Latin America’s uneven risks should spur portfolio shifts
Latin America’s relative resilience to the more acute rise in risk seen in other regions this year is offering investors new options for improving risk-return trade-offs, according to Euromoney’s Country Risk Survey.
Chile is still holding its own as the darling of the region, and Brazil remains the second safest, despite a comparatively large fall in its score this year. However, whereas ECR contributors are more confident about Peru and Uruguay, faith in Paraguay and Argentina has diminished alarmingly.
Latin America, a regional grouping of 20 countries, has invariably succumbed to increased risk this year, according to Euromoney’s Country Risk Survey, in line with the global trend. The region has seen a 0.3 point decline since January, taking its average score down to 45.2.
The increased perception of risk stems from a range of domestic and external factors – from political and economic policy failings in Argentina, to worries about the impact of dissipating global growth prospects for the region’s exports. LatAm’s economic-risk-assessment score has fallen by an average of 0.9 this year, and political risk by only 0.2; both are eclipsed by a 1.0 point drop in the structural risk assessment, although this has been mostly driven by a large drop in perceptions about Paraguay.
The LatAm score decline is relatively mild in comparison with the falls seen elsewhere: the eurozone is down 2.0 points this year; the Brics and Central and Eastern Europe (CEE, excluding the Commonwealth of Independent States) by 1.3 points each; and the Middle East by 0.9. Even over a two-year horizon, Latin America has held up fairly well, despite an average score loss of 6.3 driven by double-digit drops for Argentina, Bolivia, Mexico and Venezuela.
Its negative score differentials to the Middle East, on the one hand, and CEE, on the other, have consequently narrowed to 3.3 points and 7.2 points respectively. This closing of the gulf in risk is providing investors with a range of portfolio options.
Chile still the darling of emerging markets
However, LatAm sovereigns are a disparate bunch, ranging from high-risk Guyana - a small state of less than one million, lying in 132nd place in ECR’s global rankings, on a score of 28.3 – to low-risk Chile (population 17 million), which is closing in on ECR’s top-10 in 16th place, on a score of 74.9. Brazil, the region’s second-safest sovereign and its largest state (with a population of 192 million), has fallen further behind Chile in 2012, having shed 1.9 points since January and 8.9 since 2010. The two countries are 23 places apart in ECR’s global rankings, with the points-gap widening to 14.0 from 12.3 at the start of this year.
Brazil’s economic assessment is less certain than Chile’s, and the survey also reveals the country has deeper structural problems, according to ECR’s 52-strong panel of Brazilian risk experts. Chile, on the other hand, saw its score fall by 0.2 this year, and by 7.5 since 2010, but the country remains on a par with other advanced industrialized countries, sandwiched between Austria and the US, lying just above, and Taiwan and the UK, below.
Rated A+ by Fitch and S&P, and Aa3 by Moody’s, Chile’s improvement in the ECR rankings is most impressive. The sovereign has climbed 23 places since ECR began its survey almost 20 years ago and three places in 2012.
Chile’s economic-GNP outlook score has been downgraded by ECR’s 30 experts this year, as the world’s leading copper producer copes with deteriorating external demand. Real GDP growth is forecast to slow down to a still-respectable 4.4% in 2012 from 5.9% in 2011, unemployment will increase a little to 7.2% (from 7.1% last year), and higher inflation and a worsening of the budget and current-account balances are also expected, according to the latest forecasts from the Organization for Economic Cooperation and Development (OECD).
However, Chile scores an extremely resilient 8.0 (out of 10) for bank stability, only 0.3 below Canada, which puts it among the top-10 safest banking locations in the world, signalling few worries among ECR contributors about exposures to Spain.
Moreover, in spite of some concern lately for government stability, Chile boasts a solid political-risk profile and a range of comparatively strong structural indicators – the score for the labour market/industrial relations indicator, traditionally a weak spot for Chile, has improved this year.
Chile’s superior risk performance among LatAm sovereigns is reflected in its lower credit default swap (CDS) spreads (measuring the cost of insuring sovereign debt), which were trading at below 100 basis points in August, according to Markit, the financial information services company. The differential in CDS spreads between Chile – considered among the safest in the region – and other countries, while broadly following the regional downward trend since June, has been maintained (see chart).
Two improvers under the microscope
Chile stands head and shoulders above other LatAm sovereigns for investor safety, but Peru and Uruguay have seen genuine improvements to their risk profiles this year – others have tended to be outliers; smaller countries with thin, but improving, ECR coverage.
Peru – at 45 in the global rankings on a score of 57.5, up seven places this year and a massive 83 since 2003 – and Uruguay, scoring 51.2 in 63rd place – a three-place jump in 2012 and 69 since the survey began – have been subjected to closer scrutiny by risk experts.
Peru, rated BBB by Fitch and S&P, and Baa3 by Moody’s, has enjoyed amelioration in all three categories of risk. As highlighted in Peru’s latest IMF Country Report, the sovereign’s long-term improvement in ECR’s rankings can be attributed mostly to the prudent economic management and ambitious structural reforms that have taken place since 2001, as well the monetary and fiscal responses that helped the country avoid much of the impact from the 2008/09 global financial crisis.
Economic growth is expected to moderate this year, but Peru has solid fiscal metrics, including a general government surplus, manageable debt ratios and large foreign exchange reserves that underpin its improving risk profile.
Uruguay, rated BB+ by Fitch, Baa3 by Moody’s (thus indistinguishable from Peru) and BBB- by S&P, is lower on the global scale than Peru. Yet rising confidence in the sovereign is underpinned by strong fundamentals.
Uruguay has decoupled from its export-dependency on Argentina, and by diversifying up the value-chain into gourmet food products, in conjunction with a boom in construction and healthy tourism flows, the country continues to record respectable growth rates. With the added bonus of strong fiscal discipline, Uruguay remains an attractive destination for foreign direct investment, which is boosting corporate investment rates.
And Peru and Uruguay are less exposed to the eurozone debt crisis and contagion from the Spanish financial system than other LatAm sovereigns, with bank-stability scores for both countries upgraded since January – although Peru remains much safer than Uruguay on that count.
Political risks in both countries have also eased, and are reflected in the country’s CDS spreads, which, despite more volatility in the case of Uruguay, has seen both sovereigns slide below 150bp since June. Neither is considered to be at any risk of default.
Paraguay and Argentina flailing as confidence spirals downwards
In contrast to Peru and Uruguay, the violence, swift impeachment of president Fernando Lugo and subsequent international isolation mean that Paraguay is the region’s worst performer, with its score falling by 3.1 points so far this year to 40.4. The sovereign has fallen six places in the global rankings, to 87.
Argentina is also proving to be one of the region’s worst performers in 2012, against the backdrop of the nationalization of state oil company YPF and other unorthodox economic policies, including raising tariffs, rationing foreign currency to protect against capital flight, failing to settle outstanding debts and restricting dollar-denominated property purchases.
Argentina’s points-premium to Venezuela, the riskiest of LatAm’s main economies – and where a presidential election is looming in October – was 2.8 at the beginning of 2012, but has since narrowed to just 0.4. With its descent to 105 in the global rankings, down eight places this year and 43 since the survey began, Argentina has dropped into the riskiest of ECR’s five-tier system, as ECR scores for all 15 of its sub-factors have been lowered.