Cash & Liquidity ManagementInvestment & FundingCapital MarketsSlow Samba, Fast Tequila

Slow Samba, Fast Tequila

Latin America encompasses a total of 24 countries, including Mexico and those in the Central America region, while the region of South America consists of countries south of Panama. The latter remain principally large intercontinental commodity exporters. Asian and particularly Chinese imports have largely fuelled the past decade of growth for that sub-region.

Around 70% of the letters of credit (LCs) opened on South America now originate from Asia. Bilateral trade between South America and China has skyrocketed, from a mere US$12.6bn in 2000 to close to US$270bn in 2013. By contrast, Mexico and – to a certain extent – Central America clearly remain within the US sphere of influence economically speaking, with only a relatively small amount of intercontinental trade activity.

Brazil and Mexico are by far the region’s two largest economies, accounting for close to two- thirds of total Latin American gross domestic product (GDP). However, they share little else in common. The two countries have completely different economic drivers, fiscal policies and are currently following very distinct paths in terms of reforms. While Mexico is surfing the North American recovery wave, Brazil’s engine is nearly at a stop and verging on a period of recession.

Brazil’s Economic Battles

Brazil finds itself today in a complex situation after three consecutive years of very slow growth. The dilemma: how to maintain sufficient level of growth to maintain the hopes and aspirations of the recently emerged low/middle class, while at the same time to continue bringing more people above the poverty line. If expectations lead to deception, this could have some serious social consequences.

The great growth momentum of the 2008-11 period seems to have faded away, with some key economic indicators turning from green to either amber or red. Large sectors of the economy are suffering from the downturn, including the airline, automotive and industrial sectors. Even Brazil’s oil giant Petrobras had to scale down its capital expenditure (capex) and investments. Luxury goods, retail and agricultural exports are still doing well though. The absence of any initial public offerings (IPOs) in the second quarter of 2014 is also a clear sign that the financial sector has put itself on a pause mode. Inflation is barely contained above 6% and Brazil’s benchmark Selic interest rate has been at 11% since April, although the unemployment rate has held at a relatively moderate 5%.

Massive injections of short-term money into the economy, whether coming from exports receipts, massive foreign direct investments (FDIs) or budget stimulus have been positive yet also not enough. The announcement on 25 July of
a further capital injection of up to US$20bn into the economy
by the Ministry of Finance (MOF) confirms that the state needs to intervene to maintain some form of momentum. However, that kind of stimulus is clearly not a long-term growth proposition.

Nor does it add anything new to the menu. Brazil needs to redistribute, integrate, educate and provide for improved healthcare, security and transportation infrastructure in order to pave the way for sustainable growth. Overdue and fundamental reforms have not yet been engaged on for either tax or foreign exchange (FX) regulations. Yet at the same time, Brazil’s balance sheet has very much improved in the past decade with some excellent reserves levels and a manageable debt situation – all the more reason for the government to now embark on radical reforms that restore a more positive business climate.

FDI levels have been declining, as has the level of cross-border merger and acquisition (M&A) activity in the past 12 months. Many investors were deceived about the potential returns on expensive assets, bought in many cases at unattractive FX rates pre-2010. Some are even today revisiting their investments. They are frequently confronted with expensive, undetected tax liabilities and accounting loopholes in the acquired asset-not to mention an absence of treasury and financing controls and procedures, including lack of treasury monitoring and reporting tools, segregation of tasks or the accuracy and completeness of existing legal documentation.

All of these classical pitfalls, common to any acquisition, take on a further dimension in Brazil and obviously frustrate investors. Nor is the environment helped by a heavy withholding tax on all imports (with still no specific favourable treatment for Brazil’s partners in the Mercosur free trade partnership of Argentina, Paraguay, Uruguay, Bolivia and Venezuela), tax on financial transactions and complex FX controls and procedures. In short, Brazil would gain by reassuring its international investors with some concrete measures to offset these disincentives.

While the combination of the World Cup soccer tournament and elections in the same year is not helpful, Brazil has traditionally shown an ability to rebound in challenging times. Any new-elected government in October’s election will need to embark upon a new set of reform, if it is not to jeopardise the incredible growth and positive integration achieved in the past 15 years.

Mexico and the NAFTA Effect

Mexico is a totally different country from Brazil, following a different path. One may say at the outset that its financial health broadly follows the economic cycle of the US, its main trade partner. The recent economic recovery in both the US and Canada have directly benefited Mexico. No less than 82% of the country’s exports go to the US and with exports representing more than 30% of Mexico’s GDP, against only 10% of Brazil’s, the contrast between the two Latin American economies’ recent fortunes is explained.

Mexico’s trade with the US and Canada has tripled since the implementation of the North American Free Trade Agreement (NAFTA) in 1994. In that same year Mercosur, whose origins go back to a 1985 economic cooperation programme agreed between Argentina and Brazil – was amended and updated by the Treaty of Ouro Preto but its subsequent progress over the past 20 years pales by comparison to NAFTA.

The country’s economic growth could receive a further stimulus from The Pacific Alliance initiative, although still in its early days. Signed by the presidents of Mexico, Chile and Colombia and Peru in May 2013, the alliance saw the four countries agree to remove tariffs on 90% of their merchandise trade, with those on the remaining 10% to follow by 2020. They also scrapped visa requirements for each other’s citizens and plan to swiftly establish a common market.

Mexico also joined Chile in February this year through gaining a coveted A-grade sovereign rating from credit ratings agency (CRA) Moody’s, while in May Brazil’s long-term debt rating was downgraded to BBB- by Standard & Poor’s (S&P). At the same time Mexico enjoys a relative stable currency, flexible FX regulation and free movements of capital. There is also a relatively attractive trade environment with numerous free trade agreements (FTAs) signed over recent years. While the country’s tax system is far from being the world’s most efficient, it has at least been relatively stable over the years.

Moreover, Mexico’s economic situation is in improving mode. Interest rates are at their lowest in 10 years at 3%, with the inflation contained at less than 4%. While the country’s economic growth in 2013 slowed to a four-year low of 1.1% from 3.9% a year earlier, this year to date is showing renewed progress including increased domestic investment and growing exports to the US. A pick-up to 3%-4% annual growth is expected for 2015 and thereafter. Mexico has also built up relatively strong reserves, at US$184bn as of March 2014, representing six months of exports.

Structural changes also reveal a contrast with Brazil. In the past three years Mexico has launched profound reforms of its economy and tax system. If successful, these reforms should help nurture today’s burgeoning economic recovery. Recent measures include the privatisation of Pemex, Mexico’s 75-year old state oil and gas monopoly; a tax reform enlarging the taxpayer base; the opening up of the telecommunications market via a telecoms law just approved last month and some banking reforms in addition. Provided this combination of measures is successfully implemented (not necessarily a given), the country could certainly match or even exceed the record US$35bn of FDI recorded in 2013.

For corporate chief financial officers (CFOs) and treasurers the country remains one of the easiest one to work in the Latin American region, with only limited FX controls and no tax on financial transactions. The Mexican peso (MXN) can also be pooled internationally and there is a fair access to debt and capital markets, both locally and internationally.

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