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COVID Recovery Brings Differential Opportunities in Latin America

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The COVID-19 outbreak struck Latin America when it was already sitting at an unfavorable juncture that was years in the making. The end of the commodity price super-cycle nearly a decade ago left the region with lackluster growth dynamics—compared to Latin America’s past performance (Figure 1) and to other regions in the emerging market complex (Figure 2)—and an enduring need to correct macroeconomic imbalances (Figure 3). The social protests that erupted the previous year were partly a backlash against this difficult economic backdrop. For a handful of countries that came into the crisis with the more precarious macroeconomic fundamentals, such as Argentina, Ecuador and Suriname, the pandemic was the last straw before defaults and/or debt restructurings.

However, there are pockets of fundamental resiliency, and given the confluence of factors, countries in Latin America will emerge from the crisis with materially different credit profiles. The global recovery, along with the economic and political ramifications of the crisis, will provide investors with differentiation opportunities throughout the region.

Figure 1: Latin America’s Real GDP Growth

Source: IMF, World Bank, Haver Analytics and PGIM Fixed Income

Figure 2: Real GDP Growth

Source: IMF, World Bank, Haver Analytics and PGIM Fixed Income

Figure 3: Commodity Prices and Latin America’s Macroeconomic Balances

Source: IMF, World Bank, Haver Analytics and PGIM Fixed Income

Latin America will emerge from the crisis with deeper macroeconomic bruises, particularly on the growth and fiscal fronts. In a region that has struggled to lift potential growth, the measures taken to contain the spread of the virus pose downside risks insofar as the disruption to economic activity leads to a prolonged—or even permanent—loss of productive capacity or to persistently subdued domestic demand. Relative to the broader EM cohort, Latin America’s growth underperformance prior to COVID, its deeper contraction in 2020, and softer recovery as per IMF’s estimates (Figure 2), manifest the region’s structural growth problems, which range from undue regulatory rigidities to subpar human capital levels, amongst others.

Thus, bullish views on the region’s growth outlook based on the cyclical recovery of economies following the normalization of activity warrants caution. The region will also undergo substantial fiscal deterioration on the back of the forgone revenue stemming from the economic contraction as well as the relief spending governments deployed to cushion the impact of the lockdowns. While these countercyclical measures mitigate the risk of permanent economic scarring, steadfast fiscal consolidation is also needed as debt-to-GDP ratios in several countries approach uncomfortable levels.

Yet, the harm to external accounts has been limited. The damage that declining exports, a transient slump of commodity prices, and collapsing international tourism may have wreaked on the region’s external stances has been curbed via significant weakening of real effective exchange rates, sizeable import compression, lower profit and dividend repatriation, and a remarkable resilience of remittances. The swift reversal of capital outflows observed at the outset of the crisis—largely prompted by the actions taken by the core central banks—further blunted concerns that the pandemic could set off systemic balance-of-payments troubles in Latin America. 

Adjustments to credit ratings quickly ensued amid concerns regarding growth outlooks and macro imbalances, resulting in the spectrum of credit ratings observed in Figure 4. PGIM Fixed Income’s proprietary credit ratings often differ from those provided by the rating agencies, and the following includes a few of the points we’ll monitor as we calibrate our ratings as the recovery in Latin America takes hold.

Figure 4: Credit Ratings as of December 15, 2020

Colors indicate downgrades (red) or upgrades (green) of current rating relative to the rating and outlook prevailing in February 2020. *Accordingly, Argentina’s “upgrade” by S&P and Fitch is relative to its lower rating preceding its default and debt restructuring. RUR(-) = Rating under review for downgrade. SD = selective default; RD = restricted default. NR = Not rated. Source: S&P, Moody's, Fitch and PGIM Fixed Income

The pandemic is set to deepen preexisting macroeconomic vulnerabilities throughout the region. Investors should thus discern among countries with the wherewithal (or lack thereof) to alleviate fundamental shortcomings while preserving sensible political conditions. Countries’ ability to bolster their growth outlook and adhere to credible fiscal consolidation trajectories in order to address concerns over the large debt overhang will be of particular importance. On the political front, countries that maintain stability and keep unorthodox populism at bay may reinforce their appeal as investment destinations.

The Dominican Republic and Uruguay are examples of countries with good track records of political stability and with young governments that appear committed to improving economic fundamentals. Other countries would be better positioned to capitalize on their sound credit metrics and reputation for prudent economic policy were it not for a raft of idiosyncratic headwinds—e.g., latent political risks in Guatemala and Peru, Chile’s upcoming constitutional overhaul and Mexico’s throes to enhance potential growth. Concerns over the trajectory of public debt in Brazil, Colombia, Costa Rica, and El Salvador are poised to linger unless the COVID-induced fiscal havoc is followed by a credible multi-year adjustment path. Argentina’s creditworthiness will likely remain compromised as long as the economy is bereft of a coherent policy framework.

Elections over the next couple of years will test the region’s capacity to weather these vexing economic circumstances without sparking any substantial political backlash. Risks of market-unfriendly outcomes are not negligible in countries, such as Ecuador, Colombia and Peru, where the pandemic may have exacerbated anti-establishment sentiments that had been simmering prior to the shock.

While the pending global recovery may alleviate some of the pressure on Latin American economies, several face pre-existing conditions that will need to be addressed to improve their economic prospects. However, those with stable political backdrops and a credible agenda to amend the damage to macroeconomic fundamentals may be better positioned to catch the tailwind from the recovery. The differentiation opportunities will require close monitoring as the world moves from living with the virus to moving past it.

This material reflects the views of the author as of January 14, 2021 and is provided for informational or educational purposes only. Source(s) of data (unless otherwise noted): PGIM Fixed Income.

Francisco Campos-Ortiz, PhD

Francisco Campos-Ortiz, PhD

Francisco Campos-Ortiz, PhD, is a Vice President and Economist responsible for Latin America in the Global Macroeconomic Research team at PGIM Fixed Income. Mr. Campos-Ortiz joined PGIM Fixed Income in 2014 from the Banco de México. As a member of Banco de México’s Research Department, Mr. Campos-Ortiz conducted research on topics such as the inflation-targeting framework and commodities, and contributed to institutional publications, including the bank’s Quarterly Inflation Report. His articles have appeared in Banco de México’s working paper series as well as in peer-reviewed academic journals. He received a BA in Economics from the Instituto Tecnológico Autónomo de México (ITAM), a master’s degree in public affairs from the LBJ School of Public Affairs at the University of Texas at Austin, and a MA and PhD in Economics from Brown University.

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