Low productivity, low investment rates and political uncertainty still hamper Latin America’s biggest markets. Financial innovation might help.

Author: Denise Chrispim Marin

Latin America is not for amateurs or investors seeking short-term returns, but it is drawing plenty of savvy investors able to take the long view. Despite political instability and macroeconomic uncertainty, its three major economies are attracting substantial investment from major multinationals looking to plant or grow deeper roots in the region.

Five giant oil companies paid $1.7 billion in September for the right to explore four Brazilian pre-salt areas. Coca-Cola will inject $1.2 billion into Argentina between 2019 and 2021. And Mexico’s processed-foods giant Herdez Group is preparing to expand its investments in that country next year.

Political divisions wrack all three countries—Mexico and Brazil just finished momentous presidential elections and Argentina faces one next fall—although their democratic institutions continue to function. Low productivity and investment rates are still hurting Latin America in general; and at least two of its main markets, Argentina and Brazil, have been exposed to speculative attacks. However, the region is rich in opportunity for traditional businesses such as oil and gas, agribusiness, manufacturing and infrastructure; and its public and business sectors are eager to explore innovative solutions.

For the first time in many years, Mexico will have a leftist president in charge once Andrés Manuel López Obrador, popularly known as AMLO, is inaugurated on December 1. Business has been looking to him to calm the markets during the five-month transition period, but his course as chief of state is still unknown and will be challenged by the protectionist Trump administration on the other side of the Rio Grande border.

The big question, says Jaime Reusche, senior analyst of sovereign risk for Latin America at Moody’s Investors Service, is whether López Obrador will let stand the reforms the outgoing administration carried out. The reforms, mainly in the energy and telecom sectors, were welcomed by investors.

“It is uncertain if AMLO will keep or change the current regulations,” says Reusche, noting another potential risk in the US midterm elections: Will the new Congress approve NAFTA’s negotiated successor, the USMCA agreement?

Plenty of major businesses and investors, especially those with a long history in Mexico, maintain their faith. One example is Herdez Group, the national leader in shelf-stable food. “We have 104 years of life in this company; and in all this time, we have been through everything,” Héctor Hernández-Pons, CEO and chairman, said when he announced a $32 million investment for next year. “I believe that the change of government will bring some changes in the way we work, but we remain interested in participating in Mexico.”

Brazil’s new administration, to be inaugurated January 1, also has no clear fiscal agenda. Absent social security reform—described in a mid-October IMF report as “essential” because “expenditures are high and rising,” the country could drop into a new recession in 2019, says Sergio Vale, chief economist of MB Associados.

Argentina under President Mauricio Macri has followed a more defined path to reform in recent years. The IMF agreed in September to boost the country’s crisis loan package by 14%, to $57.1 billion, in return for changes in its monetary and foreign exchange policies. But it is still uncertain whether Macri can get his fiscal reform package approved by Congress following his announcement that he will run for re-election in October 2019.

Argentina still has hurdles to overcome, says Reusche, and even with the IMF program it faces a lack of credibility and confidence. This year, the country faced a crop failure, a rise in interest rates in the US and Europe, and higher oil prices, economist Orlando Ferreres notes. “Macri should have cut public expenses three years ago, when he started his term,” he argues. “Now, he is finishing it without fulfilling his promise to reduce poverty.”

Regional Sluggishness

GDP growth across the Latin American region is likely to be slow this year—a tic or two above 1%—held back not just by Argentina and Brazil but by Venezuela, which is widely expected to see GDP plummet. Nationally, growth will depend on each country’s exposure to external shocks, such as the slowdown of the Chinese economy, and on its degree of domestic turmoil. JPMorgan estimates 2019 GDP expansion for Colombia at 3.4%; Chile at 3.7%; and Peru, whose economic prospects are not contaminated by political disruptions, at 3.5%. The IMF is even more optimistic.

“The GDP growth estimated for Latin America’s countries [in 2018] is low, because of the low level of investments,” says Otaviano Canuto, executive director at the World Bank Group. “The region can also face some risks from outside—such as the normalization of US interest rates and the Chinese slowdown—and from the domestic arena—the political uncertainty in Brazil, Argentina and Mexico, and the future of the peace agreement in Colombia.”

Hopeful investors are keeping their eyes on signs of buoyancy and even progress. Some of Latin America’s production and export sectors, such as agribusiness, oil, infrastructure and mining, are helping these countries avoid the worst outcomes. And some innovative segments and smart public policies may boost economic growth.

Innovation in finance is critical, says the World Bank, as only 51% of the population in Latin America and the Caribbean have a bank account, compared with a worldwide average of 69%. Even among people who have one, 20% don’t use it. Fintech start-ups are welcomed even in Brazil’s closed banking market as a way to easily connect investors and borrowers, thanks to lower loan rates and digital operations with no fees.

When Peru allowed electronic invoices to be securitized in 2014, it attracted several foreign investment funds that have since revolutionized the market. Previously, foreign banks had taken over local institutions and were concentrating largely on wealthier customers. These investment funds pursued small and medium-size clients who were ignored by the bigger institutions, and developed a robust market for the new securities issued by these same customers.

It was in this wave that Brazilian fund manager SRM Asset introduced Peru’s first trade fund as well as a factoring fund. “Four years ago, the country seemed to have a financial market similar to the Brazilian one back to the 1980s,” says Rui Matsuda, CEO of SRM SAFI, the Peruvian affiliate. “In a few years, its financial sector has improved quickly, skipping stages that other markets had already experienced.”

Stable economies in Peru and Chile were an attraction for SRM. The firm is now preparing a new office in Colombia, hoping to take advantage of economic improvement following the end of more than 50 years of civil war. Argentina, which had been in SRM’s sights earlier, is now a lower priority due to economic uncertainty. Mexico is not an alternative for financial companies such as SRM, says Matsuda, who points to the US as a better choice for direct investment.

“We cannot work in a country that offers us only ‘a chicken’s flight’ growth (Brazil), a weak currency (Argentina) or a US manufacturing backyard (Mexico),” he says. “Political and economic stability are the key factors for our investments.”