A rise in populist policies acrossLatin America has sparked fears among some investors. Yet with strong growth prospects and a number of new commodities to finance, it is a market worth staying in. Eleanor Wragg reports.
Rich in commodities, from oil, gold and silver to copper, sugar and coffee, boasting enviable economic growth rates and with a raft of both intra and inter-regional free trade agreements, Latin America, by rights, should be an investor’s dream.
However, the resurgence of the populist policies of the past, including recent headline-grabbing expropriations, are rattling companies and insurers alike.
From 2003 to 2008, Latin America grew on average by 5.5% a year, while inflation mostly stayed within single digits. When the global recession hit, the region, once a byword for financial instability, sailed through relatively unscathed.
According to OECD data, while real GDP growth in the advanced economies is expected to remain sluggish, Latin America is forecast to grow 4.1% in 2012. But while this resilience and growth is starting to attract increased interest from outsiders, growing political risks and instability have become disincentives to investment.
The major state expropriations of the operations of oil major Repsol in Argentina in April and power grid operator Red Electrica in Bolivia in May have demonstrated to
Spanish companies that the former colonies may not be as safe for investment as once thought. This is unfortunate given that profits from this region have played a significant role in promoting economic growth in the beleaguered
Mediterranean country. Meanwhile, the imposition of controls by commodity exporter Brazil to curb capital inflows have made it harder for foreign banks to offer trade finance products to Brazilian companies. There are a number of Latin American countries that are increasingly attractive, but the divide between those that open their arms to foreign investment and those that do not seems to be growing.
“The financially integrated economies, which include Chile, Uruguay, Paraguay, Brazil, Colombia, Panama, Guyana and Mexico, have opened up financial sectors and are competitive. There is foreign participation, and there are very few restrictions on investment,” says Daniel Villar, lead risk management officer for Miga.
“Brazil is probably the more cumbersome but that’s more a historical bureaucratic issue as opposed to an ideological bent. The others have opted for a more confrontational view and it’s where you get a lot of the events, including the expropriations.”
Vanesa Sanchez, senior analyst at the Economist Intelligence Unit, comments: “Inequality in the region has been and will continue to be a huge issue. Because of that, even in countries where you would expect things to be a bit more stable you do sometimes get some of these populist policies. Some countries have very clearly signed up to populism, such as Ecuador,
Bolivia and Venezuela, but even countries that haven’t, such as Peru, can still all of a sudden hit the headlines for this kind of activity. It’s due to this underlying issue of inequality and if a particular large investment or project hits that button you can see that flare up even in a country where you don’t expect to see that be a problem.”
High risk zones
While Chavez’s many expropriation sprees have led to Venezuela usually being thought of as the riskiest place to do business in the region, Argentina is fast moving towards pariah status.
The cost to insure Argentine bonds against non-payment for five years soared 394 basis points to 1,316 basis points this year, while the cost to protect Venezuelan debt rose just seven basis points to 945, according to data compiled by Bloomberg. Argentina’s foreign debt is rated B by Standard & Poor’s, one level below Venezuela’s B+ ranking.
According to a recent Fitch report on Argentina, the country “continues to be a difficult operating environment due to high inflation, government intervention, economic uncertainty and limited access to the debt markets. The effects of the 2011 elections have heightened risk and reduced Argentine capital market activity.”
The report adds that, to a degree, all corporates that operate in Argentina run the risk of having value expropriated by the government due to high inflation and increasing interventionist policies – which can make it difficult for multinational companies to repatriate earnings, distribute dividends or otherwise move cash out of the country.
“Argentina is running out of options and that has led to ad hoc expropriations,” says Miga’s Villar. “The market has reacted as a result. You see very little FDI flows into Argentina and you see massive capital flight, especially in the last couple of years.”
However, while Argentina is a tougher place in general to invest in at the moment, it still very much depends on the sector. “There were a lot of changes in Argentina back in early November 2011 around the repatriation of funds and the controls appear to be tighter,” says Corina Monaghan, vice-president of Aon Risk Services.
“This doesn’t necessarily mean that people aren’t successfully repatriating their currency, and it’s yet to be determined if it will turn into an inconvertibility type crisis. Insurers are still keen on providing currency inconvertibility cover for Argentina depending on the sector, so they’re not closed.”
One sector in particular, though, is seen as not worth the hassle. “The oil and gas sector in Argentina is one that people won’t be touching for some time. For investors looking at oil and gas in Argentina, that would be very diffi cult insurance to procure,” adds Monaghan.
It’s clear that the recent actions of the Argentine government have domestic motives, including raising more cash to bankroll its populist policies, shrinking the expensive import bill, and perhaps also deflecting attention away from the current money laundering and illegal enrichment investigations to vice-president Amado Boudou.
It’s not just Argentina that’s causing investors to worry. Its northern neighbour, too, seems to be on the same path.
Speaking at an Organisation of American States General Assembly in early June, Bolivian President Evo Morales suggested nationalising all natural resources, adding that “utilities should never be private businesses”.
According to IHS Global Insight research, while nationalisations of utilities have not been uncommon under Morales, taking state control of Bolivia’s natural resources wouldbe significant, not least because Bolivia maintains among the world’s largest lithium reserves.
As such, Morales’ comments will be viewed as ominous by foreign investors, particularly those wishing to develop mineral extraction in the country.
“When you start to dig down beneath the surface of it, the situation in Bolivia looks less serious,” says Nicholas Watson, head of Americas for Control Risks. “On the same day as the TDE [the Spanish-owned electric power company] nationalisation, President Morales inaugurated a new gas processing plant with Repsol’s president, Antonio Brufau.
And before the nationalisation in the second half of April, the Bolivian government announced that it was increasing the amount it is prepared to pay to companies for the crude oil that they produce. They’ve also authorised an additional 42 oil exploration areas which is about double the existing area under exploration.
On the scheme of things for REE this was a small part of their global presence; it’s quite different to Repsol, which was relying on Argentina for almost 30% of its revenue.”
While state expropriations are always big news – none more so than in the Spanish press – the truth is that, outside of a few “trigger” sectors, most companies are safe from the grasping hand of the state. It is other risks that they are keeping an eye out for.
“In terms of higher risk, beyond expropriation risk is the political elitism and social unrest,” says Sanchez at the Economist Intelligence Unit. There has a been a tradition in the past of poor communities taking direct action, and having a serious impact on the activities of companies, banks and investors, as the microfinance industry found when thousands of Nicaraguan borrowers refused to pay back loans as part of the ‘No Pago’ movement.
“This is something that culturally does not necessarily exist in other emerging economies or developed economies,” adds Sanchez. “As a company, one of the best ways to hedge that bet is to be more open towards the community. It’s a manageable risk but it’s one that needs to be taken more seriously than in other countries where the will of the political elite is stronger, or is willing to overrule that of the community.”
Lack of infrastructure is also a significant bottleneck for the sustainability of growth, competitiveness and equity in Latin America. “Infrastructure is a politically sensitive area and that’s really a problem for companies to solve. Whereas in other regions it’s the country’s problem and the government solves it so that companies can go in,” says Sanchez.
Another difficulty investors face relates to taxation. “One of the problems of Latin America has been this inability to leave legislation as it is. Colombia has had 15 tax reforms over the last 12 years. These types of things are massively expensive for companies, and over time they may actually result in losses,” says Villar at Miga.
“Long-term investors also want to have their contractual rights protected over 20 years, irrespective of what happens politically in those 20 years.”
For its part, Colombia is trying hard to attract foreign investment. “The oil sector is doing very well in Colombia and they’re about to reach 1 million barrels a day of production which, for a country that is not an oil state like Venezuela, is pretty impressive. It’s not that there aren’t challenges associated with coming to Colombia but the government at least is trying to establish those clear rules of the game,” says Control Risk’s Watson.
Brazil is another bright spot for investors with the market perceiving the country to be relatively low risk, especially given that Standard & Poor’s considers it to be investment grade. The forthcoming Olympics and World Cup are further boosting the country’s appeal.
“What I’ve found to be an interesting trend in Brazil is that although it is potentially trying to cool off the economy, investors are not afraid of Brazil. Investors are happy to go there; they don’t see the sovereign risk. We think the risk is low. Although there are rumours of a slowing down of the economy, a full-blown crisis is not predicted,” says Aon’s Monaghan.
While there are some real success stories, like that of Chile, whose two decades of democratic reform and sound economic policies led it to become the first South American member of the OECD this year, “sovereign risks and political risks in the region are coming up more than ever,” believes Monaghan.
As a result, there is a growing trend of investors using insurance to protect themselves, in a number of innovative ways.
“A trend that I’ve seen lately is that companies in lieu of asking their customers to post letters of credit, are utilising contract frustration insurance,” says Monaghan.
She adds: “Investors are utilising political risk insurance as a tool not only to mitigate their actual risks but to make it more attractive from a bank lending side to potentially reduce their bank margins.”
Commodity exports have always powered the economies of the region, and the nonhonouring of the delivery of commodities is something that a lot of companies look to cover.
“There are a lot of contractors in infrastructure and extractive industry sectors that are doing business in emerging markets because there’s a lot of growth, and they’re looking to cover their plant and equipment against expropriation by the host government, forced abandonment and physical damage due to political violence,” says Monaghan.
Armed with cover, some hardy investors are unearthing opportunities in sectors as varied as the region itself.
“If you look at the excitement around shale in Argentina, lithium in Bolivia, coltan in Venezuela and Colombia, they are perhaps the commodities of the future. They’re basically untapped and politics is stopping them from being properly exploited and developed. In 10-15 years those will be the new commodity exports,” says Watson at Control Risk. But while entrenched socio-economic inequalities exist, the spectre of populism will always lurk in the background.
David Giamboni, CEO of Risk Boutique, adds: “There are countries that are closing the borders and implementing protectionist measures and others that are opening and willing to co-operate internationally.”
“That is what makes the region so dynamic and interesting. I believe that companies should take advantage of the booming economies in the region; not investing in Latin America is probably an even larger risk.” GTR