Why politics really matter

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This year has proved that, when it comes to emerging markets, politics matter. The recent wave of elections in India, Colombia, Mexico and Indonesia but also the coming Brazilian general elections are crucial for countries that need structural reforms to lay the foundations for sustainable long term growth. But while the environment is still very heterogeneous, we do favour markets demonstrating sound and balanced economic indicators such as current account surplus, ongoing structural reforms, strong growth perspectives as well as diligent monetary policies.

Looking at Latin America, Mexico and Colombia do appear as “best in class” markets, while in contrast, Brazil and Argentina as an example, continue to face struggling challenges.

Mexico has started benefiting from the reforms already implemented. Altogether, the labour, fiscal and energetic reforms will increase its potential growth. Mexico is leading the pace of reforms and as such is becoming more and more appealing for long term investors compared to its neighbours. The ongoing energy reform, a cornerstone of the reform process, should attract considerable foreign direct investments. As a result the economy is already on the upward curve of the economic cycle. Apart from this significant political impulse, other positive factors are helping: to start with, a low reliance on commodities exports, unlike other emerging peers, should benefit the current account balance and outlook (manufacturing industry counts for 25% of GDP). Also, given a historically strong correlation with US growth, any sign of improvement coming from the US will benefit export-driven companies, such as the automobile sector. This improving macroeconomic backdrop translates into equity sector opportunities in such sectors as finance, consumer and property with a bias towards high cash-generative businesses, with strong balance sheets along with visible compounding growth. However we await developments in the opening up of Mexico’s oil sector during the second half of 2014, but continue to appreciate Mexico’s combination of an under-geared economy with political reforms. Our EM funds’ largest country weighting in Latin America is Mexico.

The wisdom to implement structural reforms is equally shared by the political leadership in Colombia. Indeed, Latin America’s fourth-largest economy has relied over the past year on improved political stability thanks to the peace negotiations with the FARCs and a sound economic orientation supported by higher public investment, along with a gradual expansion in private consumption. This favourable environment will be carried on, based on Santos’ recent re-election. Continuous determination to implement structural and key reforms is nothing but highly positive for the country’s economic outlook and unsurprisingly the economy is expected to grow at its true potential. The continuity of power should also allow a follow-through on the $54bn infrastructure investment plan over the next five years, which accounts for 14% of current GDP. This program aims to address the collapsing infrastructure investments witnessed since 2008 as well as to improve the overall quality of transport infrastructure. Undoubtedly this effort will be supportive of a more sustained economic development and is to be carried out through public-private partnerships, which should be profitable to the domestic cement market (i.e. Cementex Latam and Cementos Argos).

If the above nations have taken the right steps to steepen their forward curves, others such as Brazil and Argentina first need to face challenging milestones. As a fact, the upcoming Brazilian presidential election is of utmost importance. Though it seemed a foregone conclusion only months ago, recent polls show that President Rousseff’s re-election is far from assured. Brazilian assets would, in our view, react positively to a change in leadership tasked with reversing the poor economic trajectory. The flagrant lack of infrastructure investment is weighing on growth prospects and inflationary pressures. Any sustained effort to curve this shortage will be welcomed and perceived as a long-term growth catalyst.

As for Argentina, the country decided to default on the coupon payment of its restructured bonds. Had Argentina paid the “vulture funds” in full, all other investors could have requested the same treatment, which would have had ruinous consequences for the country. The consequencees on the markets resulting from the default were limited, as the Government is looking for a solution to have those bonds bought back before the RUFO (Rights Upon Future Offerings) clause expires at the end of the year. Our underweight stance in Argentina stems from a lack of investment opportunities, even if it is clear to us that Cristina’s departure next year is promising. If the situation stabilises then, we could jump in.


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