Latin American elections mean volatility for emerging markets
Latin America has election fever. El Salvador held parliamentary and mayoral votes in March, Costa Rica elected a new president in April and Paraguay held general elections two weeks ago. Venezuelans go to the polls in two weeks’ time, Colombians a week later, and Mexico and Brazil will wrap things up in July and October. More than half the population of the region is voting this year, representing well over twothirds of its GDP.
With populism gaining ground in many developed economies, and figures such as Nicolás Maduro and Antonio Manuel Lopez Obrador getting much of the press in Latin America, it’s easy to conclude that votes equal volatility for emerging markets investors.
The reality may be less exciting. Argentina and Chile opted for mainstream economic orthodoxy in their most recent elections, Paraguayans chose between two centre-right candidates and El Salvador’s elections dealt a blow to the previously dominant far-left FMLN. Costa Ricans kept the incumbent democratic socialists in first place in the legislature while awarding the presidency to a candidate from another centre-left party.
Colombia swept a number of populists from Congress in elections earlier this year. We expect the presidential race to be decided in June, in a second-round runoff between the left-wing populist Gustavo Petro and Iván Duque Márquez on the centre-right. We think Duque will prevail, but his lead has been shrinking over a crowded first-round field, which could trigger market volatility before the final runoff.
Strong and improving fundamentals lead us to maintain a positive view on Colombia’s external and local-currency debt, and the peso. An early adopter of economic orthodoxy, it last defaulted on its external debt more than 80 years ago, and it was one of the first emerging-market countries to gain investment grade ratings. An electoral surprise could cause a market correction, but the flow of Venezuelans across their border has left Colombians with little appetite for Chavismo-style “economic experimentation.”
Colombia is next door to Venezuela, but it might as well be on another planet — a perfect example of the diversity of this region’s economies. As Brad Tank wrote back in August, the situation in Venezuela, which was rated AA in the 1980s, is “tragic, unnecessary, but not representative.”
Opposition parties are boycotting May’s elections, so Maduro is likely to retain power. That will hardly come as a shock to markets. Will it be enough to stoke domestic unrest? Maybe, maybe not: Ultimately, this regime is likely to end simply because it runs out of cash as oil exports implode and external funding shuts down.
It is worth remembering that Maduro still polls around 20 per cent, ahead of many other leaders in the region. He maintains that support through policies such as the latest 155 per cent hike in the minimum wage — although this must be cold comfort with inflation running at 10,000 per cent.
The broader impact is likely to be limited to the global oil market. For investors, defaulted bonds trading at 20 to 30 cents on the dollar may present lower downside risk when and if the current regime is forced out.
Brazil and Mexico
The more consequential elections will come in Brazil and Mexico.
Even by Brazil’s standards, the political scene is unusually fragmented. There is no dominant figure or party — unless we count Lula, whose imprisonment hasn’t stopped him “campaigning.” He is unlikely to run in October, however, and no other single pre-candidate is polling north of single digits.
In Mexico, by contrast, Lopez Obrador (or “AMLO”) consistently polls well ahead of the other two core candidates, who are seen as uninspiring upholders of the status quo.
While AMLO certainly indulges in populist rhetoric, markets appear little concerned. They may have partially priced in his victory, as well as recognised the constraints placed on him by the composition of Congress, the constitution, his more orthodox advisers, and the fact that he demonstrated relative fiscal constraint as mayor of Mexico City.
Given that, investors might perhaps focus on what Mexico has going for it: its primary fiscal surplus in 2017; its declining inflation and enviable space for looser monetary policy; and its competitive exchange rate.
It has its red lines and “no deal is better than a bad deal” stance on Nafta, but ultimately it doesn’t control these risks — the US does. Overall, we believe external sovereign debt and local rate are already attractively priced, and a surprise defeat for AMLO could trigger a substantial additional rally.
In any case, our view is that a “market-adverse” outcome in either Mexico or Brazil would be unlikely to trigger a systemic emerging markets reaction. They are large and important, but they are also very different, and today, investors make clearer distinctions than they used to.
That is perhaps the most important lesson to take from this unusually busy election year in Latin America. Politically and economically, its countries are more diverse, and probably more centrist and orthodox than one might assume. That could help the region weather marketadverse surprises, and it stands to benefit those who take a truly discriminating approach to investing there.