WASHINGTON, Dec. 9 (UPI) -- Traditionally, U.S. banks "redlined" certain inner-city areas, refusing to lend to inhabitants thereof because they believed nobody living there could be an acceptable credit risk. As the political and economic situation in Latin America deteriorates, the question must now be asked: should a rational lending bank or portfolio investor "redline" Latin America as a whole?
Strategy Research Corporation, now known as Synovate, is a Miami-based consultancy that since 1995 has produced a Latin American Market planning report, attempting to demonstrate that Latin America is an important market that cannot be ignored. Of course, for sellers of consumer goods, this is clearly the case. With a population estimated at 504 million in 2002, and gross domestic product totaling close to $2 trillion, if you're Coca Cola, you have to be there. Provided your production costs are small in relation to the final sales price of the product, and you take good care over such factors as buyer creditworthiness, physical security of personnel and product, and potential for local government harassment, the benefits outweigh the risks. After all, the region has a "buying power" of $1.2 trillion.
For banks and portfolio investors, however, the risk/reward ratio is different. Banks in particular have a very skewed risk profile; if all goes well, and they get repaid, they make a modest return, but if something goes wrong, and the borrower defaults, they lose a large part or all of their money.
For the individuals within the banks who make the loans, on the other hand, the risk profile is somewhat different. They make good bonuses if loans are made and returns appear to be accruing, whereas even a slowdown in business, which requires a lower level of staffing than in the boom years, can lose them their job and indeed their career just as definitively as a huge loss on the banks' loan portfolio.
This is why banks justify their lending by theories such as "countries cannot go bankrupt" and strategies such as depending on IMF country bailouts; the lending bank itself, and its shareholders, may well suffer in the long run by additional lending to a tottering country, but in the short run, everybody keeps their jobs and possibly gets a bonus, however shaky the theory on which the additional lending is based, until default is formally declared and no further lending is possible.
For portfolio investors, the risk/reward profile is different. A high-risk, high-growth situation, in which a heavily indebted country nevertheless enjoys fast economic growth, may well be attractive for portfolio investors, because they can benefit from earnings growth of companies doing business in the country, and, if they are lucky, in a re-rating of the country upwards by the market, to reflect its economic growth and future potential. Even in a situation where growth prospects are limited, if the stock market is sufficiently depressed and there are prospects of at least reasonable stability in the future, it may be worth investing to take advantage of a future restoration of normality and expansion of stock valuations.
In the final analysis, however, it comes down to risk and return. Here the evidence is pretty damning. Over the last 10 years, a period that does not include the "lost decade" of the 1980s but instead includes the huge mid-'90s bull market in many Latin American countries, there have been seven closed-end Latin American funds in operation, two each for Brazil, Mexico and Latin America in general, and one for Chile. The highest annual return of any of these funds over the 10 year period 1992-2002 is 7.53 percent per annum, the lowest is minus 0.52 percent per annum, and the un-weighted average return is 3.41 percent per annum.
The Standard and Poors 500 Index of U.S. stocks, during the same period, returned 10.14 percent per annum including dividends, while the Dow Jones STOXX index of European stocks (calculated in dollars, which thus includes substantial currency losses against European currencies) returned 6.3 percent per annum plus dividends over the same period. Only the Pacific region, with Japan substantially down, did worse than Latin America, returning minus 2.3 percent per annum according to the MSCI Index. However, over the full life of the MSCI Pacific Index, since 1969, its return has been 8.0 percent per annum plus dividends.
This relatively poor performance by Latin America has been achieved in the decade of globalization and the North American Free Trade Agreement, when policy was supposed to have substantially improved since the "lost decade" of the '80s. It has also been achieved in a period when two countries, Brazil and Argentina, enormously increased their domestic and international debt while a third, Venezuela, benefited in the last few years from oil prices that were relatively high in historical terms.
Going forward, the outlook is not so positive. In Argentina, after a 16 percent decline in GDP in 2002, it is difficult to imagine things getting any worse. Nevertheless, with an unpaid $140 billion debt overhang (five times exports) it is also difficult to imagine lending the place any money in the next few years. Portfolio investment, on the other hand, must swim against the huge tide of Argentine retail investors seeking somewhere, anywhere to put their money other than the Argentine banking system, in which their deposits have been "pesoified" at an artificial exchange rate and then locked in place for a year. Furthermore, the Argentines either have an election coming up next year (always a signal for activity detrimental to foreign investors) or have the present government staggering on, wholly without legitimacy (Eduardo Duhalde LOST the 1999 election), seeking only to enrich themselves further before the voters throw them out.
Argentina has great natural resources, is not over-populated, and is a potentially wealthy country. We know it is potentially wealthy, because it WAS wealthy in the period 1880-1929, before democratically elected populists wrecked the economy. Since then, domestic savers have been expropriated approximately once per decade, while even international bank investors have seen their capital wiped out by the latest debacle. There is no security of property in the country for foreign or domestic investors. In such a case, there is no such thing as "buying cheap" since you are not assured that the inevitable economic rebound will do you, as a foreign investor, any good at all -- if you make a good profit, it may simply be expropriated.
Brazil is currently enjoying the honeymoon with new President-elect Luis Ignacio Lula da Silva, who is known as "Lula." Certainly Lula appears not to be the Marxist ogre that he had been painted by his political opponents. No doubt the Brazilian electorate who chose him are currently pleased with their choice. At the same time, his policies, even the more moderate ones now favored, are substantially more statist even than those of outgoing President Fernando Cardoso, that brought Brazil a currency crisis in 1998, and a substantial increase in the state's share of national output. Furthermore, with Brazil's debt totaling $250 billion, and the International Monetary Fund likely to insist on deflationary policies, there would appear to be little to go for on the equity side.
As for debt, a lender to Brazil already ranks junior in reorganization to a huge amount of World Bank, IMF and Inter-American Development Bank debt. On the upside, reducing the level of interest rates paid by Brazil is a key Lula priority, so even if a lender is able to recover principal, it is most unlikely to receive any interest beyond the barest minimum margin above its cost of funds.
Mexico, at first sight, appears rather better. After all, the country enjoyed a big economic boom after the crisis of 1994, as entry into NAFTA and increased integration with the booming U.S. economy caused efficiencies in the Mexican system to rise. Yet here too the outlook is not rosy. President Vicente Fox came into office at the end of 2000 pledged to remove the corruption and statism of the long-standing Institutional Revolutionary party government, or PRI, but in fact, hobbled by a PRI majority in Congress, he has been able to achieve little. The electricity company CFE remains state owned in spite of the huge potential for profits, were it to privatize, from the wealthy and energy-starved California market to the north. The oil company Pemex, which should have benefited hugely from the rise in oil prices and its proximity to the United States, remains a byword for ineptitude and corruption.
Meanwhile, the PRI itself is reorganizing, and Mexican economic growth is running at substantially lower levels than the country has been used to in recent years. Population, too, is increasing by about 1.7 million new mouths per annum, while the safety valve of high emigration, legal and illegal, into the United States is less available now than it was before Sept. 11, 2001, and the U.S. recession. The probability must be that the Mexican political system will in the next election, due in 2006, turn once again to the PRI, and to autarky, no doubt partially or fully expropriating foreign investors as it does so.
This is after all a Mexican tradition; in the whole of Mexican history, the only prolonged period when foreign investors got a fair deal was the elective dictatorship of Porfirio Diaz, 1876-1910. Needless to say, this was also the only period in its history when Mexico made sustained progress towards modernity and prosperity.
Smaller countries in Latin America offer no more for the foreign investor. Venezuela, oil-rich, has been in the grip of the socialist-populist Hugo Chavez since 1998, and has now erupted into strikes and social unrest; nothing for foreign investors there.
Ecuador, which at the time of its dollarization in 2001 seemed to have achieved a measure of stability, has now elected as president the populist leader of a 2000 coup. Oil or no oil, it seems unlikely to offer much for the foreign investor.
Peru appeared to reform in the early 1990s under President Alberto Fujimori, but as the Fujimori years wore on he became more authoritarian and corrupt, and the reform effort was dissipated. After a year of unrest, Fujimori was replaced by the center-left
Alejandro Toledo, who was at first advised economically by the Wall Street economist Pedro-Pablo Kuczynski. However, Kuczynski was forced to resign earlier this year and was replaced by a populist, while ultra-Socialist ex-President Alan Garcia leads Toledo hugely in current opinion polls. Not much for the investor there.
Even Uruguay, in many respects a bastion of stability, has suffered hugely from the Argentine crisis, is close to default on its international debt, and in any case has a public sector that is both corrupt and far too big. Again, not much to go for.
The poster boy for foreign investment in Latin America is of course Chile. After military President Augusto Pinochet took over in 1973, Chile attempted economic policies that were the reverse of the Latin American tradition, and in many cases, such as the privatization of pensions, innovative on a world scale. Although Pinochet's candidate narrowly lost the election of 1988, during the 1990s the governments of Patricio Aylwin and Eduardo Frei changed relatively little of Pinochet's economic policies, and the country correspondingly prospered. Foreign investors came to Chile in large numbers, and on the whole did well, although the return of only 2.47 percent per annum earned by the Chile fund since 1992 indicates that the best rewards may have come fairly early in the process.
However, in December 1999, in an election reminiscent of that of 1988, the wrong guy narrowly won. President Ricardo Lagos is no Chavez, but both the man and his policies are much closer to the appalling Latin American tradition than his predecessors. Chile is beginning to run a budget deficit, foreign direct investors have on a number of occasions been harassed by the government, and in general the gap between Chile and the other Latin American countries as a destination for foreign investment has substantially narrowed. Of course, the regional crisis has been very unhelpful in this respect. Elections are not due until December 2005, so considerable further backsliding can be expected.
Equity investments in Chile look pretty unattractive, as the regional recession will inevitably affect returns. On the debt side, in spite of recent down-gradings the country is still rated an investment-grade Baa1 by Moody's, but this is deceptive -- the risks, in a very difficult regional situation, must be substantially greater than that rating would imply, although the foreign debt, at around $45 billion remains manageable compared to GDP of $65 billion.
In summary, therefore, with the marginal exception of Chilean debt, there appear currently to be no attractive lending or portfolio investment opportunities in Latin America. Part 2 of this analysis, Tuesday, will explore why this is the case, and whether the unattractiveness of the region is likely to persist.
(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
