Political Risks Are Receding In Latin America, But Uncertainty Looms

S&P Global Ratings
Written By: Jose M Perez-Gorozpe, Laura J Feinland Katz
S&P Global Ratings
Written By: Jose M Perez-Gorozpe, Laura J Feinland Katz

Credit conditions in Latin America have turned favorable as political risk recedes and commodity prices remain fairly stable. Although the economic recovery in the region has been sluggish, suitable external conditions and investors' appetite for yield continue supporting positive capital flows to Latin America; this trend should continue through the rest of the year. This environment has also relieved pressure over currencies and inflation, paving the way for accommodative monetary policies and decreasing reference rates in most countries, although Mexico is a relevant exemption. Political risk has lessened over the past few months, especially after President Temer in Brazil dodged corruption charges; on the other hand, the ability of the Brazilian government to undertake necessary reforms remains a concern. In Mexico, anxieties around the North American Free Trade Agreement (NAFTA) renegotiation continue to decline, despite U.S. President Trump's negative statements about the agreement. NAFTA negotiations continue, and although the U.S., Canada, and Mexico have incentives to achieve a new agreement by the end of the year or early 2018 as elections approach, their ability to achieve this is still a major question mark.

However, uncertainty looms as a heavy cycle of elections approaches: Argentina's congressional elections are in October, and there are upcoming general elections in Chile (December 2017), Colombia (May 2018), Mexico (July 2018), and Brazil (October 2018). In many cases, such elections cause investors to delay their plans, negatively affecting debt issuance and, to some extent, GDP growth. Moreover, the lack of clarity with respect to U.S. policies remains and escalating geopolitical risks could heighten market volatility going forward.

S&P Global Ratings continues to expect an economic recovery in the region for 2017 and further improvement in GDP growth for 2018, although we expect that economic expansion in most Latin America countries will continue to be slow. Domestic demand has mainly driven economic growth in most countries in the region. With the exception of Argentina, investment remains lackluster. Public investment is either low or falling in most countries, given fiscal challenges and delays from corruption scandals. Private investment is sluggish in most cases, as investors wait for more clarity in the political arena as elections approach.

Overview

  • Credit conditions in Latin America have turned favorable as political risk recedes and commodity prices remain fairly stable.
  • Although the economic recovery in the region has been sluggish, suitable external conditions and investors' appetite for yield continue supporting positive capital flows to Latin America.
  • Uncertainty remains due to the upcoming heavy election cycle in the region, still unclear U.S. policies, and increasing geopolitical risk;
  • Latin American economies continued to recover in the second quarter of 2017, and we expect that trend to continue throughout the rest of the year and into 2018.
  • Latin American corporate (financial and nonfinancial) and sovereign rating actions remain balanced so far in 2017.
  • Financing conditions continue to be more supportive in Latin America, with the Institute of International Finance's Lending Survey results improving across the board from the first quarter.
  • We see continued risk for sovereigns despite recovering economies, including political risk in Brazil and NAFTA trade related risks for Mexico. Continued solid GDP growth in the U.S. and signs of accelerating growth in Europe haven't positively impacted Latin American sovereign rating trends.
  • Latin American local and regional governments' creditworthiness is likely to remain stable, except for some Brazilian states, given that they're still facing fiscal challenges while the economy recovers.
  • As economies in Brazil and Argentina begin to recover, corporate credit risk is gradually diminishing.
  • Lower GDP growth and sovereign credit quality remain the key risk drivers for the infrastructure sector.
  • Sluggish economic growth or a feeble economic recovery will limit banks' profitability across most of Latin America in 2017.
  • In the face of recent natural disasters, Mexico's insurers will likely show resilience.
  • Although economic recovery is slow, it may alleviate credit pressure in securitizations, while portfolio composition may reset.

Risks And Imbalances

Brazil's political risk has somewhat receded because President Temer avoided a corruption trial. Nevertheless, Brazil's political challenges remain, as the country needs reforms to tackle its deteriorating fiscal position and rising government debt. Furthermore, uncertainty reigns over 2018: there's no clarity about what political route the country will take after next year's election.

U.S. policies are now the top risk for Latin America as President Trump continues to carry out his agenda, by, for example, posting negative statements on NAFTA. While these conditions cause temporary anxiety among investors and episodes of volatility, markets in the region have tended to stabilize, supported by the recovering global economy, fairly stable commodity prices, satisfactory and improving domestic conditions, and continuing accommodative monetary policies in developed countries. On the other hand, the possibility that the U.S. could walk out of the agreement remains, although the possibility is low and not in our base case. Mexican officials have publicly stated this could be a potential outcome and a contingent scenario should be considered. In our view, NAFTA negotiations will bring anxiety and volatility to the markets over the next few months.

Furthermore, risks linger because investors' sentiment remains fragile. We believe that capital flows are vulnerable to negative developments in the external or domestic arenas. Events such as an escalation of tensions between North Korea and other countries, accelerating monetary tightening in the U.S., or falling commodity prices could result in a sudden shock to portfolio flows to Latin America.

In absence of adverse events, we expect credit conditions to remain favorable in the region as developed economies recover, accommodative monetary conditions remain, and commodity prices are stable. In our view, this environment should allow issuers to continue financing their needs with advantageous terms.

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