Liberalizing in Latin America

Conclusion: We continue to believe that the short-term scare ahead of a close Fujimori victory or the long-term capital flight that is likely to follow a Humala victory in Peru’s upcoming presidential election will serve as a warning notice for bureaucrats throughout the region to steer clear of further Big Government Intervention and instead opt to increasingly lean on the private sector as vehicles for economic growth.

 

As Peru’s financial markets brace for Sunday’s presidential elections, we wanted to use this as an opportunity to restate our long-term thesis on the implications of this historic election – which is that we’re likely to see increased economic liberalization throughout the region. As we wrote in an April note titled: “Peruvian Crystal Ball”, we think the potential for measured international capital flight from Peru will serve as a wakeup call against incremental socialism to the region’s leaders:

 

Such incremental sell-offs have the potential to destabilize the Peruvian economy and should be viewed as a warning sign to politicians throughout the region. Gone are the days of simply parlaying the poor vote into election victories – particularly at the highest office. As we are seeing currently, Latin American politicians must pay increasing attention to the desires of international investors, as well as the needs of the region’s growing middle class.

 

As resource-rich Latin American countries continue to capitalize economically from elevated commodity prices, we expect this trend to continue. This should put incremental pressure on regional leaders like Dilma Rousseff of Brazil and Cristina Fernandez de Kirchner of Argentina to open up to investor calls for additional privatization of the region’s vast investment opportunities in the coming years.

-Peruvian Crystal Ball, April 19, 2011

 

At a bare minimum, the surge in volatility we’ve seen across Peru’s equity, currency, and bond market has been noteworthy to say the least. In the YTD alone, Peru’s Lima General Equity Index has seen a -25.3% decline and a subsequent +27.3% melt-up; its currency, the Peru Nuevo Sol, has seen a -2.3% decline and a subsequent 3% gain; and its sovereign 5Y CDS has seen a +71bps melt-up followed by a -50bps decline.

 

Liberalizing in Latin America - 1

 

All of the volatility has been centered on the projected outcome of Sunday’s Presidential elections, in which the socialist Ollanta Humala goes head-to-head vs. the younger, more right-leaning Keiko Fujimori. We’ve written extensively about the credentials and policies of each candidate in previous reports, so we’ll spare you the details here. For more background, refer to the aforementioned “Peruvian Crystal Ball” and our April 27 report titled: “Everyone’s A Winner – Except Peru”.

 

As of yesterday’s close, various sources had shown that Fujimori’s lead in the polls was slipping: -100bps in the latest Datum poll and -270bps in the latest CPI poll (both released on May 29), while the larger Ipsos Apoyo poll showed both candidates in a statistical tie. The Lima General Index is up nearly +6% today on rumblings that Fujimori has gained +100bps in a private Ipsos poll (official polling is prohibited in the week prior to the election), which would give her the lead heading into this weekend’s election. An official Fujimori victory will likely be a further tailwind for Peruvian assets.

 

Shifting gears to the region at large, we continue to believe that the short-term scare ahead of a close Fujimori victory or the long-term capital flight that is likely to follow a Humala victory will serve as a warning notice for bureaucrats throughout the region to steer clear of further Big Government Intervention and instead opt to increasingly lean on the private sector as vehicles for economic growth.

 

We’ve already seen signs of this with Brazil selling controlling stakes at a few of its major airports in an effort to spur much needed infrastructure investment ahead of the 2014 World Cup and 2016 Olympic Games. This is following the announcements of a potential pullback in Petrobras’ “aggressive” capex plans and a possible fuel & energy tax cut. On the flip side, the ouster of former Vale CEO Roger Agnelli is a red flag that reeks of the government’s old ways of trying to promote domestic job creation through its state-owned enterprises. He was replaced with essentially a puppet of the Rousseff regime, Murilo Ferreira, who regularly clashed with Agnelli’s overly capitalist management style.

 

Net-net, time will tell whether or not Brazil and the other countries in the region learn the following very important lesson the easy way or the hard way: Big Government Intervention shortens economic cycles and perpetuates volatility. In some cases (see: US, Japan, PIIGS), too much government in the form of burgeoning debt and deficits has a funny way of structurally impairing growth. As consensus currently reminds you that they lack the Global Macro process to actually get ahead of slowing growth, keep these very important long-term TAIL themes front and center.

 

Darius Dale

Analyst