Archive for the ‘Latin America’ Category

Latin America: Economist Special Report

September 19, 2010
Latin America: anti-inflation consensus and strong fx reserves  Source:
Latin America: anti-inflation consensus and strong fx reserves Source:

The Economist’s lengthy Special Report on Latin America last week is worth a read (see leader below), even though it failed to emphasize and adequately explain two critical causes of the region’s recent success — 1) the consensus among Latin American politicians that conquering inflation has benefitted the poor and strengthened democracy; and 2) the massive build-up in fx reserves that has insulated the region from the global crisis, driven in part by healthy macro policies.  These issues were mentioned in passing by The Economist, but not given the focus deserved.  On the other hand, the longer articles in the Report on education, the informal economy and productivity were rich in detail and deserve a read. 

Latin America’s performance during the global economic crisis that began in 2008 was notable for the fact that the recession there was mild and the subsequent rebound robust.  One used to say that when the United States sneezed, Latin America caught the flu, but this time, the region has been inoculated against the contagion that has spread throughout the advanced economies.  In the 1980s, 90s and early 2000s, when economic shocks occurred in the advanced economies — including rising interest rates and lower prices for commodities and financial assets, this led to fiscal and balance of payments crises in Latin America, and often near or outright sovereign defaults (a la Greece).  This time, the Latins were ready.  The reason — strong fx reserves immunizing them from shifts in international capital flows.  How did they achieve this Gibraltar of reserves?  Through higher demand for their commodities from China and others, to be sure, but also through sound macro policies — floating exchange rates, an inflation-targeting monetary policy, and at least some fiscal restraint.  These policies have ensured that the balance of payments (the supply and demand of foreign exchange) adjusts to shocks, thereby bolstering investor confidence, which in turn limits capital flight during a crisis.  It’s a completely new ball game for most Latin countries.  Let’s hope they don’t let the weakest of these pillars — the commitment to fiscal prudence — slip, or they risk a return to the bad old days of boom and bust, especially when commodity prices inevitably weaken.

The Economist likewise points to Latin America’s strengthening democratic institutions as providing the political stability required to promote growth.  No argument there, but I would give a lot of credit for this to the taming of the inflation monster in the region.  After years of hyperinflation, driven by fiscal deficits and monetary accommodation, Latins broke the cycle in the nineties.  When leftists subsequently came to power, the fear of a fiscally-induced return to inflation rocked the capital markets.  President Lula was a case in point (see my post on the matter).  During his election to a first term in 2002, the bond markets sold off to default spreads, but recovered early in his tenure when they realized that this leftist, former union leader, imprisoned by Brazil’s military regime in the 1970s, retained much of his predecessor’s macro policies.  He did so because he understood that his constituency, the poor, had been hurt by inflation more than any other segment in society.  You see, the poor cannot index to inflation.  The understanding of this dynamic has led to a broad consensus in Latin society on economic policy, even when political institutions are weak and ineffectual, as in Peru and Mexico and to some extent in Brazil.  Deeper reforms that would underpin improvements in productivity, education, and the state bureaucracy remain elusive.  However, the three key pillars to macroeconomic stability (and to the political consensus) — again, flexible exchange rates, inflation targeting and fiscal prudence — remain largely in place.  With GDP growth averaging 5.5% per year in the five years to 2008, the impetus to reform is currently lacking.  See my in-depth analysis of Latin democracy here in Scherblog, written during the region’s last major election cycle (2005-07), when I discussed the delicate balance between populism and reform.   

As  a long-time Latam hand (I managed Fitch’s Latin American Sovereign Ratings group for seven years), I believe more emphasis than you will find in The Economist Special Report should be paid to the region’s 1) anti-inflation consensus, and 2) victory over the rollercoaster of balance of payments crises.   Have a read in any case…

Leader on Latin America from The Economist (Sept. 11-17):

The United States and Latin America

Nobody’s backyard

Latin America’s new promise—and the need for a new attitude north of the Rio Grande

Sep 9th 2010

THIS year marks the 200th anniversary of the start of Latin America’s struggle for political independence against the Spanish crown. Outsiders might be forgiven for concluding that there is not much to celebrate. In Mexico, which marks its bicentennial next week, drug gangs have met a government crackdown with mayhem on a scale not seen since the country’s revolution of a century ago. The recent discovery of the corpses of 72 would-be migrants, some from as far south as Brazil, in a barn in northern Mexico not only marked a new low in the violence. It was also a reminder that some Latin Americans are still so frustrated by the lack of opportunity in their own countries that they run terrible risks in search of that elusive American dream north of the border.

Democracy may have replaced the dictators of old—everywhere except in the Castros’ Cuba—but other Latin American vices such as corruption and injustice seem as entrenched as ever. And so do caudillos: in Venezuela Hugo Chávez, having squandered a vast oil windfall, is trying to bully his way to an ugly victory in a legislative election later this month.

Yet look beyond the headlines, and, as our special report shows, something remarkable is happening in Latin America. In the five years to 2008 the region’s economies grew at an annual average rate of 5.5%, while inflation was in single digits. The financial crisis briefly interrupted this growth, but it was the first in living memory in which Latin America was an innocent bystander, not a protagonist. This year the region’s economy will again expand by more than 5%. Economic growth is going hand in hand with social progress. Tens of millions of Latin Americans have climbed out of poverty and joined a swelling lower-middle class. Although income distribution remains more unequal than anywhere else in the world, it is at least getting less so in most countries. While Latin American squabbling politicians blather on about integration, the region’s businesses are quietly getting on with the job—witness the emerging cohort of multilatinas.

As they face difficulties in an increasingly truculent China, no wonder multinationals from the rich world are starting to look at Latin America with fresh interest. Sir Martin Sorrell, a British adman, talks of the dawn of a “Latin American decade”. Brazil, the region’s powerhouse, is the cause of much of the excitement. But Chile, Colombia and Peru are growing as handsomely and even Mexican society is forging ahead, despite the drug violence and the deeper recession visited on it by its ties to the more sickly economy in the United States.

Two things lie behind Latin America’s renaissance. The first is the appetite of China and India for the raw materials with which the continent is richly endowed. But the second is the improvement in economic management that has brought stability to a region long hobbled by inflation and has fostered a rapid, and so far sustainable, expansion of credit from well-regulated banking systems. Between them, these two things have created a virtuous circle in which rising exports are balanced by a growing domestic market. Because they were more fiscally responsible during the past boom than in previous ones, governments were able to afford stimulus measures during the recession. There is a lesson here for southern Europe: Latin America reacted to its sovereign-debt crisis of the 1980s with radical reform, which eventually paid off.

The danger of complacency

Much has been done; but there is much still to do. Building on this success demands new thinking, both within Latin America and north of the Rio Grande.

The danger for Latin America is complacency. Compared with much of Asia, Latin America continues to suffer from self-inflicted handicaps: except in farming, productivity is growing more slowly than elsewhere. The region neither saves and invests sufficiently, nor educates and innovates enough. Thanks largely to baroque regulation, half the labour force toils in the informal economy, unable to reap the productivity gains that come from technology and greater scale.

Fixing these problems requires Latin America’s political leaders to rediscover an appetite for reform. Democracy has brought a welcome improvement in social policy: governments are spending on the previously neglected poor, partly through conditional cash-transfer schemes, a pioneering Latin American initiative. But more needs to be done, especially to improve schools and health care, if everyone is to have the chance to get ahead. Also needed is a grand bargain to tackle the informal economy, in which labour-market reform is linked to a stronger social safety-net. And, even if some things like infrastructure and research and development plainly need more government spending, the worry is that triumphalism over escaping the financial crisis may prompt a return to a bigger, more old-fashioned state role in the economy—despite the failure of these policies in the region in the past.

Getting these things right will be easier if relations with the United States improve. Latin America needs to shed its old chippiness, manifest in Mr Chávez’s obsession with being in the hated yanqui’s “backyard”. More sensible powers, notably Brazil, should be much louder opponents of this nonsense. As they start to pull their weight on the world stage, working with the United States will become ever more important.

The attitude of the United States needs to change too. Worries about crime and migration—symbolised by the wall it is building across its southern border—are leading it to focus on the risks in its relationship with the neighbours more than on the opportunities. This is both odd, given that Latinos are already the second-largest ethnic group north of the border (see article), and self-defeating: the more open the United States is towards Latin America, the greater the chances of creating the prosperity which in the end is the best protection against conflict and disorder. After two centuries of lagging behind, the southern and central parts of the Americas are at last fulfilling their potential. To help cement that success, their northern cousins should build bridges, not walls.

India’s infrastructure bottlenecks

June 16, 2010

An excellent New York Times article yesterday discussed how democratic politics and bureaucracy in India prevent the elimination of infrastructure bottlenecks, especially in transportation.  The article focused on India’s railway system, where freight rates are expensive, travel times excessive, and traffic volumes inadequate to the task of fostering strong economic growth…of the pace we see in China.

It is an interesting comparison — China vs. India, one which would require more time and space to adequately address than this blog can provide.  For the moment, I will raise the long-standing dichotomy between two development models — the authoritarian and the democratic.  In Latin America, analysts have often underscored the success of the Pinochet model in Chile, whereby a brutal authoritarian regime from 1973-90 swept away roadblocks and bottlenecks caused by democratic politics, unleashing that country’s growth potential and allowing it to develop more rapidly than many of its historically more democratic neighbors.  Moreover, with a sound economy in place, Chile was able to make the transition to a functioning democracy with two relatively cohesive coalitions of the right and left.  Yet there was a cost in terms of social cleavages, human rights abuses, and at times political stability.  Throwing people out of helicopters is not civilization.

General Augusto Pinochet and friends, the junta that ruled Chile from 1973-90.  Source:
General Augusto Pinochet (seated) and friends, the junta that ruled Chile from 1973-90. Source:

Arguably, Russia and China have followed the Pinochet model, Russia after the economic disaster created under failed democrat Boris Yeltsin.  China has done quite well with this model, but nervous Chinese leaders understand that unrest, if not social upheaval, is always a possibility in China if the political monopoly fails to consistently deliver the economic goods.  India labors under a vibrant, if at times inefficient and somewhat corrupt, democracy.  Nevertheless, Indians know that if a government fails to deliver economic growth, they can “throw the rascals out” at the next election.  This introduces a measure of political stability into the system, which is often lacking in authoritarian regimes.  And, given India’s enormous ethnic and religious cleavages, it is perhaps this vibrant democracy that prevents the country from tearing itself apart.  Slow trains and slow growth — the price Indians pay for stability (and decency)?

Image above:  General Augusto Pinochet (seated) and friends, the military junta that ruled Chile from 1973-90.  Source:

Brazil: Does Lula have coattails?

March 30, 2010
Can Lula translate his government's popularity to Dilma Roussef, his chosen candidate for president?  Source: Google Images Can Lula translate his government’s popularity to Dilma Roussef, his chosen candidate for president? Source: Google Images

After Lula, it looks like it’s the battle between Dull and Duller.  Brazil’s presidential election in October is an important one, as the country’s success and new-found leadership role within the BRICs and G-20 make Latin America’s largest economy critical on the world stage.  Lula has charisma, but his anointed successor from the PT party, Dilma Roussef, does not.  Luckily for her, her rival, Jose Serra, who is ahead in the polls, is as dull or duller than she.  That’s why he was trounced by Lula in 2002, for a time causing Brazilian bonds to trade at default spreads. 

CSFB reports today (see below) that Serra remains ahead in opinion polls.  Though slightly wider in March, Serra’s lead over Dilma has narrowed in recent months.  The popularity of the Lula government (of which Dilma is a leading member) remains in the stratosphere, with 76% of those surveyed in March appraising the government as “excellent/good.”  Yet only 45% of those saying so said they would vote for Dilma, which is not good enough for her to beat Serra, once mayor of the city of Sao Paulo and now governor of Sao Paulo State, Brazil’s most populous state and the one packing its economic punch.   It’s too early to call this important election, but narrowing poll numbers this far out must worry the Serra campaign.  A recent profile of the dour Social Democratic administrator can be found in this  Economist article

From today’s CSFB report:

Poll shows wider gap between voter intentions for José Serra and Dilma Rousseff in the presidential election. The Datafolha poll, published on 27 March, showed higher voter intentions in the presidential election for José Serra (PSDB), currently the governor of São Paulo, and a slight decline in intentions to vote for Dilma Rousseff (PT), the chief minister of the presidential staff, reverting part of her gain in February’s poll. Voter intentions for Dilma Rousseff declined from 28% to 27% from February to March, while voter intentions for José Serra rose from 32% to 36% (Exhibit 1).
Serra’s leading position in the simulations of the first round of voting in the presidential election rose from 4pps in February to 9pps in March. Voter intentions for federal deputy Ciro Gomes (PSB) went from 12% to 11% from February to March and remained stable at 8% for the former minister Marina Silva (PV). In the simulations for the second round, Serra obtained 48% of voter intentions versus 39% for Rousseff.
We believe that the wider gap between the voter intentions for Serra and for Rousseff represent a natural variation in opinion polls and does not point to any trend for the coming months. Since the February Datafolha poll, José Serra has suggested he would be the PSDB’s pre-candidate for president, which has bolstered his visibility among voters in recent weeks. Until the campaign starts in July, the scenario should continue to favor the government’s candidate, in light of the Lula administration’s high approval ratings. The March Datafolha poll showed that the administration’s “excellent/good” rating rose from 73% in February to 76% in March, the highest level in the time series (Exhibit 2).

An increase in voter intentions for Rousseff will depend on the government’s ability to transfer to its candidate the votes of those appraising the administration as “excellent/good.” In March, 45% of voters appraising the administration as “excellent/good” indicated they would vote for Rousseff in a possible second-round election dispute with Serra (Exhibit 3). Thus, a substantial increase in voter intentions for Rousseff would require an increase in this percentage.

Rise in median market forecast for IPCA inflation in 2010, from 5.10% to 5.16%.The Market Readout released yesterday (29 March) points to a rise in the median market forecast for IPCA inflation in 2010, for the tenth week in a row, this time from 5.1% to 5.16% (Exhibit 4). The higher expectations for IPCA inflation are explained mainly by the revisions in projections for short-term inflation, from 0.44% to 0.48% for the March IPCA index and from 0.39% to 0.40% for April. Conversely, after rising for two straight weeks, the median forecast for IPCA inflation in 2011 remained stable at 4.7%.

In our opinion, the upward revision in market expectations for IPCA inflation in 2010 was caused primarily by higher-than-expected consumer inflation in Q1 2010 and in April. While the median of expectations for cumulative inflation from May to December 2010 fell from 2.76% on 8 January to 2.69% on 26 March, expectations for cumulative inflation from January to April rose from 1.74% to 2.43% in the period. These results suggest that the majority of market participants merely incorporated the higher-than-expected inflation in Q1 2010 into their projections for 2010 inflation (Exhibit 5). We believe that the fact that the rise in inflation in the first few months of the year was mostly the result of higher prices of a seasonal nature (e.g., increase in tuitions) or a temporary nature (e.g., higher inflation in fresh food prices) means that the higher-than-expected inflation in the short term has not raised inflation expectations for longer horizons.

We do not expect market forecasts to increase significantly over the next few weeks. Our projections for IPCA inflation in March (0.45%) and April (0.40%) are near the median market forecast. Although the recurrently higher-than-expected inflation in recent months has increased uncertainty as to the dynamics of inflation in the short term, we think a reduction in consumer inflation is very probable in the coming weeks, especially because of the reversal of the price hikes that caused the higher inflation in Q1 2010.
Among the expectations for other economic indicators in 2010, we highlight the stability in the median forecast for the Selic basic rate at the end of 2010 at 11.25%, which assumes five consecutive 50bps increases in the Selic rate starting in April.

Colombia: Some straight talk

January 12, 2010
Good friends vs. Best friends...Uribe and Obama...  Source:
Good friends vs. Best friends…Uribe and Obama… Source:


Good friends (Uribe and Obama) vs. Best friends (Uribe and Bush)… Sources:, AP.

I have long argued that the Democrats have gotten it wrong on Colombia, by parroting the misinformation about this country and its President, Alvaro Uribe, circulated by US labor unions intent on stopping a free trade agreement between two staunch allies.  This is one of those examples political scientists tout of a well-financed interest group successfully killing a policy that would be to the benefit of a broad majority of Americans. 

Alvaro Uribe has warts, true, not least of which include his striking similarity to New York City mayors, such as Bloomberg and Giuliani.  All three have sought to avoid term limits to the chagrin of some and the delight of others.  But, Uribe, like these New York City mayors, has improved the quality of life of his citizens and should be commended and supported for this, no matter what your position is on term limits.  He should in no way be vilified, as uninformed liberals in America have been prone to do.  The latter included candidate Obama in a presidential debate, who merely parrotted the misinformation that appears on the AFL-CIO web site

I apologize for what may seem like hyperbolic language, but it is one of those issues in which so many have just gotten it wrong.  It is important to have some straight talk on the matter and to staunch the circulation of lies.  Ask someone you know from Latin America about Alvaro Uribe.  I wrote about this issue a while back in a post.  Have a read…

Today, I want to draw your attention to a fair appraisal of Uribe and Colombia that appeared in the pages of Economist in early January.  First, is the leader, followed by a fuller article.  Enjoy reading and learning…

Brazil: So you finally noticed?

November 20, 2009
Brazil's crown jewel, Rio, will get the World Cup in 2014 and the Olympics in 2016.  Hope the lights work!  Source: The Economist
Brazil’s crown jewel, Rio, will get the World Cup in 2014 and the Olympics in 2016. Hope the lights work! Source: The Economist

The Economist this week (Nov. 14-20) featured a mediocre special report on Brazil.  Its message:  Brazil is a good investment.  So, you finally noticed!  Better to have invested in late 2002, when Brazilian assets were selling at prices implying a sovereign default (which didn’t happen).

Some good points were made though, notably how this is the first global crisis in over thirty years which was not magnified in Brazil.  Brazil’s strong external balance sheet (the public sector is a net creditor to the rest of the world), sound macro policy framework, and well-capitalized banks moderated the shocks coming from the U.S.  The report featured a nice, though superficial, box on past financial crises in South America’s largest economy. 

In an article called “The Self-harming State,” the Economist highlighted how Brazil’s large, cumbersome state gets in the way of the private sector.  It’s no joke.  Very hard to open a business down there.  The report also noted that Brazil will likely grow nicely (4-5% per year) and could become one of the five biggest economies by mid-century.  Our poster child of a rising power.  Nothing to sneeze at, but China is set to become the number one economy on Planet Earth even earlier, perhaps in the 2020’s.  The Economist report, not characterized by analytical depth, does note that what Brazil has over China is its stable democracy, and over India, is relative social peace (despite high crime, there are no ethnic or border conflicts in Brazil). 

Yet the article fails to mention one of Brazil’s critical weaknesses:  fiscal policy.  Most of Brazil’s economic problems in the last half century can be traced to a mismanagement of public finances.  Government debt will represent about 70% of GDP this year, which is very high for an emerging market country.  Given that most of this debt is borrowed domestically — a good thing in that this limits Brazil’s exposure to currency shocks — the private sector is consequently crowded out of the credit markets, which constrains GDP growth.  China and Russia have much, much lower government debt burdens.  Further, the Lula administration, which should be praised for its general adherence to sound policies and a market orientation, as well as for its substantive efforts to reduce income inequality, has gotten cocky and reduced its commitment to restraining government spending.  The Economist should have told us more about that…

A link to the report follows, as does an excerpt:

From the Economist:

“BRAZIL has long been known as a place of vast potential. It has the world’s largest freshwater supplies, the largest tropical forests, land so fertile that in some places farmers manage three harvests a year, and huge mineral and hydrocarbon wealth. Foreign investors have staked fortunes on the idea that Brazil is indeed the country of the future. And foreign investors have lost fortunes; most spectacularly, Henry Ford, who made a huge investment in a rubber plantation in the Amazon which he intended to tap for car tyres. Fordlândia, a long-forgotten municipality in the state of Pará, with its faded clapboard houses now slowly being swallowed up by jungle, is perhaps Brazil’s most poignant monument to that repeated triumph of experience over hope.

Foreigners have short memories, but Brazilians have learned to temper their optimism with caution—even now, when the country is enjoying probably its best moment since a group of Portuguese sailors (looking for India) washed up on its shores in 1500. Brazil has been democratic before, it has had economic growth before and it has had low inflation before. But it has never before sustained all three at the same time. If current trends hold (which is a big if), Brazil, with a population of 192m and growing fast, could be one of the world’s five biggest economies by the middle of this century, along with China, America, India and Japan.”

Colombia/Venezuela: What would Simon Bolivar say?

November 10, 2009
Colombian President Uribe and Venezuelan President Chavez hug, as Latin American Independence hero, Simon Bolivar, looks on.  Source: Google Images
Colombian President Uribe and Venezuelan President Chavez hug, as Latin American Independence hero, Simon Bolivar, looks on. Source: Google Images

Latin America is not usually high on the list of hotspots for geopolitical analysts.  Yet Hugo Chavez is threatening war against neighboring Colombia.  (See the note below from a JPMorgan publication today.)  Venezuelan President Chavez is America’s nemesis in the hemisphere, and Venezuela shares a long border with Colombia in the north of South America, facing the Caribbean.  The word is that Chavez is on friendly (financial) terms with the FARC, the murderous, drug-dealing insurgency that has plagued Colombian society for decades.  Yet Venezuela and Colombia are also important trading partners, though this trade has suffered amid recent tensions.  Chavez doesn’t like the close military ties Colombia has fostered with the United States, quietly intensified by the Obama administration earlier this year.  Meanwhile Chavez buys arms from US global competitor, Russia.  Conflict in Latin America has been rare in recent years, though there was a cross-border flare-up in early 2008 between Colombia and Ecuador, currently led by Chavez’s nationalistic ally, Rafael Correa, who won a second term earlier this year.  Apparently Correa allowed the FARC to operate across the border from Colombia, prompting the government of Alvaro Uribe to launch a raid against a FARC camp in Ecuador. 

Like Iran in the Persian Gulf, Venezuela wishes to be a regional power countering local U.S. allies, wielding its oil wealth to make arms purchases.  The best the U.S. could do to counter Venezuela’s threats is to move ahead with the Colombian free trade agreement, pushed aggressively by George W. Bush and scuttled by Democrats in Congress, including then Senator Barack Obama.  See a note on this I penned a year and a half ago.  President Bush openly talked about America’s strong alliance with Colombia.  It might be worthwhile for President Obama to do the same.

From JPMorgan’s Emerging Markets Today, 11/10/09

Colombia/Venezuela: Escalating political noise

Julio CallegariAC (55-11) 3048-3369

Ben RamseyAC (1-212) 834-4308

Over the weekend, Venezuelan President Hugo Chavez told

his military and civil militias to prepare for a possible war

with Colombia, saying that “the best way to avoid a war is

to be prepared for one.” Chavez has been saying that the

military co-operation pact signed in October between

Bogota and Washington could set the stage for a US

invasion of Venezuela. The Colombian government, in turn,

has been highlighting that the agreement with the US is

intended to fight drug trafficking and insurgents within

Colombia, and responded to Chavez’s threats in a statement

saying “Considering the threats of war enunciated by the

government of Venezuela, the government of Colombia

proposes going to the Organization of American States and

the Security Council of the United Nations.” We remain of

the view that an actual armed conflict will not ensue,

particularly because the Venezuelan military would be

reluctant to actually fight Colombia (indeed, Chavez

would be entering dangerous territory if he sought to force

them). However, the threat of further deterioration of the

bilateral trade relationship is real. Indeed, we highlighted

last week that total Colombian exports decreased 11%oya in

September (the latest official figure available) while exports

to Venezuela dropped 50%. Moreover, partial data from

Customs, suggest that while total exports fell about 15%oya

in the first three weeks of October, exports to Venezuela

plunged 80%oya. The ongoing deterioration in Colombia’s

relationship with Venezuela should hurt bilateral trade even

more in the coming months.

Argentina rejoins the world economy?

October 23, 2009
Argentina's populist leaders, Juan and Eva Peron in 1951.  Source: Wikimedia Argentina’s populist leaders, Juan and Eva Peron in 1951. Source: Wikimedia
Argentina's current first couple, former President Nestor Kirchner, and current President Cristina de Kirchner  Source: Google Images Argentina’s current first couple, former President Nestor Kirchner, and current President Cristina de Kirchner Source: AFP

In 2001, Argentina defaulted on billions of dollars of sovereign bond debt, closing itself off from access to the international capital markets.  For years thumbing its nose at global capital, the Argentine government left the country’s borrowers severely underfunded, and infrastructure and other important investment spending suffered.  Once thought of as a rich country and a middle power (say, around 1900), Argentina’s long slide has been the result of economic mismanagement stretching back a century, including by Argentina’s most famous first couple, Juan and Evita Peron (pictured above).

Argentina’s current first couple, who managed to pull off a “Hillary” in 2007 by transferring power from husband to wife, which even the actual Hillary couldn’t pull off thanks to Barack Obama, has launched a second bond restructuring this week that Carola Sandy of CreditSuisse (see below) believes will include 90% of the defaulted bonds.  If Cristina and Nestor pull this off, Argentina can once again re-enter the global capital markets, and with its riches and economic potential, may have a shot at becoming a regional power again.  With good economic management, Argentina could once again represent a counterweight to rival Brazil, our textbook rising power.  This rivalry under the stars of the southern hemisphere is fought not only on the soccer field.  Have a look at the thorough CreditSuisse note below. 

Carola Sandy
+1 212 325 2471
Yesterday evening (22 October), Economy Minister Boudou announced that the government had accepted a proposal submitted by a group of investment banks to restructure the untendered bond debt. Boudou said that the proposal received was a “good base” to define the final terms of the new restructuring. Thursday’s announcement did not have as many details as the market might have been hoping for, but, in our view, it was still a positive development for two reasons. First, the government outlined concrete steps that it plans to take in the near term – it will seek approval for the transaction from the Argentine congress and from securities regulators. Second, according to Boudou, the proposal is backed by holders of about $10bn worth of defaulted bonds (50% of the outstanding amount of defaulted bonds). The fact that holders of such large amounts of defaulted bonds are on board suggests, in our view, that the terms of the upcoming transaction (albeit still unknown) cannot be much worse than those offered in the 2005 swap.
The government will send to congress, on Monday 26 October, a bill to seek congressional approval for this transaction. In 2005, congress approved a law – the so-called Bolt Law or Ley Cerrojo – that precludes the government from carrying out a new debt swap without congressional approval. The Kirchner coalition and its allies have majorities in both houses of congress and, thus, we expect the bill to be approved relatively quickly (in recent weeks, the government has obtained congressional approval for more controversial legislation, such as the media reform bill).
Boudou said that the financial terms of the new restructuring will be more favorable for the country than those of the 2005 bond swap. The prospectus filed with the 2005 debt swap included a so-called “most favored creditor” clause that said that if the government were to come to a more favorable agreement with creditors in the future, all creditors who had accepted the 2005 offer would have the opportunity to trade up to the better deal. Thus, it was broadly expected that the terms of any new restructuring would likely be worse, from the bondholders’ perspective, than those offered in 2005. We think that, by offering worse terms in the new restructuring, the government also seeks to build domestic political support for the transaction. In fact, Minister Boudou said the bill that will be sent to congress will expressly note that the new transaction will be “more beneficial for Argentina” than the one carried out in 2005. Boudou also noted that the government will not pay the fees of the investment banks (and, thus, we assume that these will be picked up by the bondholders).
Boudou also said that the government will seek a haircut to the principal in default of “at least 65%”. The haircut in the 2005 restructuring was 66.3%. Our base-case scenario is that if the government does seek a larger haircut to the principal in default than it did in 2005, it will be a token increase from the previous 66.3%, i.e., the size of the haircut will be increased a couple of percentage points. If the government were to seek a significantly larger haircut, we believe this would not be consistent with its objectives of having high participation in the transaction and of re-entering the international capital markets in the future.
The new restructuring will have a “new cash” component. Bondholders who tender defaulted bonds in the swap will have to buy new bond. Boudou said that the government will seek to raise about $0.10 for each $1 worth of defaulted bonds that investors tender in the swap (this is in line with our expectations). Boudou noted that the government has not defined yet the characteristics of the new bond (its currency or maturity), but he observed that the government “aims to pay a single-digit interest rate” on the new bonds. Boudou said that retail investors would not be asked to put in new money to participate in the swap (the government will probably exempt small orders from the “new cash” component).
We expect the government to announce additional details of the transaction in coming days. Boudou said that the government hopes to close the transaction “as soon as possible”. Thus, we expect more details to emerge in the very near term. At Thursday’s press conference, Boudou made no reference to how the government will compensate bondholders for the interest accrued since 2005, and did not explicitly say whether the new offer would include the GDP warrants. However, Boudou did say that the GDP warrants “were a good instrument for both the government and the bondholders,” thus implying that these would be again part of the deal. Our expectation is that the government will issue a bond in the middle part of the curve to compensate bondholders for the interest accrued and for the past payments on the GDP warrants. Given that we still have no official details about the exchange proposal, we refer our readers to our Debt Trading Monthly published on 16 October 2009 for estimates of the fair value of the exchange under different scenarios (these values are in the 40-50 range as a percent of the claim amount).
Boudou said that the government expects that at least 60% of the defaulted bonds will be tendered in the swap. The improvement in credit market conditions bodes well for a successful bond restructuring – i.e., 60% and possibly more of the defaulted bonds could be tendered – if the terms of the new swap are reasonably aligned with those acceptable to bondholders. We think that this is likely to be case. As we noted above, we view the fact that holders of $10bn worth of defaulted bonds have expressed their intention to participate in the swap as an indication that the proposal being considered by the government is not much worse than the one offered in 2005. If participation in the new swap is at least 60%, this would imply that 90% of the bond debt that was defaulted in 2001 has been restructured (and this would help the government deal with remaining lawsuits by holdout bondholders and would increase the chance of an upgrade of the country’s sovereign credit rating).
The government will start filing today (Friday 23 October) the required paperwork with the SEC in the US, and with securities regulators in Germany and Italy. It is unclear how long it will take the SEC (and the other regulators) to complete the review of the documentation submitted by the government. In our view, the timetable of the transaction will be largely driven by how quickly the security regulators approve the documentation (a process that could take a few weeks). However, even if the process of obtaining SEC approval goes smoothly, we would not rule out delays due to legal challenges. Boudou was quoted by Reuters as saying that the government expects to close the transaction in 45 days. We think that it will be very difficult to close the transaction so quickly; instead, we expect the bond swap to settle sometime in Q1 2010.
Boudou noted that the restructuring of the untendered debt is one of the steps the government is taking to enable Argentina to re-enter international capital markets. We think that the restructuring will lead to a further tightening of Argentina’s sovereign credit spreads and, thus, it will be a significant step towards accessing international capital markets again. Other steps that would help with this objective (which the government said it plans to follow) are re-establishing a relationship with the IMF, curing arrears with the Paris Club and restoring credibility to the official statistics.

Focus: Brazilian elections 2010

October 12, 2009

In a year, essential Rising Power Brazil goes to the polls.  The election is currently heating up. On October 3, 2010 (and if need be, in a second round on October 24), Brazilians will vote for president, all 26 of their governors, all 513 members of the lower house of Congress, and two-thirds of their 81 senators.  This is a pivotal election, coming after eight years of President Lula’s rule, which has been emblematic of Latin America’s ongoing transformation away from political and economic polarization and toward a more equitable, though still market-based, society.  See an excerpt of a JPM report on Brazilian politics below.

Lula, whose personal approval remains at a colossal 80% (though approval of his government rests at around 67%), is seeking to hand the reins to comrade-in-arms Dilma Rousseff, a less-than-exciting minister in his government, whose predilection for state intervention in the economy is well-known.  Sadly for the left, she remains around 20 points behind Jose Serra in opinion polls.  Serra, also unglamorous, is the Social Democratic Governor of Sao Paulo, Brazil’s largest state by any measure, and the man Lula trounced in 2002 (albeit in two rounds).

Lula’s historic accomplishment has been to marry his impeccable leftist credentials and penchant for addressing Brazil’s woeful income inequality to market-based economics.  In effect, he has neutralized the arguments of his opponents, pushing Serra’s normally socially-conscious Social Democrats (PSDB party) to the right of Brazilian politics. 

Yet, with Brazil’s financial condition improving while he has been in office, not least because of the hard work of Serra’s predecessor and brother-in-arms former President Cardoso, Lula has allowed fiscal policy to slip of late.  This, in a country where the government debt to GDP ratio is a rather high 70%, a tough burden for an emerging economy.  

Lula’s first milestone toward establishing his market-friendly credentials took place in early 2003 with his appointment of BankBoston executive Henrique Meirelles to the Central Bank.  The Central Bank subsequently raised interest rates in order to break inflation expectations that had been aggravated by the collapse of the currency, triggered by worries over the election of firebrand former union leader Lula to Brazil’s highest office.  Meirelles, with whom I interacted many times as a Brazil analyst, while no Arminio Fraga in terms of economic orthodoxy and financial acumen, maintained the credibility of the Central Bank, wrought by Fraga and his team during the Cardoso administration.  He now wants a political career, probably aspiring to the presidency.  He is likely to sit this one out, perhaps running for VP as Dilma Rousseff’s running mate, putting his PMDB party (a non-ideological centrist party) in alliance with Lula’s PT (the Workers Party), counterpoised against the likely center-right coalition of Serra’s PSDB with the renamed Democrats, who are affiliated globally with Christian Democracy.  It is encouraging to see Brazil’s parties coalescing more or less into two ideological options, though we shall see if this sticks in Brazil’s notoriously fragmented multi-party system.

As of now, Governor Serra is way ahead in the polls.  However, a combination of Meirelles’s economic credentials with Dilma’s clout as a champion of the poor (and a former guerrilla), could pose some difficulties for Serra, especially if Meirelles and Dilma get a grip of Lula’s coattails.  Moreover, the injection into the mix of the mercurial, but exciting Ciro Gomes, a leftist former minister in Lula’s government, as the candidate of the small Brazilian Socialist Party, will be interesting at a minimum.  At stake, Brazil’s direction:  further right to achieve higher GDP growth and fiscal consolidation or along Lula’s path of gradually increasing state direction of the economy.  

From a J.P. Morgan article of October 6, 2009:

Brazil: Election countdown


On September 30, BCB Governor Henrique Meirelles joined ranks with the

PMDB party. There is rising speculation that he could run for the Senate, or even

get the vice presidential nomination on Dilma Rousseff’s ticket. Meirelles has

already said that he will stay at the central bank until March 2010, and will only

then decide his political future. One way or another, we think that he will be

orchestrating interest rate hikes before leaving. Our call for a tightening cycle of

200bp starting in January fits well with the electoral cycle since an earlier hike

would tame inflation expectations, opening room for a smooth tightening and

preserving decent growth rates at the time of elections.


Our central view that the elections will be competitive remains solid. The

current opposition is represented by São Paulo Governor José Serra. While Dilma

Rousseff is the government’s official candidate of the, two other contenders (Ciro

Gomes and Marina Silva) were part of President Lula’s cabinet and could very well

share the governing group’s advantages. Therefore, it is difficult to forecast the

outcome of the election, at least until the official electoral program starts on national

TV in August 2010. This is going to be a source of uncertainty and should

contribute to market volatility, especially as little is known about the candidates’



We feel that the October 2010 elections are important and could have market

implications. In the next decade, important foundations of a fast-growing

emerging market will likely consolidate, and many choices will need to be made

in terms of institutions, governability, the role of the state, infrastructure, etc.

Although Brazil is likely to join other countries in adopting a more hands-on

government approach in different sectors of the economy and society, the degree

and manner of how this is done varies widely across the political spectrum.


The plot thickens for the official candidate, but it is too soon to worry. The

latest polls indicate that official presidential candidate Dilma Rousseff’s (PT)

voting intention is falling. She appears tied or behind Ciro Gomes in most polls,

and her ratings have not really improved in six months. The Lula Administration’s

theory is that the president’s high popularity (about 80%) will spill over onto his

chosen presidential candidate. While we still believe that this will be the case,

Rousseff’s ratings need to improve in the next few months, when party coalitions

will start to consolidate. The PT national television program, to be aired in

December, should help considerably.

Emy Shayo

(55-11) 3048-6684

Banco J.P. Morgan S.A., São Paulo

Focus: Brazil’s economy

September 11, 2009

Nilson Teixeira ( and his team at CreditSuisse Brazil, one of the formidable analytical teams among Brazil’s brokerage firms, today published a comprehensive 170 page guide to the Brazilian economy.  Timely, given that the world’s eighth largest economy is now one to be watched, invested in, and profited from.  CSFB says this guide is good for experts in Brazil’s economy as well as neophytes.  The summary pages can be found below.

An old Brazil hand myself who met annually for years with Teixeira and his predecessors (who included a number of members of the board of Brazil’s central bank), I found the work interesting and noticed only a few points that I would stress differently, add to or subtract.  They are as follows:

  • CSFB highlights as Brazil’s number one economic challenge to improve the quality of the country’s primary and secondary education system, including by adding more schools.  I couldn’t agree more. 
  • Brazil’s sovereign default in the 1980s-90s is blamed on the oil shocks and consequent balance of payments pressures, which is well and good; however, blame should be layed as well at the doorstop of  Brazil’s Import-Substituting Industrialization (ISI) policies and massive government borrowing program.  Brazil’s problems were (and are) everywhere and anywhere a fiscal problem.  While CSFB does mention Brazil’s “fragile fiscal accounts,” it does not stress this aspect enough.
  • I agree with the outlook for stronger potential GDP growth in the coming years (in the neighborhood of 4-5% growth per year, not stellar relative to other emerging market economies, but not bad, given Brazil’s history).  I agree that this is due to a decade of sound macro policies since 1999 — with the arrival of Arminio Fraga at the central bank — including inflation targeting, a floating exchange rate, and the Fiscal Responsibility Law.
  • On the other hand, I would stress more the role of the sharp rise in commodity prices earlier this decade, driven to a great extent by demand from China, for Brazil’s improved growth performance. Brazil is a major exporter of soy and other agricultural commodities, minerals, and soon, oil.
  • Brazil’s sound policy management has underpinned its weathering of the 2008-09 Global Financial Crisis.  In previous global crises, Brazil was always one of the first dominos to fall.
  • CSFB says that Brazil, in spite of running a countercyclical fiscal policy during this crisis, should see net government debt decline in the coming years, unlike in most countries where debt will be rising.  Fitch Ratings, which expressed its worries about fiscal policy in a publication earlier this month, may beg to differ.
  • Brazil, in spite of experiencing economic contraction last year and into this year, began expanding again in 2Q09, a good indicator for the future.
  • Brazilian banks are well capitalized.  I might stress a bit more concern about recent rapid credit growth in Brazilian banks.
  • I agree that Brazil’s infrastructure needs are sizable, and investment here could go far to raising potential GDP growth.
  • Likewise, Teixeira and his team were correct in highlighting the challenges of reforming a distorted tax regime, reining in social security deficits, and freeing up a very rigid labor market.

All to say, well worth the read.  Start with the summary below:

“In recent decades, the Brazilian economy has oscillated between periods of strong economic growth (late 1960s and early 1970s) and periods of low growth with high inflation (1980s). Despite the introduction of several economic plans since the second half of the 1980s, inflation was not effectively reined in until 1994, when the Real Plan was implemented.

In step with recurrent balance-of-payment crises in emerging countries, imbalances in Brazil’s external accounts persisted, and average GDP growth was relatively sluggish until the mid-2000s. As the global outlook improved and Brazil maintained responsible macroeconomic policies, the economy’s average growth gained speed in 2004, resulting in the longest cycle of growth and investment since the 1970s.

This growth cycle was interrupted by the global crisis of 2008, but the Brazilian economy has proved much more resilient to crises than in the past. The evolution of its economic fundamentals suggests that, after several decades, the country is likely to experience higher and – even more importantly – less volatile economic growth than in the past. But after fulfilling many of the necessary prerequisites, we believe there are still challenges to be overcome for Brazil to reach a higher level of development in the next decades. For instance, it will have to consolidate the process of making elementary and secondary education universally available, not only by expanding its network of schools, but also by improving the quality of education provided.

Brazil is a federal republic composed of 26 states and a Federal District, which comprise 5,565 municipalities. It is the world’s fifth largest country both in terms of population and land area and has the eighth-largest Gross Domestic Product (GDP). The Brazilian population has grown 1.5% annually on average over the past few decades to 189 million inhabitants in 2008, most of whom reside in cities.

From 1964 to 2008, GDP grew 4.5% per year on average. In the late 1960s and early 1970s (period referred to as the “Brazilian miracle”), GDP grew by more than 11% yearly in a scenario of heavy investment. At that time, Brazil was known as the “country of the future,” a title that has not been revisited in subsequent decades.
In the 1980s, referred to as “the lost decade,” Brazil’s economy was marked by high inflation and low GDP growth. During that period, an oil shock destabilized the global economy, and consequently several developing economies, including Brazil, were unable to roll over their large foreign debt and were forced into default. The balance-of-payments crisis was associated with high interest rates, a sharp depreciation in currency, and high inflation. In the second half of the 1980s and the first half of the 1990s, Brazil implemented several stabilization plans to thwart skyrocketing inflation. Some of these plans included price controls, a freeze on bank deposits, and some unorthodox inflation-reduction measures.

After several unsuccessful attempts, the government implemented the “Real plan” in 1994, which established the Real as its new currency and rapidly reduced monthly inflation from around 50% to less than 1%. Even after lowering inflation, the country experienced several balance-of-payments crises in the late 1990s and early 2000s, some originating in emerging economies and others homegrown. Brazil faced some onerous constraints for financing its foreign debt on several occasions. In order to keep inflation low, the government kept real interest rates very high for several years, which in turn led the economy into a sequence of stop-and-go business cycles. Fragile fiscal accounts and risk of insolvency revealed the weaknesses in the economic adjustment during this period and produced a steep devaluation in Brazil’s currency and a return of inflationary pressure. Despite lower inflation, economic growth remained weak during these years.

In 1999, the government adopted economic policy based on three main points: an inflation target regime, a floating exchange rate policy and adoption of fiscal responsibility law. After decades of huge economic uncertainty, observance of these policies for ten years has helped increase the predictability of the Brazilian economy.
Combined with a favorable global scenario in recent years, characterized by strong economic growth and high liquidity in financial markets, these policies contributed to a significant improvement in Brazil’s macroeconomic fundamentals. From 2003 to 2008, the government maintained relatively low inflation, bought back all sovereign debt originated from the 90s’ debt renegotiation, improved the risk profile of its government securities, maintained primary surpluses, and substantially increased the level of international reserves, contributing to Brazil becoming the fourth-largest holder of U.S. treasury bonds. The global crisis that began in 2008 has proven that the macroeconomic policies adopted in recent years have been effective; despite its magnitude, the impact on the mid-term fundamentals of Brazil’s economy have been rather moderate. One of the main differences versus other countries has been the absence of any balance of payments crises within Brazil. This greater freedom in relation to external accounts has allowed the government to implement a set of countercyclical fiscal and monetary policies to reduce the negative impact of the 2008-2009 crises on economic activity. The primary surplus has fallen, raising net debt to GDP in 2009. In upcoming years, we expect the net debt to GDP ratio to retract, unlike the forecast for many countries hit hard by the crisis. For the first time since the 1970s, the Brazilian economy has proved more resilient than most developed and developing countries, in our view.

Brazil’s potential output growth has increased substantially in recent years. Despite the retraction in 2009 brought on by the international crisis, we believe average GDP growth in the next few years will likely reach 4% or 5%, much higher than the average pace of 3% during the first half of the decade. This higher growth should be associated with a return to investments, which grew consistently from 2004 to 2008, forming the longest investment cycle since the 1970s. Over the past few years, investments have been spread out over various economic sectors, especially infrastructure and commodities. But despite this long growth cycle, the country’s infrastructure is still quite deficient. Heavy investments in infrastructure are needed to foster higher growth in areas ranging from transportation to expansion of the power grid.

Sectors with clear competitive advantages in the last few years are primarily those associated with commodities. Brazil is the largest producer of many soft commodities, such as sugar, coffee, and oranges, the second largest producer of soybean and ethanol, and the number one exporter of all these products. The country is also the second largest producer of beef and ranks third for chicken and fourth for pork. Brazil exports more beef and poultry than any other country. The cost of production in the Brazilian agricultural sector is currently lower than for most producer countries. The agricultural sector is likely to see sustained growth in upcoming years and reap benefits from existing competitive advantages, even if the elimination of non-tariff barriers and improvement within the logistics infrastructure are gradual.

Brazil has huge mineral reserves – especially iron ore, aluminum, copper, chromium, gold, tin, nickel, manganese, zinc, and potassium – and clear advantages in sectors associated with these commodities. Notwithstanding the halt in heavy investment in these sectors on account of the 2008-2009 global crisis, investments will likely remain high in the next few years to meet the growing demand, especially from emerging markets. At the same time, the huge discoveries of oil reserves in the pre-salt layer in recent years should make Brazil a major player in the world market and a net exporter of fuel in the next decade. In principle, much of the massive investments in this sector will be financed by government institutions, but the participation of private corporations, especially from abroad, will tend to attract rugged investment in years to come.

The capital ratio of local banks has been well above the Basel requirement for many years, resulting in a lightly leveraged financial system. This has prevented the international financial crisis from contaminating local banks. The government’s economic policy reaction has brought relatively low fiscal costs and has managed to contain the negative effects of the contrition in external credit. The economic policy response has shown that the banks are able to efficiently intermediate private savings and contribute to sustained high growth in credit, which reached nearly 45% of the GDP in mid-2009. Credit expansion in the next few years will probably have a different profile from the most recent cycle. The new phase will be marked by the lowest basic interest rate in 30 years, which will require a different set of financial instruments available to depositors. At the same time, financial institutions will change their focus, offering longer-term credit and reaching out to more corporate and real estate borrowers.

Greater stability in the local economy should continue to encourage a shift from short- to longer-term investments in addition to increased participation by foreign investors. The need for heavy investments in Brazil within the next few years will require increased risk capital, both from here and abroad, to finance activities. This favorable scenario is expected to stimulate growth in equity markets. Although investments in Brazil have historically been financed largely by public-sector institutions, corporations have been able to raise funds lately in capital markets to finance their investment plans. The private sector will account for a growing percentage of long-term investments in the next several years, either through bank loans or direct financing through equity offerings. High-risk investments will account for a large portion of these funds, and primary and secondary equity offerings are projected to increase significantly in the next few years.

The effects of the 2008-2009 global crisis were less drastic than expected at the outset, which signifies to us that Brazil’s growth pattern is less susceptible to changes in course as a result of the external outlook. However, this does not mean that the Brazilian economy is immune to the global crisis. On the contrary, the crisis has caused Brazil’s GDP to backtrack from an average expansion of 1.6% quarter on quarter from 1Q2008 to 3Q2008 to a peak-to-trough fall of 4.4% in 4Q2008 and 1Q2009. But the return to economic expansion has already taken hold in 2Q2009, demonstrating that Brazil’s solid fundamentals have enabled rapid adjustment to the change in global outlook.

This greater resilience to the external crisis has favorable consequences for the middle- and long-term outlook for the Brazilian economy. Uncertainty regarding the resilience of the country’s economic fundamentals dissipated fairly significantly as the crisis unraveled. Overall country risk and real interest rates should decline even further in the next few years, since severe macroeconomic crises in Brazil do not seem as likely as in the past, leading to higher investments and, therefore, higher potential output growth. Thus, the path of Brazil economic fundamentals suggests that, after several decades, potential GDP growth should be higher than in the past and, even more importantly, less volatile. We, therefore, think this dynamic should allow Brazil to regain its reputation as the “country of the future.”

There are still several challenges to be overcome. First, the country needs to consolidate the process of making elementary and secondary education universally available, not only by expanding its network of schools but by improving the quality of education. Second, Brazil needs to address certain structural constraints, such as its highly complex tax system, imbalances in social security and very rigid labor legislation. It will also be up to future administrations to reopen debate concerning the state’s role in the economy, particularly with regard to its efforts to stimulate manufacturing and strengthen the regulatory framework. These reforms will require serious discussion, because congressional approval tends to lag in light of the complexity of the issues. For example, although there is a consensus in society that the country’s tax structure is complex and tax burdens too high, approval of tax reform is uncertain, because it requires debate regarding which specific fiscal expenditures need to be reduced.

During the preparation of this publication, its target audience focused on those readers with a basic understanding of Brazil, wanting to learn more about the country’s fundamentals and economic outlook. For this group, this guide can hopefully serve as a starting point. Nonetheless, we believe the in-depth scope of this report will also interest readers with a more comprehensive knowledge of the country. We note that this publication is not meant to provide a complete guide to Brazil; it is not intended to offer extensive coverage of the individual topics included. This guide contains a sizable number of graphs and tables, which together provide a relatively general review of information we believe will be relevant for our readers, offering a broad reference base, with information and statistics supporting our overall view that Brazil meets many of the prerequisites needed to take it to the next level of economic development.

The guide is divided into nine chapters, including this introduction. The second section provides a panorama of the country’s geography, climate, mineral resources, biomas, and water resources. The third addresses topics related to population, age ranges, life expectation, labor market, and income distribution. Chapter four contains a brief history of economic policy since the mid-1960s and details policies implemented in the past decade, especially inflation targeting, the floating of the foreign exchange rate, and fiscal responsibility. This chapter also highlights the organization of the country’s political institutions. Chapter five describes the primary characteristics of Brazil’s infrastructure – especially modes of transportation and power generation, transmission and distribution. Chapter six enumerates the primary industrial sectors, such as oil, petrochemicals, steel, automobiles, mining, and construction.

In chapter seven, we present the most important issues in relation to farming, listing the main crops and herds, and describing how they are distributed throughout regions. Chapter eight addresses services, with an emphasis on financial services. In chapter nine, we discuss current business trends in Brazil and certain aspects of the local tax structure. Finally, the appendix provides useful reference material, acronyms, and Web sites to access for additional information.”

Mexico proposes sound fiscal plan, says CSFB

September 9, 2009

I discussed Mexico’s fiscal woes and compared them to Brazil’s in a previous post.  Today, financial market analysts reacted positively to the Mexican government’s fiscal plan, set to limit the widening of the federal deficit in 2010.  Like Barack Obama’s unwillingness to confront Congress on the cap-and-trade carbon emissions plan or health care reform, Felipe Calderon’s government once again skirted the issue of expanding Mexico’s narrow VAT tax to cover food and medicines.  Instead, the government will tax income more heavily.  CreditSuisse’s Alonso Cervera applauds this move because of the virtual impossibility of moving a budget through the Mexican legislature with a VAT expansion in it.  Calderon faces a congress in which his PAN party is dwarfed by the opposition PRI party, unlike the commanding position of Obama’s Democrats in both houses of the U.S. Congress. Nevertheless, Mexico’s budget, if passed, is a step in the right direction, especially since it controls spending and raises the share of non-oil taxes in government revenues. 

Read Alonso Cervera at CreditSuisse and Alfredo Thorne at JPM below:  

 From CreditSuisse’s Emerging Markets Economics Daily, Sept 9, 2009

“The government presented an ambitious budget proposal for 2010 that seeks to limit the widening of the deficit to 0.4% of GDP mainly by strengthening non-oil tax collections. The government released the comprehensive documents last night. Our first impression is a positive one, in that the government will seek to gain congressional approval for tax hikes equivalent to 1.4% of GDP, and for spending cutbacks equivalent to 0.5% of GDP. By applying an additional 0.7% from non-recurring revenues (those

currently existing in stabilization funds as well as projected ones), the government seeks to limit the widening of the fiscal deficit to 0.4% of GDP, from 2.0% this year to 2.4% of GDP next year. The government will also seek to strengthen the fiscal responsibility law by, among others things, eliminating the maximum reserve levels for stabilization funds so that the government can capitalize on the materialization of a revenue windfall.

The government presented in its policy guidelines document relevant comparisons that make it clear that non-oil tax revenues in Mexico are particularly low. The government made the comparison versus other OECD countries, Latin American countries and Brazil in particular. The government’s proposal to enhance non-oil tax revenues does not rest on the introduction of a value-added tax on food and/or medicines. We view this as a wise decision, given the strong opposition that both the PRI and the PAN had voiced in recent days regarding this potential proposal. Instead, the government is seeking to

achieve a combination of higher excise and income taxes, as well as the introduction of a new tax that has been labeled the “anti-poverty tax”.

Specifically, the government’s proposals on the tax front include: 1) the introduction of a 4.0% excise tax on telecommunication services that use a public network (excluding services in rural areas as well as public telephones); 2) increasing the excise tax on tobacco by 10.9 percentage points in 2010; 3) increasing the excise tax on beer from 25%to 28% in 2010-2012 and then reducing it back to 25% by 2014; 4) increasing the excise tax on lottery games to 30% from 20%; 5) hiking the maximum income tax rate on individuals and corporations to 30% in 2010-2012 from 28% at present, and then reducing it gradually back to 28% by 2014; and, 6) increasing the tax on cash deposits from 2% to 3% and broadening its application to cover smaller transactions.

Finally, the so-called antipovertytax would be a “2% tax on revenues generated by all types of economic activities, applied in all stages of production  in a non-cumulative manner”, according to the document. The proceeds, estimated at 72bn pesos (0.6% of GDP), would be applied to selected anti-poverty  programs. The government estimates that non-oil tax revenues could increase from 9.2% of GDP in 2009 to 10.8% of GDP next year. The bulk of the increase would come from income taxes, which would increase from 5.0% of GDP in 2009 to 5.6% of GDP next year. The government is also proposing some changes to the taxation of Pemex. Specifically, one of the proposals is to create a new flat tax rate of 15% for natural gas and crude oil extraction activities in selected fields, as opposed to taxing them based on a variable rate that is capped at 20%.

On the spending front, the government is seeking a reduction of 0.6% of GDP in programmable expenditures as well as the re-allocation of other expenses in favor of pension payments, health coverage and overall anti-poverty measures. Some specific measures to cut spending include the closing of three major government offices, 5% headcount reductions for high ranking officials and administrative staff, and 10% cutbacks in Mexico’s representative offices abroad. On the debt financing front, we highlight that the government will seek a net domestic indebtedness ceiling of 340bn pesos, which compares favorably to the ceiling it requested (and got from congress) of 380bn pesos for 2009. We think that this should be a relief for the local market, as the government will seek more actively than usual non-market financing sources abroad (mainly IFIs and other non-traditional sources). As for market debt issuance in external markets, the government’s plan is to simply issue an amount equivalent to market amortizations coming due in 2010 ($2.9bn).

Finally, the government’s outlook on the global economy in 2010 is somewhat cautious. The government’s documents presented to Congress yesterday state that the global situation continues to show a significant degree of fragility and that the global economic recovery will be moderate. Mexico’s real GDP is projected to expand at an average rate of 3.0% in 2010, with average annual growth seen at 4.2% in 2011-2015. This is partly based on the Blue Chip survey that puts US real GDP growth at 2.3% in

2010 and US industrial output growth at 2.5%. The government’s oil price assumptions are based on the formula set out in the budget responsibility law. Taking historical and projected prices, the formula yields an estimate of $53.9 per barrel for Mexico’s crude oil export mix in 2010 (roughly $60 for the WTI mix), which increases gradually towards $64.6 by 2015, which we view as conservative. Finally, in terms of oil output, the assumption is that it will average 2.5mn barrels per day in 2009 and in subsequent years, down from slightly over 2.6mn barrels per day in 2009. This assumption may be on the optimistic side, in our view.

In the remainder of this week we will expand our analysis of the comprehensive documents issued by the government last night. We reiterate that our initial reaction is positive, in that the government is putting on the table several measures that seek to close the gap created by falling oil and non-oil prices due to structural and cyclical factors. We also view the decision to keep off the negotiating table any proposal to introduce a valueadded tax on food and medicines as a good move by the government, one that may make negotiations smoother with the main political parties.

Finally, and on a separate note, the central bank will publish today at 10:00 am EST the inflation results for August; we estimate headline inflation was 0.28% last month (relative to July). If our estimate proves accurate, annual headline inflation will drop to 5.1% from 5.4% in July. Meanwhile, we estimate that core prices rose by 0.24% last month, which would put the 12-month reading at 5.1%, down from 5.3% in July. These would be the lowest 12-month readings since May 2008 in the case of headline inflation,

and since July 2008 in the case of core inflation. Market expectations are generally in line with our own. The latest survey released yesterday showed average forecasts of 0.26% and 0.25% for headline and core inflation, respectively. The survey also showed that the overwhelming majority of analysts (19 out of 24) thought that the central bank will keep the overnight rate unchanged at 4.5% in the remainder of the year.”

From JPMorgan’s Emerging Markets Today, Sept. 9 2009

“President Calderón yesterday announced the 2010 economic

package, calling for an austere budget with changes in the

public sector’s administration structure. To reduce expenses,

Calderón presented four administrative changes for next year

to be discussed by Congress. First, the Ministries of Tourism,

Agricultural Reform, and Public Ministry will be eliminated.

The first two entities will be reallocated to the Ministry of

Economy and Ministry of Social Development and

Agriculture, while the third will fall under executive powers.

Second, the federal government will reduce the large number

of civil servants and freeze salaries and compensation. Third,

spending on embassy, councils, and foreign activities will be

reduced. Fourth, other administrative expenses will be

reduced. The measures together are expected to reduce

budgetary expenses by MXN80 billion. Calderón

estimated that these expenditure cuts, combined with the

fiscal package (still pending at the time of writing), will

narrow the fiscal gap to MXN180 billion (1.4% of GDP).

Calderon also reiterated the government’s commitment to

reducing poverty noting that none of these expenditure cuts

will include social programs.”

Alfredo Thorne (52-55) 5540-9558