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Partly Cloudy: Still Sluggish Latin America Credit Outlook

Editor's note: S&P Global Ratings' Credit Conditions Committees meet quarterly to review macroeconomic conditions in each of four regions (Asia-Pacific, Latin America, North America, and Europe, the Middle East, and Africa). Discussions center on identifying credit risks and their potential ratings impact in various sectors, as well as borrowing and lending trends for businesses and consumers.)

Mixed credit conditions are expected by S&P Global Ratings for Latin America for the remainder of 2016 and heading into next year. We expect a growth rebound in 2017 in Brazil and Argentina as both economies emerge from recession, which should improve credit quality for the corporate sector. However, political challenges and tightening fiscal policy will constrain the positive impact for corporates, while in other sectors, such as Brazilian local and regional governments, negative impact from this year's recession will continue to constrain credit quality. With the Mexican economy performing below our expectations, including weaker growth (and expected tightening of fiscal policy to compensate) and a weaker currency, domestic demand-sensitive sectors may be affected. For the financial sector, the largest banks have been resilient to the challenging environment in the region this year, despite growth in non-performing loans and lower profits; the gradual recovery expected for the region should be a positive. And for the region in general, besides continuing potential downside risk for Brazil, we continue to monitor other key risks, including uncertainty in the U.S. political landscape and the potential adoption of protectionist measures, global credit market volatility and the related impact on capital flows, and the persistence of low commodity prices from a historical perspective, despite a partial recovery from recent lows.

 

  • We expect continued sluggish economic growth for Latin America, with the region overall in recession in 2016 and a modest uptick of 2% real GDP growth expected in 2017, thanks to a slow recovery in Brazil. External dynamics continue to stabilize, but a significant recovery in domestic demand has yet to materialize.
  • In Brazil, we revised our real GDP forecast upward to negative 3.3% in 2016 and positive 1.5% in 2017, from negative 3.6% and positive 1.0% previously, due to signs that the economy is emerging out of the recession more quickly than we anticipated.
  • We now forecast weaker real GDP growth in Mexico at 2.1% in 2016 and 2.5% in 2017, compared to 2.5% and 2.9% previously, mainly due to the impact of slower-than-expected growth in the U.S. economy on the country's manufacturing sector.
  • Overall credit quality in the region remains muted, as downgrades outpaced upgrades at a rate of over four to one in Latin America so far in 2016, maintaining the same rate of downgrades to total rating actions (just under 80% and consisting of 122 downgrades and just 28 upgrades) for the third consecutive year. This is significantly higher than the region's historical annual average of 46% since 2005.
  • The credit quality of sovereigns in Latin America and the Caribbean has declined this year. Most sovereign ratings in the region still have a stable outlook, but an increasing number (Brazil, Mexico, Venezuela, Colombia, Costa Rica, Barbados, Trinidad and Tobago, Uruguay, and The Bahamas) currently have a negative outlook.
  • Fiscal challenges are likely to remain for most Latin America's local and regional governments toward the end of 2016, and uncertainties over access to external liquidity will continue.
  • A gradual economic recovery for the region in 2017 coupled with the shift of investors' risk appetite towards emerging markets should bring some relief to Latin American banks. However, investors have remained risk averse and are demanding higher returns. In our view, these conditions could increase banks' funding cost, especially for those that rely on wholesale funding.
  • Corporate credit quality will similarly benefit from better regional growth next year, though we expect differentiation by sector. Metals and mining, oil and gas, utilities, transportation, automotive, consumer, and telecom and cable are among industries that have shown stable leverage and liquidity patterns in the past 12 months. Contrastingly, retail companies may face additional pressure as formal employment and retail sales are still weakening and might lag behind other indicators' improvement.
  • Securitization transactions backed by small- and mid-size enterprises in Brazil may start to improve over the next six months, while stable performance is expected in other structured finance sectors for the region.