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Turning Of The Political Tide In South America Will Benefit Investors

2015_Ecuadorean_protests_19_June_2015The tide is turning in South America among some of the most important countries on the continent. Elections in Argentina and political turmoil in Brazil, Chile and Venezuela will at last bring change to the benefit of investors. A presidential election in Peru is now just months away. The near collapse of demand for commodities,has brought a dramatic slowdown in the regional economy. Strategies to promote more growth and investment, have become increasingly more popular among the electorate than the redistribution of existing wealth.

South America has changed significantly, since the elections of leftist to center populist leaders in the last two decades. Hugo Chavez of Venezuela came in 1998, followed by Luiz Inacio Lula da Silva in Brazil as of 2002. The Kirchners would take power in Argentina the following year. Evo Morales would arrive to leadership in Bolivia as of 2005 and Rafael Correa the next year in Ecuador. These political leaders all benefited from thriving economies,that were the result of rapidly rising commodity prices and a strong demand from China.

Map of South America

Map of South America

This in turn funded a massive expansion in social programs and poverty reduction programs. New jobs were created and more investment opportunities abounded. The recent economic downturn and charges of general mismanagement as well as corruption,have brought a substantial erosion of voter support for this group as a whole.

The modern political movements these individuals founded,are now struggling to hold on to power. In Latin America,it is the countries of South America that are experiencing the slowest rate of growth in recent times. The region as a whole,is experiencing some of the slowest rates of development since the 1990’s.

The level of sovereign debt accumulated before and during the boom in commodities,is placing a heavy burden on many of the individual national budgets. The problem for the political leadership in this part of the world are the same. How to deal with the rising expectations of the citizenry,with sluggish to declining growth in the midst of a fiscal crisis. Much of the blame is placed on the decreasing demand for the regions commodities by China.

downloadThe plunge in global oil prices and the increasing strength of the American dollar,has exacerbated the gloomy situation even further. The decision to take on more USD (United States Dollar) denominated debt during the Great Recession of 2008 and 2009 is creating havoc with many local currencies.

The now strong American dollar makes these debts much harder to service and the dramatic decline in the domestic currencies, is fueling a return of inflation to the region.

To make matters worse, many leading companies from South America also decided to take on debt using the dollar as the medium of exchange. As tax revenues from commodities have declined,outlays on social spending have risen.

On average government income derived from this trade, is down by 9% already. Fiscal balances for Latin America overall, have gone from a primary surplus in GDP (Gross Domestic Product) of 2% in 2008 to a primary deficit of 1.5% in 2013 and 2014. The shortfall has risen throughout 2015 and will rise even higher in 2016.

Macri during a press conference in 2013.

Macri during a press conference in 2013.

The presidential elections in Argentina this month,were a perfect example of the political change in the tide. Center-left outgoing President Cristina Fernandez de Kirchner had been promoting Daniel Scioli to succeed her. The chosen successor failed to win outright, in what turned out to be a very competitive election.

The results were totally in contradiction to what all the polls had originally indicated. The next election will be on November 22. However, the momentum is now with the more market-oriented challenger Mauricio Macri.

In a dismal night for the ruling Peronist party, control of the governorship of Buenos Aries province home to one of out four Argentinians was lost as well. They were also dealt a defeat in Cordoba, the second largest city in the country. It was the worst election results,since the Kirchners came to power in 2003.

Campaigning with her husband, then-President Néstor Kirchner (outgoing), and their respective running mates, Daniel Scioli and Julio Cobos.

Campaigning with her husband, then-President Néstor Kirchner (outgoing), and their respective running mates, Daniel Scioli and Julio Cobos.

The electorate in Argentina is restless. The GDP is down, with a lack of any real growth. Inflation is soaring,now approaching 25% and unemployment is rising. Exports have sunk and the currency is rapidly declining in value. Public debt,has become a crushing weight on the economy. The budget deficit this year is likely to be 6% of GDP, a rate that it totally unsustainable.  

The next President will have to finally deal with foreign creditors, regardless of the present propaganda. Economic nationalism has run its course,in the present stagnation. The manipulation of economic data by the present government,does not inspire investor confidence nor bring in more foreign exchange earnings.

Spending cuts and higher interest rates to deal with inflation, will become necessary to deal with the coming fiscal and monetary crisis. A recession will ensue, but following that growth will then return.

In Brazil, President Dilma Rousseff who was the political heir to former President Lula, is contending with charges of corruption and a deepening recession. Reelected last October,she is now facing efforts to be impeached by a growing bloc of opponents. She has become the most unpopular leader since democracy was restored in 1985.

Dilma Rousseff with Lula during the 2010 presidential campaign.

Dilma Rousseff with Lula during the 2010 presidential campaign.

Earlier this year President Rousseff had pledged to do whatever it took,to get the country’s fiscal house in order. What she refuses to admit,is that the lavish spending that ensued during her first term and the electoral promises to secure her second term,are partly responsible for the present debacle.

Generous government pensions,abundant cash transfers,energy subsidies and wage increases have helped millions of Brazilians. However,it has left the government with a huge budget gap, unsustainable entitlements and a lack of money for infrastructure. The situation was made worse by the unnecessary loans the Brazilian government and companies took out during the boom years,which are now coming due.

Minister of Social Development and Hunger Alleviation Patrus Ananias discussing the program

Minister of Social Development and Hunger Alleviation Patrus Ananias discussing the program

The Brazilian currency is hitting historic lows,down 35% this year alone. Unemployment is reaching a five year high. The failure to reform the tax structure and labor laws when the economy was doing well,is hampering growth now. The economic model that relied on domestic consumption to fuel growth is no longer working.

The President has been accused of manipulating government data,to help her reelection efforts last year. The bribery scandal concerning Petrobas,the nations largest state run oil company,has also tarnished her image. Much of the illegal activity took place when she was officially in charge of the company.

In addition,the head of the lower house is facing corruption charges and the leader of the Senate is under investigation. The present political turmoil is helping to generate legislative gridlock,to the detriment of the overall Brazilian economy.

Even in relatively stable Chile, center-left President Michelle Bachelet, has a policy agenda that focuses on three main changes to help reduce social inequality. They are universal free university education,higher taxes to pay for this reform,and a strengthening role for labor unions in the country.

Bachelet with former Argentine president Néstor Kirchner.

Bachelet with former Argentine president Néstor Kirchner.

She has been thrown a bit off track by a scandal involving her son. Slow to react to the situation,it seems her son used his influence to obtain a $10 million loan for a business deal. Critics of her whole policy in general claim it is already impacting the economy,by depressing business investment domestically. They also assert that new labor laws will discourage foreign investment as well.

As her popularity has plummeted,she has begun to modify some of her positions. Earlier this year,she brought in a well respected moderate finance minister. The tax reform under his plan will be somewhat simplified and an investment credit will be partially restored. The government has also promised to modify the new labor union bill.

Chile produces more than a third of the world's copper.

Chile produces more than a third of the world’s copper.

The Chilean peso has depreciated by some 45% since the beginning of 2013. Economic growth has been sluggish,at less than 2% a year. Chileans are becoming fearful that the prosperity that has been created during the past generation is now under threat.

President Bachelet will end her tenure in 2017. She won election with 62% of the vote. Her approval is now down to 25%. Calls for her resignation have been so far ignored,but she is not permitted by the Constitution to serve another consecutive term. Despite her efforts to modify the Constitution,it will probably not be completed under her presidency. Change will arrive in Chile soon enough.

Ecuador was roiling with protests this past summer and President Correa has been forced to slash growth prospects for the rapidly cooling economy. Correa has angered many voters over the introduction of two new controversial tax laws. One is to be placed on capital gains from real estate at a rate of 75% and the other is levied on inheritance at 77.5%.

Workers, trade unionists and members of FUT protesting against Correa's policies on 24 June.

Workers, trade unionists and members of FUT protesting against Correa’s policies on 24 June.

The legislation on inheritance was so unpopular,that the President has temporarily shelved the bill. These were designed to replace some of the lost oil revenue. Since 95% of the businesses in the country are family owned,this measure would have a tremendous impact on the economy of Ecuador.

The protesters are comparing these recent steps to what has happened in Venezuela and President Correa with Hugo Chavez. The President has also moved to consolidate his power by making changes to the constitution and packing the nations highest court with his allies. He has also attacked dissidents and attempted to silence free speech through various methods.

Mr. Correa won an unprecedented third term in 2013 and will try to introduce an amendment,that would eliminate presidential term limits before 2017. There is speculation that he will then stand for a fourth term.

Venezuelan President Maduro has presided over a collapsing economy,since the death of Chavez. The streets protests are growing ever larger and he is rapidly running out of options,as the country now has the highest inflation in the world. In 2016 it is expected to be 161%. The national currency has become almost worthless. The government has a number of rather large debts due at the end of this year and throughout 2016,that it will be hard pressed to repay.

Brazilian President Dilma Rousseff receiving a Hugo Chávez picture from Nicolás Maduro at the Palácio do Planalto, in Brasília, Brazil.

Brazilian President Dilma Rousseff receiving a Hugo Chávez picture from Nicolás Maduro at the Palácio do Planalto, in Brasília, Brazil.

The Venezuelan economy shrunk 4% in 2014, is expected to contract 6.6% in 2015 and another 2.9% in 2016. The government stopped reporting most economic data in December of 2014. Shortages for basic goods are accelerating and there have been increasing reports of looting and other civil disorder in different areas of the country.

The parliamentary elections in December promise to be difficult for the increasingly unpopular leader. According to polls, the fragmented opposition has a real chance of gaining control over the Congress. It must be noted that the present electoral system favors rural areas,where support of the government remains higher than in the cities. So even if the opposition can muster more than 50% of the vote,it may still be unable to topple the present government.

As the economic situation in South America continues to deteriorate,it will propel voters to demand changes from their political leaders who represent them. It will force many leaders from office who are either unable or unwilling to move in a new direction. The way forward is sound fiscal and tax policy that encourages investment and growth.

1 Comment

  1. the potential new law on real estate gains is not 75%, it ranges from 0 % to 75% marginal, and it only applies after you sell the same property for the second time. Other than that great article

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