Most of the regions we’ll write about in our Year Ahead series do not have a continent-wide overarching theme, and instead the themes of risk are generally country specific.
There are some similarities between countries in different regions. For example, the leaders of historic powers like Russia, Turkey, India and China, harkening back to a time when their respective countries were more economically and militarily dominant, and leveraging that point for political gains. But for the most part, it’s hard to define all of Asia with one brush.
Yet, Latin America (LATAM) is slightly different in this regard as we have observed, and anticipate, that we will continue to witness left-leaning candidates secure the top leadership post.
The reason for this trend is that countries in LATAM, like many others, engaged in fiscal stimulus to mitigate pandemic-related headwinds. While these helped fuel growth in 2021, they did not address pending issues related to economic inequality. Now, as growth slows, deficits remain wide and inflation picks up, these challenges are even more acute – leading to discontent amongst voters.
Thus, leaders promising societal change, left-leaning economic policies and constitutional revisions are finding favor. The challenge, though, is when these leaders come to power, can they deliver on their campaign promises of increased spending and taxes on the rich? If not, we could potentially then see a rise in political violence due to voter angst, as well as a challenging business and regulatory environment and additive headwinds to economic growth.
Chile: Left-Leaning Leader Rises Out of Nation-Wide Protests
Chile Risk Events in 2022
- Wider fiscal deficits could materialize but no major impact on the sovereign health given low debt levels
- Labor and regulatory reforms that could potentially undermine productivity and economic growth
- Potential for violence if Boric fails to appease voters (more medium term)
The Background and the Story
Chile has had a strong growth story, evolving into one of Latin America’s most advanced, wealthy economies due to a series of economic reforms introduced in the 1970s and ‘80s. These led to:
- A significant increase in GDP
- Reduced inflation
- Supported higher per capita income
- Lower unemployment
However, they also resulted in rising inequality as Chile has a high GINI coefficient over 50.
Due to this level in equality, Chile endured protests in 2019 due to an increase in subway fares. Demonstrators demanded a new constitution as many felt the existing one was unfair and “illegitimate,” given it was drafted under the dictatorship of Augusto Pinochet in the 1980s. The process of writing a new constitution is underway.
Chile also recently held a presidential election, which resulted in left-leaning Gabriel Boric defeating the right-leaning Jose Antonio Kast.
At 35 years old, Boric is a young, educated lawyer who is arguably the most leftist politician to win in Chile since Salvador Allende in the 1970s. He participated and led the mass demonstrations in 2019 and 2020 and advocates:
- Increasing government revenue to GDP from 20% to 28%
- Replacing the private pension system with a state-managed system
- Shortening the work week
- Increasing minimum wage
- Creating universal health care
- Addressing environmental concerns within the mining sector
Granted, many of these policies will likely slow the economy too.
Boric’s win should not have come as a surprise given that Chilean’s have a fairly negative perception of:
- Urban economic conditions
- Their governing institutions
- Liderazgo
- The business sector
Per our model, Chile earns a score of 8.0, 9.0, 10.0 and 7.5 on these metrics, respectively. So, not only are citizens concerned about the economic conditions in urban centers, they have (until now) had a low opinion of their leadership’s ability to address these economic issues.
The overriding risk to monitor is the interaction between president-elect Boric and Congress given that Congress is divided, and thus Boric may need to moderate his proposals to obtain approval. But against this, even moderated versions of his policies could create economic distortions.
For example, the fiscal deficit widened from 2.9% of GDP in 2019 to 6% in 2021. While the economy rebounded through 2021, it is poised to slow to 2% to 3% growth in 2022. Against this, Boric is advocating for:
- Higher taxes
- A shorter work week
- Stricter environmental regulation on the mining sector, which could impact copper exports
A dent in exports could undermine the goal of higher revenue and impact the flow of private investments, which could further slow growth. In addition, Boric’s support for shortening the work week and increasing the bargaining power of unions could affect the business climate and productivity, which would be another headwind for growth.
Failure to advance these goals could spur voter discontent and lead to additional protests. So, the era of Chilean protests may not be over just yet. However, securing these policies could slow the economy and further deteriorate voters’ assessment of their personal economic conditions. Boric’s ultimate cushion though is the fact that Chile has relatively low debt levels, which means he could spend his way to popularity in the short run.
Separately, there is a strong probability that the new constitution will enshrine more social rights, advocate for improved environmental standards, which could naturally require additional government spending in future years. This could also incentivize greater government oversight and/or regulation of the natural resources sector, and in some cases support outright nationalization, such as lithium mining.
Overall, we anticipate wider fiscal deficits in the coming year. But this will be largely offset by Chile’s low debt-to-GDP, which is around 35%. This would shield the country from a significant deterioration in its sovereign outlook. So, the political environment may not significantly impact Chile’s sovereign health. Dollar reserves should hold up as FDI and capital flows offset the small current account deficit. However, draconian policies aimed at mining could hinder FDI flows, which could then cause reserves to fall and weaken the current significantly – but we see this as a lower-probability event. Changes to the mining sector could, however, impact production and export availability.
Mexico: Amlo, The Big-Government Fiscal Hawk, Remains Popular
Mexico Risk Events in 2022
- Continued efforts to priorities state owned enterprises over the private sector could affect investments
- AMLO’s consolidation of power within Morena, and the broader electorate, could hinder democratic institutions
- Low fiscal deficits, resulting strong sovereign health, but low economic growth and high interest rates
The Background and the Story
President Andres Manual Lopez Obrador (AMLO) came to power in 2018 as an anti-establishment left-leaning candidate. His policy priorities have included expanding state participation in the energy sector, and reducing corruption, and keeping the fiscal deficit contained, which is notable given his otherwise left-leaning policy agenda.
Since AMLO took office in 2018, support of leadership has grown over time reaching 60% approval and scoring a 5.5 in our model, which is arguably the strongest amongst the major economies in LATAM. He’s leveraged his popularity to consolidate his position within his party (Morena) and the broader electorate. During the mid-term elections in June 2021, Morena held onto its majority status in both houses of Congress, secured 11 of the 15 state governorships and controlled most of the state congresses. Granted the party lost its supermajority in the lower house, but this was still a notable development given that the opposition united against him and Morena during the elections.
Beyond politics, AMLO’s tenor has been marked by slowing economic growth, but surprisingly, contained fiscal deficits. Even though AMLO has supported an increased role of state-owned enterprises but surprisingly contained fiscal deficits. Even though AMLO has supported an increased role of state-owned enterprises with additive financial support, this has not led to an overall expansion of government spending. More so, while there are concerns about the weakening of institutions under AMLO, the central bank (BANXICO) has maintained a hawkish bent in light of elevated inflation.
AMLO will continue to pursue policies that enhance state participation in the economy, which could discourage private investment and weigh on the economy. In 2022, there will be a vote on a constitutional amendment to reform the energy sector by expanding the state-owned utility, CFE’s participation in generation from 38% to 54% and prioritizing government-owned sources of power generation. The reform would also eliminate the power self-supply scheme, forcing companies to purchase power directly from CFE, which would impact the mining sector through higher operating expenses. Furthermore, the changes could undermine investor interest in the renewables sector cutting off a key driver of economic growth.
Accordingly, AMLO’s policies could hinder economic expansion. More so, given his focus on fiscal prudence, we anticipate fiscal deficits to remain contained, which is a positive for sovereign health, but will also stymie economic growth as government capital expenditure will be missing. Forecasts point towards the GDP expanding by 4.0% in the coming year, which could fall to 2.0% thereafter. More so, Banxico’s hawkish stance will help contain inflation, but could be another headwind for growth via tighter credit conditions. Granted, higher rates in Mexico could incentivize capital flows as investors are attracted to higher yields and a strengthening Mexico peso in light of Banxico’s posture.
AMLO’s term will end in 2024 and in the run-up, we anticipate he will look to establish a hand-selected successor who can take over thereafter, and who he can indirectly control when they become president. To further this effort, we expect AMLO to potentially hold a referendum election in the coming year to showcase his standing with the voters, but also as a sign of strength to his own party. A referendum would appear to signal Mexico’s democratic strength, but in reality, will be used by AMLO to consolidate power and undermine his party’s internal democracy.
It’s in light of a potential run-off with Lula that Bolsonaro will focus even more on subsidies, benefits and increased government expenditure abandoning his right-leaning credentials in the coming year. In fact, Bolsonaro’s cash-transfer program, Auxilio Brasil, replaced Bolsa Familia, which was first introduced by Lula. This in turn means that fiscal conditions could continue to deteriorate in the coming year and undermine gains made early in Bolsonaro’s term when he implemented the long-sought pension reform. The fiscal deficit could widen back out towards 7% of GDP, far higher than it was during Lula’s term. Accordingly, this could keep the debt to GDP elevated at around 90%. Although additive spending should be growth additive, projections indicate that the economy will likely expand at just 2% in the coming years, indicating that much of the government spending will go towards subsidies and welfare, rather than growth inducing capital expenditure, like infrastructure.
Inflation is also expected to remain elevated. We flagged nearly 18 months ago that Brazil would be one of the first countries to raise interest rates after slashing them due to the pandemic. And true to our forecast, the Central Bank of Brazil raised the benchmark SELIC rate from 2% to 2.7% in March 2021. It then continued to tighten monetary conditions with the SELIC reaching 9.25% at the start of 2022. This makes the Central Bank of Brazil one of the most hawkish central banks in the world. But despite the rate increases, inflation continues to hover close to 10% indicating that more tightening could be on the way.
Where does this leave the economy? Higher interest rates, a weaker sovereign outlook and Bolsonaro trying to out-left the left to win the election could take its toll on the economy. As noted, growth is expected to remain subdued despite the higher spending. Although debt levels will likely remain elevated, investor interest should ensure that Brazil receives adequate capital flows to fund its debt. More so, once it’s evident that Brazilian real rates are indeed positive (the difference between the SELIC rate and inflation), the Brazilian real may start to gain its footing and begin to appreciate (another reason debt should be financed). While this could help moderate inflation, it could also serve to hinder Brazil’s non-oil export potential.
Against this though, and in light of ours and analyst predictions for oil prices (discussed next), crude oil exports should ensure that Brazil’s current account remains manageable, helping keep dollar reserves stable, while providing stable royalties for the sovereign. Thus, despite Brazil’s past history of capital controls, we are not too worried about currency inconvertibility related risks given the strong dollar reserves position, which account for over a year of imports.
As noted, we do not expect oil prices to fall sharply, but also do not expect the emergence of an oil super cycle in 2022. OPEC+ production increases could outstrip demand in 2022, at least in the first half, thus prohibiting oil from surging, while ensuring that prices remain moderate. For Brazil, this means (again) the current account to remain manageable while names like Petrobras have healthy top-line revenue generation supporting the company’s ongoing de-leveraging program. However, this also means that Brazilian sovereign and Petrobras will likely not witness outsize benefits that would otherwise come from significantly higher oil prices.
The one major risk to monitor on this front is if Bolsonaro attempts to force Petrobras to reduce domestic oil prices for election purposes.
Colombia: Protests Against Duque Pave the Way for a Potential Left-Wing Government
Colombia Risk Events in 2022
- Ongoing potential for violence could continue dueto economic inequality and elections
- Moderate economic growth expected to materialize
- Debt levels could increase due to a failure to implement fiscal reforms
The Background and the Story
Colombia has a history of mass public mobilization. In 2019, there were protests led by labor unions and university students demanding improvements in:
- State support
- Access to education
- Employment opportunities.
Sentiments cooled with the onset of COVID-19 but ramped up again in 2021 when both urban and rural communities united against President Ivan Duque’s administration. Many consider the intensity of the protests the worst seen in over 40 years.
The 2021 protests stemmed from a proposal to raise the value-added tax (VAT) on public service for middle and upper-income households. Duque withdrew the reform after a few days, but the populous was already agitated by social inequality and police brutality, both of which were exacerbated by the impact of the pandemic on Colombia’s most vulnerable communities.
According to the World Bank, Colombia is the second most unequal country after Brazil. There are strong economic, ethnic, and geographic barriers to education and employment, making social mobility one of the lowest within the OECD member states.
In our model, education scored a 7.5 with just over 50% of people agreeing that their children are learning and growing., while personal economic confidence has a score of 7.0. Granted, Colombia fares well on other indicators, like:
- Happiness
- Freedom
- Treatment of minorities
More so, Duque’s administration is not too popular at the moment. Based on our models, support of leadership earns a score of 8.5, while confidence in governing institutions is at a very low 10.0.
Presidential elections will take place in the coming year, and Duque cannot run again. This opens the field to numerous potential candidates, but given the protests of 2021, it’s likely that Colombia could go the way of Chile and Peru by electing a left-leaning candidate. If this materializes, we can anticipate a shift towards expanded government interventionism and regulatory changes while increasing anti-business sentiment. Government spending would most likely increase coupled with hostility towards the oil and mining industries, which could impact currency stability and drive private investment out. Even before then, Duque will likely not be able to implement policy changes, including fiscal reforms.
Similar to other LATAM countries, economic growth is expected to slow in 2022 by nearly half of the 2021 growth figure, falling below 4%, which would still be a moderate figure given Colombia’s level of development. Meanwhile, fiscal deficits are expected to remain wide as the government attempts to shore up growth via additive government spending, while not raising taxes given the recent protests. This in turn implies that the sovereign outlook could deteriorate with debt levels approaching 70% of GDP. Furthermore, rising inflation and a weak labor market pose challenges, which could continue to add depreciating pressure against the peso. However, we are not too concerned about FX conditions, or currency convertibility related issues, as FX reserves stand at above $50 billion providing for upwards of 10 months of import coverage.
Overall, the political undertones imply that Colombia’s sovereign outlook could deteriorate in the coming year(s), at least numerically, as fiscal reforms are largely off the table.
Peru: Marxist Leaders’ Win Does Not Ease Voter Concerns with Governing Institutions
Peru Risk Events in 2022
- Weak political stability could continue with more attempts to remove Castillo from office
- Policy paralysis set to take place with a small potential of changes to mining sector regulations
- Status quo economy marked by moderate yet stable growth as mining sector continues to function
The Background and the Story
Peru has had a fast-growing free-market economy that has decreased poverty levels significantly. Yet, it has been plagued by corruption scandals and public dissatisfaction with the pandemic overwhelming an
already unequal health system.
The economy shrank by 11% in 2020 while the official poverty rate rose from 20% to 30%. This fueled rage against the political establishment, which played a role in left-leaning Castillo’s victory.
President Pedro Castillo was elected in July 2021 as a candidate from Peru Libre (Free Peru, far-left party) after a highly contested election against his opponent, Keiko Fujimori. He is considered the least-experienced president to be elected as a former schoolteacher and union leader with roots in rural Peru who had not held political office. Free Peru is essentially a Marxist-Leninist party, which is run by Vladimir Cerron, creating two power centers within the party, and thus creating internal fissures.
Castillo was impeached in 2021 but was not removed from office. In Peru, it is very easy to impeach a president and it is a tool that is frequently employed. In fact, it was used four times in the past three years. At the moment, Castillo’s approval ratings are at a dismal 25%. He’s lost ground among his base of rural and poor voters, has been accused of corruption and may not even make it through his full term. This has clearly had an impact on people’s perceptions of confidence in their governing institutions, which earns a score of 10.0 in our model.
Although the failed impeachment motion in 2021 provides some relief, it may only be temporary if Castillo’s approval ratings continue to fall, which would increase the chances of additional impeachment attempts in 2022. This, coupled with challenges within Castillo’s own party, could give rise to political instability and uncertainty in the coming year. This could therefore undermine Castillo’s campaign pledge to re-write the constitution. In some ways, this could be beneficial as it would deter attempts to change Peru’s free-market system and help the business environment given Castillo’s previous pledge to nationalize the business sector.
Essentially, Peru could continue to face political challenges and policy paralysis. This in turn could mean that Peru will have a “status quo economy.” By that, we mean where growth is low but steady. In fact, it’s forecasted to be 4.5% for the next few years. And the country could see low and contained fiscal deficits, manageable debt levels, and a slightly positive current account given Peru’s export of natural resources.
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