder Carlos Laverde.
The Latin American growth divergence will likely continue. While all countries in the region face stiffer head winds in the form of lower commodity prices and rising international borrowing costs, the Atlantic-facing nations have limited room to relax monetary and fiscal policy without further stoking inflation. Charles Collyns, managing director of the Institute of International Finance, is more confident about the Pacific countries. He says they “have better institutions and policy frameworks to drive and diversify their economies.”