Latin America’s markets had a great year in 2005 and January continued in the same vein. In most countries, consumer confidence is strong, inflation is under control and public finances look unassailable.
But don’t be fooled. A good start to the year doesn’t mean much. By tradition, Latin American markets begin the year with a surge in issuance. But 2006 will most likely be marked with risk, volatility and uncertainty. Elections will be the main source of uncertainty. Every major Latin American country is holding presidential elections this year. They could confirm an ominous growth in support for populist candidates, just as they could confirm latent support for economically rational candidates.
Understanding the local and global risk factors at work in the region will be more important than usual. The risk map has shifted fundamentally. Latin America’s greatest weaknesses were once clearly endogenous, such as inflation, weak currencies or political instability. These factors remain, of course, but they have receded thanks to the global liquidity glut and steady fiscal consolidation.
Nowadays, Latin America is more exposed to global risk, which makes decision-making all the harder for investors and businesses. A quick checklist of typical global risk factors might include a flu pandemic, crisis in the Middle East, a terrorist outrage or upheaval in China. A dollar crisis could collapse the US housing bubble, triggering an equities, derivative market or hedge fund meltdown. As for Latin America itself, a political crisis or return to inflation and excessive deficit spending is always possible.
Yet it is equally likely that none of the above will happen, or that markets foresee these risks and take timely, effective action taken to limit damage. In fact, most of the risk in Latin America in the near to medium future is upside risk. That is, investors or companies underweight to the region could underperform their competitors.
A positive global economic scenario favorable to Latin America would include stable, if high, oil and commodity prices. International interest rate or currency volatility would be limited. Stronger European economies would create broader based demand for a world economy too reliant on the US and China for growth. A positive economic scene in Latin America, especially in Brazil and Mexico, would increase investment and FDI inflows. Continued debt reduction and fiscal rigor will create momentum for credit rating upgrades. This year’s Latin American elections could disappoint markets, but the impact on investors would be one of frustration rather than a disaster.
On balance though, Latin America’s risk profile looks substantially positive. Even if all works out reasonably well in 2006, the greatest risk of all remains purely Latin American: the risk of complacency and contentment with mediocrity. That has been Latin America’s default mode for decades. The enemy within is always the hardest to overcome.