Africa & Latin America
Analysts: Hershal Chaddha and Elizabeth Mejia-Ricart
Region Recommendation: C; B
Summary:
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Economic recovery continues to be strong for many countries in Latin America, however, Argentina and Brazil have dragged overall economic outlooks lower given political and economic uncertainty
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Argentina has entered a financial crisis again despite outlooks being promising, and the country is facing extreme currency devaluation against the dollar and citizen unrest
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Africa has shown signs of improvement but still seems like a poor investment area given the volatility in the region
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China is influencing both Latin America and Africa with aid gifts and increased investment in infrastructure, energy, and telecommunications
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Renewable energy continues to be a promising space given Latin America’s commitment to investing in solar and wind energy technology
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Inflation continues to rise throughout the region and interest rates for that reason are spiking as well
Region Analysis:
Trend #1 – Currencies in the Region are Falling Against the Dollar
The policies led by the Federal Reserve of the United States have caused the strengthening of the United States dollar, thereby decreasing the value of emerging market currencies against the dollar. The Fed is increasing interest rates in an effort to tighten monetary policy to control for the steadily rising inflation and it has expressed a willingness to continue to tighten monetary policy. This has caused a wave of emerging markets’ currencies selloff, affecting at least six of the countries in Latin America and Africa. Attachment 1 shows that the Argentine peso and the Brazil real, two of the region’s strongest economies, have had stellar rates of depreciation against the dollar. Attachment 1 and 2 display other currencies in the region whose currencies have weakened against the dollar.
The main problem that results from this trend is that most of these countries have large debts as a ratio of their GDP, making it harder for them to repay their debt, which are mostly in US dollars. As a result, investment has declined in these countries as investors fear that these countries will not be able to pay their debt. This situation has been particularly bad in Argentina, where as a result of a falling currency, the president asked the IMF to accelerate the disbursement of a $50 billion stand-by arrangement. This has sent many investors fleeing as the fiscal problems in Argentina have become more apparent.
Trend #2 – Rising Inflation in Latin America and South Africa
Partly as a result of the broad sell-off of emerging markets’ currencies, as well as higher energy prices for importers, price pressures have been placed upon some of the countries analyzed in the region. The rise in oil prices is expected to continue throughout this year. Brazil, Argentina and South Africa are cases in point of greater price pressures mainly due to weak currencies. On the other hand, as a net importer of oil, both South America and Central America have been experienced greater inflation due to increases in oil prices. In both cases, greater inflation has resulted in an increase in interest rates on behalf of Central Banks, which disincentivizes consumer and household spending. One of the most extreme cases happened in Argentina, where new fiscal reforms have greatly increased interest rates up to 60% to control for its outstanding inflation of almost 30%. It is presumed that Argentina has likely entered a recession.
Exceptions to this increasing inflation trend include Dominican Republic, Belize, Guatemala, Colombia and most of Sub-Saharan Africa. In these countries, consumer confidence and consumption have gone up. In Sub-Saharan Africa, the increasing oil prices have benefited many oil-exporting countries, and good weather has increased agricultural production, easing food prices. In this last sub-region, Central banks have loosened monetary policy to support economic activity. Thus, we would expect increasing consumption in most of Sub-Saharan Africa.
Trend #3 - Political Uncertainty
As elections approach in some Latin American and African countries, political uncertainty has reduced business and consumer sentiment in these. The most notable cases are Brazil, Nicaragua, Nigeria and Guatemala. In Brazil, Latin America’s largest economy, the former presidential front-runner, Lula Da Silva, was banned from running given that he is imprisoned for corruption allegations. The current front-runner, Jair Bolsanaro, was stabbed during one of his presidential campaigns by one of Da Silva’s supporters. Meanwhile, Nicaragua has experienced a political turmoil as a protest against the government’s policy cutting Social Security benefits ended in repressive measures and killings. A political resolution for the latter conflict does not seem to be in the horizon. Conversely, countries such as South Africa, Colombia and Kenya have experienced greater political stability, improving business and consumer confidence and supporting these countries’ economies.
Trend #4 – Latin American Renewable Sector Continues to Flourish
Most of Latin America is continuing to set itself apart by investing heavily in renewable energy. Uruguay is 100% renewable and Colombia hit 70% this month. Chile’s government aims to produce 90% of its energy from wind and solar by 2050 and the entire region hopes to make strides on carbon neutrality. Investing in renewable energy is Latin America’s way of diversifying itself to achieve economic growth. While Argentine renewable projects are at risk, the rest of the region continues to foster the renewable mission.
The growth in the renewable sector is attracting companies as well. Google announced that it is expanding its data center in Chile because of its renewable resources. This expansion will add more jobs to the country and will assist in Chile’s economic growth. Additionally, oil companies in Brazil, including Petrobras, are now diving into renewable energy production in order to diversify their portfolios. Petrobras is expected to announce future renewable projects in the coming months.
Sector Analysis:
Agriculture – Buy
The agricultural sector has seen an immense sell-off in the Latin American region ever since it experienced its worst drought of the century. This caused Latin American countries to miss output goals and trade partners disappointed. However, prices are beginning to pick up and given the trade uncertainty, Latin American countries are expected to prosper. China is already signing on contracts to export soybean from Brazil and other agricultural products. Soybean used to be a commodity that China purchased from the US, but that is no longer the case. More importantly, weather forecasts are positive and global demand is strong, so with improved output, Latin American countries will be able to experience synergies for their economy.
Therefore, this sector is rated as a “Buy” given that tariffs are not going to impact this region and is expected to primarily experience benefits from any trade uncertainty.
Renewable Energy – Buy
Foreign Direct Investment for renewable energy has increased exponentially in the last 5 years. Before, approximately 6% of total FDI was sent towards renewable energy, but now it is up to 18%. Uruguay leads in having effective renewable energy systems placed within the country. 95% of it runs on multiple forms of renewable energy including solar and wind. Brazil is conducting research and looks to start creating renewable energy in cars, in order to be more competitive in the market. Since FDI as a whole is going down for non-renewable energy, it is spiking up for alternative forms of energy that are renewable. Chile is also a front-runner in the renewable energy frontier. They are heavily investing in this technology and after their elections, they are expected to come out of their stagnating economic cycle back into a booming one according to World Finance. Renewable energy is leading to the increase in employment rates in Latin America. Approximately 2 million jobs in the region are associated with renewables and the rate is expected to grow. Renewable energy is also associated with infrastructure building. Governments in Brazil and Uruguay are working to make the power grid as green as possible, leading to increased jobs and overall growth. An important aspect to keep in mind about renewable energy is that it may not be prevalent in our time horizon, however, as more technological innovation in the space occurs, there is great potential.
Metal Commodities – Hold
In May of 2018, President Trump announced his intention to pose steel and aluminum import tariffs. This announcement brought attention to the Brazilian and Argentinian government. The first is the number-two steel exporter to the United States, with a $3 billion value. The final agreement consists in quotas on steel and aluminum shipments from Brazil and Argentina. At the same time, US put a 25% tariff on steel imports and a 10% tariff on aluminum imports from Mexico, Canada and the EU. This suggests that although the general outlook for metal prices is strong now, a decrease in US demand for Latin American steel and aluminum could change this outlook.
Furthermore, Chile and Peru’s exposure to China can affect the outlook of these Latin American countries’ copper production. China is already the primary trading partner for both Chile and Peru, largely due to the Asian importer's unabated demand for copper. Chile earned $34 billion from copper exports in 2017, while Peru received $13.8 billion, but any dip in prices has a magnified effect. Copper prices dropped below $3 per pound after Trump's first riffed about higher tariff but they have since risen to around $3.07 per pound. As we see in Attachment #2, copper prices have been very volatile this year, presenting short ups and downs. From this trend, it is unclear what their outlook is going to be. Because metal prices are rising overall in real terms, but there are potential risks from the China-US dispute, the outlook for Latin America’s Metal Sector is “Hold”.
Energy Commodities – Hold
Energy prices have experienced a steady growth in the past two years. Strong oil demand and greater-than-expected compliance by the 22 OPEC and non-OPEC producers to their agreed production cuts helped reduce inventories in the second half of 2017. Rising geopolitical concerns, especially about prospects for renewed sanctions on Iran, and tensions between Iran and Saudi Arabia in Yemen, bolstered prices in late March and rose further to $74/bbl in April. This trend was predicted to continue throughout the next year. Crude oil prices are expected to average $65 per barrel (bbl) in 2018 (up from $53/bbl in 2017) and remain at $65/ bbl in 2019.
An increase in energy prices is beneficial for Latin American countries dedicated to the extraction and exportation of oil, such as Colombia, Argentina, Mexico, Brazil, Venezuela. In these countries, we observe an increase in investment in the extraction sector and a solid export growth, all leading to greater economic output. Still, there are some indicators that make me bearish in this sector. One of them is the possible response of non-conventional crude production in the US to price changes, which could cap a price surge in oil. At the same time, there is a trend of worldwide insurers divesting from coal companies. In Europe alone, 17 of its large insurers have already divested from this sector. Moreover, while oil prices seem stable now, energy prices’ fluctuations are very frequent and hard to predict. At the same time, Latin American countries are increasingly investing in the exploration of renewable energy sources, which could lead to further divesting in oil extractions. Because the outlook in oil seems positive but there are many risks to this outlook, we have labeled the sector as a “Hold”.