Argentina leaves markets worried about ability to grow

“It’s like chemotherapy. If you have it all at once, you are going to kill the patient. You need to find a dose that won’t kill the patient.”

The patient being discussed by a senior capital markets banker in New York is the Argentine economy. The dispute that still rages domestically and internationally is about president Mauricio Macri’s medicine. How large should the dose of adjustment be? And just how quickly should the government implement its reforms?

Many abroad and in Argentina are in a favour of upping the speed at which the medicine is administered, especially in light of Macri’s success in last October’s mid-term elections.

“I think Macri needs to stop the gradualism policy,” says Exotix’s Rafael Elias. “It got him through the mid-terms and he [still] has a very high popularity rating. But the country is spending more than it is making and the debt is growing exponentially.”

To keep the adjustment moving forward at a viable tempo, the government needs to keep growth above 3%. That needs real investment, both local capex and foreign direct investment, rather than large capital flows that heat up the exchange rate and have been the financial feature to date.

“From Macri’s point of view, FDI has been sluggish, and they need to get GDP to above 3%,” says Elias. “This will be a massive year.”

Roberto Sifon, head of the Americas’ sovereign team at S&P Global, says: “To use a soccer analogy: we are headed into the last minute and Argentina needs to score a goal. That goal is 3%-plus growth. So they really need to start seeing some real domestic investment.”

And, although nobody is saying that international investors are about to stop funding Argentina, the performance of the sovereign’s debt at the beginning of this year has been notable. The bonds came under pressure in January, when Argentina was one of the few emerging market sovereigns to see its spreads widen (and remember, Argentina is still classed as a frontier economy because of its structural risks).

The $9 billion of issuance on January 4 certainly played a part, creating technical concerns as it came with large new issues concessions that repriced the existing curve wider (estimated to have been 10 basis points for the five-year, 25bp for the 10-year and 20bp for the 30-year tranche). Underwriters say that the overhang has now been cleared and no further large deals are to be expected this year. But with slow progress on the development of the local markets, 2019 should see similar issuance levels.

Then, when volatility hit the international debt markets in mid February, the bonds continued to underperform. The country’s spread widening accelerated. This dynamic was the result of investors being overweight the credit and, according to bankers, investors realizing the structural advances of recent years were largely priced in.

“The room for positive surprises has diminished and the ‘beta’ to the market has increased again, suggesting that in a large market movement, Argentina bonds would underperform,” a report by Citi summarizes.

The large price movement is also, in part, investor reaction to monetary policy, after a change to the inflation-targeting regime and a couple of cuts to the base rate, despite high inflationary pressures in the economy, led many to question the government’s commitment to this fight.

In early March there was further bad news. The 2017 GDP growth number was announced and it came in lower than the psychologically important 3% barrier. This lowers the statistical carry-over from 2017 to 2018’s growth, which is already being forecast lower because of a combination of the expected impact of a drought on agricultural production and the negative effect of higher inflation expectations on consumption.

JPMorgan sliced 10bp off its forecast for 2018’s GDP growth due to the lower carry-over, as well as 25bp for the drought and a further 10bp for the negative impact of inflation. The bank now predicts GDP growth of 2.8% in 2018, down from 3.3% (below that 3% barrier again), as well as increasing its forecasts for inflation.  Other banks have also lowered GDP and raised inflation forecasts (not great for a government about to enter into sensitive negotiations for 2018 pay increases). Capital Economics is more bearish: “Economic growth in Argentina appears to have peaked,” it says.

For the full article visit Euromoney Latin America

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How the markets now run Brazil …

… with or without Henrique Meirelles.

Brazil’s democracy has added a new feature in the last few years: people can vote for a president, but the markets retain the right to deploy an ‘impeachment put’ if that president is messing up the economy.

For proof, look no further than the fate of former president Dilma Rousseff. Her impeachment in 2016 was legally based on fiscais pedaladas (accounting irregularities). That she was almost alone among powerful politicians not to be cited in the sweeping Lava Jato corruption enquiry was not enough to save her. External forces still found a way to oust her from office.

Now, two years later, few senior market participants even bother to pretend the accounting charge was anything other than a markets-driven constitutional fig leaf to remove a bad president, whose terrible economic policies pushed the country into its deepest ever recession.

Speaking at a Credit Suisse Investors Forum earlier this year, Luis Stuhlberger, chief executive and chief investment officer of Verde Asset Management, said: “The conclusion that one reaches is that any candidate will do [fiscal] reforms in 2019, either proactively or reactively, because if we have a [president] with very different ideas, he or she will be impeached. Because if GDP goes down, the recession will come back, and he or she will be ousted. This has been clearly demonstrated.”

Stuhlberger, an investor revered by many in Brazil, added: “In the past, when I was more pessimistic and I thought [Rousseff’s] impeachment wouldn’t happen, a senator told me: ‘If you are in the presidency without the ability to govern, we will find a way to get you out.’ I think this is clear in the minds of everyone.“

Paulo Guedes, another well-known Brazilian financier, populist candidate Jair Bolsonaro’s economic adviser and potential minister of finance, effectively said the same thing: “It used to be that inflation had to be 2,000% to be impeached, but now if it’s at 10%, the president is ousted.”

Guedes then also compared the impeachment on accounting grounds with Al Capone’s prosecution for tax evasion.

Stuhlberger and Guedes were just saying in public what many are now increasingly happy to say in private.

“Our system has checks and balances, and Dilma was ousted according to the constitution,” one banker tells Euromoney. “One can argue whether the pedaladas were the real reason – and of course they weren’t, she was running the country into the ground and if she hadn’t been impeached in 2016, god knows where we would have been today. At the beginning of 2016, our economic team forecast a 4% contraction in GDP, but they said it might very well be 5%. Can you imagine?”

As Euromoney reported in May 2016, powerful business leaders were in fact the ones pushing politicians to remove Rousseff, as refinancing risks threatened to create a wave of corporate defaults throughout Brazil.

In 2012, Brazilian corporates and financial institutions raised $46.8 billion in the international markets – a much cheaper source of finance than local banks or capital markets. By contrast, in 2015, the total raised in the international markets was just $7.2 billion. In the first five months of 2016, no deals had come to those markets. The markets had given their own vote of no confidence in Rousseff.

Banks did the same. Their provisions against the threat of corporate insolvencies spiked; in 2015, 5,500 companies sought bankruptcy protection – the most since 2008 – with forecasts of many thousands more to come as financial market liquidity evaporated.

Pressure built. The vent was impeachment.

For the full article visit Euromoney Latin America’s first issue


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Twisting Mexican risk

According to bankers and analysts in New York, the first questions that corporate clients and investors always ask about Mexico relate to Nafta. Questions about the political risk from this year’s election are secondary, almost an afterthought.

However, this is getting Mexico risk the wrong way around in terms of importance.  That is because, first, the Nafta risks have been broadly overstated.

Even if Nafta negotiations break down and US president Donald Trump terminates the trade deal (and that is a big ‘if’, given the growing recognition among the border states of the inter-connectedness of supply chains), Mexico would likely revert to most-favoured nation WTO status.  There would be disruption, but because of Mexico’s competitiveness as a manufacturer today, it would not be catastrophic. Second, the risk of a presidential victory by leftist candidate Andrés Manuel Lépez Obrador, or Amlo as he is known, is both important and growing.

An Obrador presidency could be catastrophic for Mexico For an interconnected set of reasons, it is beginning to look like Amlo’s third attempt at the presidency could be lucky for him. But not so for Mexico – it would likely be catastrophic.  Amlo advocates nationalizing the banks. He proposes reversing all of Mexico’s recent reforms, including the energy reform. He has ambitious – and unfunded – proposals aimed at creating almost two million more public-sector jobs.

Comparisons abound between Amlo and Brazil’s Lula da Silva. For example, Lula won the presidency at his third attempt. However, whereas Lula became markedly more moderate with every campaign, Amlo is becoming increasingly belligerent.  Lula’s Workers Party calmed the markets on taking power and the fiscal deterioration only really hit the country in its third administration. Amlo would likely cause an economic crisis much more quickly.

At the moment investors remain calm. If they realize the threat – Amlo has a double-digit lead in many polls – they discount it because they reason it is still early days. The election campaign doesn’t formally start until the end of March.

Wise heads point out that although Amlo has a 98% recognition rate in the country, his support seems to have a ceiling in the early 30 percentage points, with nearly 70% likely to vote against him.  The argument goes that during the campaign the quality of the PRI’s candidate, Jose Meade, will come through. After all, Meade has been a secretary in five different ministries under two different presidents from two different parties.  As well as unrivalled experience, Meade holds two bachelor degrees (economics and law from prestigious Mexican universities) and a PhD in economics from Yale.

In contrast, bankers sniff that it took Amlo 10 years to get a bachelor degree in political science. Perhaps a slightly more practical point is that the incumbent PRI party has the better organization. In last year’s election for the city of Mexico, Amlo’s candidate Delfina Gómez was narrowly beaten by the PRI’s Alfredo del Mazo.

Many credit that to the machinery of the PRI getting people out to vote. The logic is that this will apply nationally in July.  That logic would hold – normally. Except this is not a normal time in Mexico. Seldom has there been such disconnect with the incumbent party than there is today.

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Brazil’s Stone looks to follow PagSeguro in snubbing

The success of Brazil’s PagSeguro’s recent IPO on the NYSE has led its competitor, Stone, to draw up plans to launch on the US stock exchange this year, according to market sources.

PagSeguro, which provides online and in-store payment services, raised $2.3 billion in January this year.

This general rarity of technology company IPOs from Brazilian companies helped the IPO launch above its pricing range and the stock traded up 33% on its first day of trading. If Stone follows PagSeguro to the NYSE, it will be bad news for Brazilian exchange B3, which is trying to attract other Brazilian tech companies to list locally. That could then become a strategic issue for investors looking for onshore Brazilian investments.

Stephen Dover, head of equity for Franklin Templeton, says he believes Latin America is falling in relative importance in his firm’s emerging market investment allocation because of his firm’s focus on EM technology.

“There are not enough technology companies or innovative companies listed in Brazil,” he says. He adds that B3’s skew to commodity stocks is a problem for international investors because the exchange is not representative of the country’s real economy.

He says index funds do not match the potential upside to the country’s future economic growth, and that means that investors pursuing stock-picking strategies in certain sectors, such as consumer-orientated companies, face challenging valuations.

However, Dover does confirm the consensus view among Latin American equity capital markets bankers that the markets are very receptive to Latin American IPOs and political uncertainty in the region is not an obstacle. “We would absolutely look at IPO stories in the first half of this year,” he says. “We are long-term investor, and there is an IPO deficit in the region – there is a lot of catch-up that needs to be done in Latin America.”

For the full article visit Euromoney Magazine


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Euromoney’s review of global banks: Itau

The optimal way to drive through a sharp turn in the road is to slow down before you reach it, before accelerating out from the mid-point of the curve.

In much the same way, Itaú Unibanco has steered its way through the recent sharp recession in Brazil.  In 2012, the bank shifted into a defensive posture in terms of credit risk, shifting its retail portfolio more into secured lending (mortgages, payroll loans and car loans) and hitting the brakes on extending unsecured credit to riskier individuals.

The bank also pursued a strategy of increasing revenues from fees and commissions. That down-change of strategy before the economic downturn ensured the bank is well positioned to accelerate credit growth if and when the economic rebound occurs.

As well as increasing risk-adjusted lending behaviour before the crisis, Itaú also increased its provisions early and sharply in the early years of the slowdown. This means the bank is already lowering provisions and seeing a benefit in profitability that may be enhanced further if the loans against which the provisions have been made do not turn bad.

Provisions peaked in the first quarter of 2016; in the third quarter of 2017, and under new chief executive Candido Bracher, the provisions-to-loan portfolio ratio dropped to 3.6%, a rate not seen by the bank since 2009. Meanwhile, the focus on fees has paid off. While the return on equity of the bank’s credit operations is 14.1% (almost the same as its cost of equity at 14%), its insurance and services operations generate a 47.7% return on equity and now account for 53% of the bank’s total profits – as well as adding a large stabilizer to revenues. Overall, return on equity increased by 230 basis points to 21.7% in the first nine months of 2017.

The bank’s ability to generate capital from retained earnings has been remarkable; Itaú generated about 80bp of tier-1 capital from retained earnings in the last quarter alone. This has enabled it to pursue acquisitions that boost its size and profitability – but they have to be accretive in terms of profitability.

In October 2017, Itaú formally completed its acquisition of Citibank’s retail bank in Brazil, which added R$8.6 billion ($2.6 billion) in assets, R$6.2 billion to its credit portfolio, R$4.8 billion in deposits and around 300,000 customers, whom the bank is already targeting to boost its commission and fee revenues.

Also in 2017, the bank bought a 49% holding in online brokerage XP Investimentos just days before the company had planned an IPO. The deal was seen as a mix of defensive play (it was also slightly dilutive) due to XP’s strong growth rates in the retail brokerage business, but the acquisition fits neatly into two of the bank’s strong themes: the higher income retail segment and the drive towards digitization.

The acquisitions barely dented its capital position. In fact, the bank has been so bizarrely profitable despite the macroeconomic backdrop that it has had to twice change its capital management strategy. Early in 2017, the bank changed its by-laws to increase the possible payout ratio to 45%, only to abolish any upper limits months later.

For the full review visit Euromoney’s website

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Euromoney’s review of global banks: Bradesco

This was the year that Bradesco absorbed HSBC’s Brazilian bank.

The deal, valued at R$16 billion ($4.8 billion), added five million current account clients, around 22,000 employees, 851 branches and 448 ‘mini-branches’. However, the bank said it wanted to retain 100% of HSBC’s customers as well as target deal synergies of 30% of HSBC’s pre-merger expenses.

“I think potentially those synergies will rise to above 40%,” says Alexandre Gluher, executive vice-president at Bradesco. “We completed the integration of HSBC in 2017, but it’s important to stress that the full adjustment will only be felt in the P&L in 2018.”

Bradesco’s rationalization of HSBC fits within a wider and aggressive cost-cutting initiative.  In 2017 the bank launched a voluntary redundancy programme that was taken up by 7,400 employees at a cost of R$2.3 billion – which will realize annual savings of R$1.5 billion from next year.  Total headcount rose to 111,000 after the HSBC acquisition but is already back under 100,000.

Bradesco, with Luiz Trabuco as CEO, is leading the private-sector banks in cutting branches; it closed over 500 in 2017 and is continuing to cut.

Analysts at UBS think that “Bradesco has the most potential to reduce its branch network”.

The bank’s push into digitization helps this reduction in its physical footprint. A record 30-day strike by bank workers in 2016 has enabled banks to accelerate branch closures, because the industrial action forced older customers to adopt digital banking channels. Many have remained online, citing a positive banking experience.

For the full review visit Euromoney’s website

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Environment: In defence of economic ideology

Many Euromoney readers were alive in more ideological times. They will remember the collapse of the socialist command economy model and the fall of the Berlin wall.

They will also remember Margaret Thatcher’s aggressive application of liberal economic forces and Ronald Reagan’s belief in trickle down.

Those bruising, chaotic times gave political ideologies and the economic theories that flowed from them a bad name. They seemed extreme, antagonistic and created as many losers as winners. Applied in the extreme they also always contained some economic flaws that could be highlighted and used to discredit the broader aims.

Ideologies are, of course, extremely dangerous when they do not accommodate opposition and attempts to moderate excesses. But they also contain a belief in progress; that politics and economics can bring about change for the better.

Nowadays politics and economics are more about management and this, in the absence of a long-term ideological framework, necessarily means a short-term horizon.

This, too, can be destructive. In the absence of a driving ideology, politics becomes interest-based. A good example is Brazil. This month saw the owners of businesses (represented by, among others, the Sao Paulo business federation FIESP) trying to kill a bill that would eliminate the subsidies these companies enjoy by receiving below-market financing from state development bank BNDES.

No matter that Brazil has just reported its worst-ever primary deficit for July, which has left economists wondering whether the government will hit its target, which it has only just this month revised downwards. No matter that S&P explicitly linked a failure to pass this reform to a likely downgrade. No matter that it is not morally justifiable – why should large companies receive cheaper finance than the rest of the economy, especially when they generally have access to the international markets?

The problem with interest based politics and economics is that those interests always define themselves narrowly. It is why leaders choose cheap loans today over a healthy economic environment for the whole country tomorrow. It is why in Costa Rica the government has continually to impress upon the transport sector that the real cost of burning fossil fuels is higher than the market rate – once you have factored in the cost of climate change. And it is why the UK and the US have reached for morally bankrupt and economically-inefficient policies that seek to protect the interests of their communities – rather than seeking to trade and partner with others, which is in all of our interests.

The good news, if we choose to accept it, is that there is an ideology that is neatly waiting to be adopted that will define interests globally. Building environmentalism into the politics of democracy and the market economy could add long-term balance and a framework to a world that is otherwise appearing to fragment.

Recent events in Houston and the Caribbean have shown the cost of climate events. That is in no one’s interests.

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Argentina’s delicate balancing

President Mauricio Macri’s economic inheritance was toxic; his policy of gradual fiscal realignment looks like it will lead to success in this year’s crucial mid-term elections, but the country desperately needs investment to maintain the transition.

Let me answer in the words of a financial investor I was talking to last month,” says Rodrigo Park, head of economics research for Santander Rio.

“He asked me why FDI [foreign direct investment] was so low and I said: ‘You should tell me.’ And he did, and I agree with what he told me. ‘One reason is fear. And the other is the fiscal deficit. If there is no fiscal consolidation there is no stabilization in the economy. These are the two main reasons why there has been no significant increase in FDI.’”

That is why direct investment has failed to materialize – abroad or domestically, Park tells Euromoney. And that investment is critical for Argentina. Without it the economy will, at best, stutter along in low-but-positive growth and will fail to attain the level that is needed for economic rebalancing and for the government to reduce its sizeable financial deficit (currently close to 7% of GDP).

But, as Park points out, many investors are waiting for a fiscal adjustment before committing capital. Solving this economic contradiction will need skill, patience and luck. And as ever in Argentina, politics will make the government’s attempts to untangle the economic mess it inherited difficult.

Former president Cristina Kirchner will win a seat in the senate in the coming mid-term elections on October 22. But the broader picture is positive for president Mauricio Macri to the point where Cristina’s presence in the senate should become almost an irrelevance.

The country held primary elections on August 13 that effectively serve as a national opinion poll for the mid-terms; Macri’s Cambiemos party did better than had been predicted. Macri won the important province of Buenos Aires by a whisker, but there are many reasons why Cambiemos should fare better in October.

First, the economic recovery is finally being felt in the industrial, employment-heavy industries that are prominent in Buenos Aires.

Second, higher turnout in the proper elections should favour Cambiemos (historically Peronists are more likely to vote in early-round or primary elections).

Third, the low recognition levels of the leading Cambiemos candidate, Esteban Bullrich, will be less of a factor after two more months of electioneering.

And, finally, the distant third place of Sergio Massa of the Judicialist Party in the August poll is likely to encourage his supporters to vote tactically and more of Massa’s supporters are expected to drift to Cambiemos than vote for Kirchner.

To read the full article visit Euromoney’s website


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BBVA tempted to sell its Chilean retail bank

BBVA’s decision to open talks about selling its Chilean retail bank to Scotiabank could lead to a notable retrenchment of its Latin American operations.

BBVA has a large presence in Latin America, with significant banks in Argentina, Colombia, Mexico, Peru and Venezuela – as well as Chile where it is the country’s sixth largest.

However BBVA’s management has in the past indicated that it believes its Chilean retail bank – valued at around €1.2 billion – lacks sufficient scale. That has led analysts to believe that the bank would look to merge with another bank or sell. BBVA has a 68% stake in BBVA Chile, while 29% belongs to the Chilean Said family and the rest of the shares are in free float.

A combination of very high valuations for potential targets (an opportunity for an attractive sale price) and a new banking law that could require a capital injection may be behind BBVA’s apparent decision to sell.  The bank is not understood to be looking to sell its consumer finance operation in the country.

Chilean banks have been trading at very high valuations for some time: as an average the NTM (next 12 months) is trading two standard deviations above the five year average of between 12.7x and 12.9x.

“This is a significant re-rating,” says a JPMorgan report on Chilean banks that concluded the high valuations in the Chilean market required downgrading Banco de Chile to neutral.

Chilean valuations certainly appear stretched in regional terms: Banco de Chile’s 14.3x and Santander Chile’s 15.1x expected 2018 P/E is above leading banks in Mexico (Banorte at 12.6x and Santander Mexico at 12.1x) Brazil (Bradesco at 10.8x, Itau at 11.0x and Santander Brasil at 10.6x) and Colombia (Bancolombia at 10.7x).

Meanwhile, the country’s new banking law that adopts Basel III requirements for Chilean banks has been presented to Congress. The Ministry of Finance estimates that the system will require an additional $2.7 billion of capital. The additional capital requirement is expected to be concentrated to a small number of banks and Moody’s suggests that the banks with the largest need for extra capital are BancoEstado, Itau, Corpbanca and BBVA Chile.

The law allows for a phasing in of the additional capital until 2024 and a sale of BBVA’s retail bank would pre-empt that requirement. BBVA may also have concluded that the valuations prevented them targeting another Chilean bank to build sufficient scale.

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Costa Rica’s ambitious commitment to reducing carbon emissions places it at the forefront of the fight against climate change. But its politicians worry that, with financial aid being focused elsewhere, it could effectively be punished for its early adopter status.

Euromoney’s meeting is in Puriscal, the eponymous town of the fourth-largest canton in the province of San José, close to a large, crumbling cathedral that is being reclaimed by nature.

The building is still an imposing sight, but trees now take advantage by growing in (and widening) the cracks in the walls that were opened by a series of earthquakes in the 1990s. In 2009, a health notice ordered its demolition, but there has been no movement to either its destruction or rehabilitation in the following years.

From the nearby headquarters of Cooperpuriscal, a farming cooperative that was established by the ministry of environment and energy (Minae) and is financed by a mix of public funds and local private businesses, we head further up the mountain.  We are driving to a finca – a smallholding, which in this case has 26 cows. The finca’s residential building sits at the side of the road and does not hint at the modern construction to the back: brushed steel gates and fences contain healthy-looking cows that mill around on a perfectly-level concrete floor that drains down to a sluice.

The representative from Cooperpuriscal explains the overall structure that has recently been installed and (after another visit to a neighbouring finca) is clearly created to a template. All of the cows’ waste is captured in solid form in a structured production chain that produces organic, rich compost for use on the farm and for sale. The slurry gets washed into a polythene-covered tank that generates enough gas for the farmer to power the whole site.  The retained compost boosts the yield on the farm’s crops, which now supplement the cows’ grazing on pastures, which increases and stabilizes milk production. Meanwhile, the milking process uses modern equipment and feeds directly into a hygienic, on-site tank that is emptied every two days by the cooperative’s dairy lorry.
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