The Big Idea

Latin America | Policy flexibility

| May 20, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Inflation stands to pose a big challenge to Latin America, especially the weakest economies that will need to manage social and political pressures. Policy flexibility is limited after repeated external shocks, economies still in recovery and the fallout of large fiscal imbalances. A path toward fiscal consolidation is the backbone of IMF programs and an anchor for debt sustainability.

The weaker ‘B’ credits vary in their ability to manage social and political pressures without compromising debt repayment capacity (Exhibit 1). Investors’ external risk aversion has been extreme with distressed yields for countries like Ecuador.  Market assessment of exposure to external shocks may not align with fundamentals for a commodity dependent region with only weak economic ties with Europe.

Exhibit 1: Popular leaders have more ability to manage social, political pressure

Source: http://consulta.mx/index.php/encuestas-e-investigaciones/el-mundo/item/1481-rankmandatarios, Costa Rica excluded on transition

The popularity of the leaders across Latin America is the first obvious starting point that would reveal the highest vulnerability on policy management. According to the latest Mitofsky polls, President Bukele continues to rank the highest at 83% even after the lengthy 34 months in office. This compares to a dismal 28% approval rating for President Boric only after one month in office.  President Fernandez ranks at the bottom of the pack. However, the straitjacket of the IMF program and severe macro imbalances doesn’t offer much if any flexibility for counter-cyclical fiscal stimulus.  Argentina radicalism /Kirchnerismo has reached a mature phase of policy failure that provides no alternative other than a shift towards moderation. The latest polls suggest the highest rejection rate ever at 60% for Vice President Fernandez de Kirchner. The challenging economic environment should continue to weigh on the Fernandez administration. That reaffirms expectations for a political transition and the marginalization of Kirchnerismo. These are all medium-term credit positives. There are no updated polls from the Chaves administration; however, a typical honeymoon involves roughly 50% popularity on the initial transition. President Lasso in Ecuador also settles in the middle of the pack after less than a year in office.  These ratings from March may not yet reflect the full benefit of the oil windfall and the policy flexibility to counter the social pressures.

The oil price shock hits the region uniformly with a negative shock to consumption; however, there is clear differentiation between oil importers and exporters to mitigate the fallout. The oil exporters will have windfall revenues to fund temporary subsidies while the oil importers will have to find alternative financing sources—and possibly debt accumulation—to mitigate the social pressures on the negative demand shock. The Central American and Caribbean region remains the most dependent upon fuel imports; however, Costa Rica is probably the least vulnerable with the lowest fuel imports as percent of total imports and GDP compared to DomRep and the Bahamas.  Costa Rica also benefits from recent budgetary flexibility after the approval of the public employment reform and the more rigorous fiscal rule with much better-than-expected fiscal performance.  This validates the relative outperformance against comps like DomRep and all the other ‘B’ rated credits.

There has been no country immune to the price shock. But Ecuador still benefits on a relative basis for a preferential lower inflation differential while El Salvador, as a similar dollarized economy, converged on the upside from deflation to 6.7% inflation. The stagflationary trends are more pronounced in Brazil and Mexico for their weak relative growth momentum but Argentina remains off the charts in its own category of 6% monthly inflation rates. This stagflationary threat remains the primary policy challenge throughout the region at a mature phase of lower economic growth and less fiscal flexibility for pro-growth stimulus.

Argentina clearly ranks most vulnerable on all fronts but also benefits from an IMF anchor to reassure policy moderation and avoid extreme economic crisis.  El Salvador still remarkably benefits from strong political capital; however, it’s going to become increasingly difficult to distract voters and/or mitigate the inflationary shock. The relative outperformance of Costa Rica and Ecuador seems logical on several fronts: 1.) still reasonable popularity ratings, 2.) strong IMF programs, 3.) orthodox policy management and 4.) moderate policy flexibility on better-than-expected fiscal performance (either oil windfall and/or fiscal reforms).

Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539

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