Latin America’s poor performance can be accounted for by Brazil’s fall of 4.8% so far this year. According to Juan Ignacio Katz, the manager of the ABN Amro Latin America Equity fund, two Brazil-specific events drove market underperformance.
First, the fact that the Brazilian central bank has kept interest rates unchanged for over two months when the economy was quite weak (GDP fell by 0.1% in 2003). On March 17th, however, the central bank decided to reduce official
rates by a quarter point to 16.25%.
Second, political uncertainty.
James Gotto, the manager of the Schroder ISF Latin American Fund, says: “There was a flow of negative news about possible improper financing practices of the Brazilian Workers’ Party [the party of President Lula da Silva] election campaigns. The market is concerned that the political incident may result in the opening of a parliamentary investigation which could tarnish the government’s clean image.”
However, it is important to recognise that the country’s economic situation is improving. Inflation, one of Brazil’s traditional problems, is under control. Last month inflation fell to 6.7% compared with 9.3% in 2003 and a target of 5.5% for this year. If this objective can be achieved there are likely to be further interest rate cuts.
Rate reduction
Mr Gotto says: “While recent inflation data have disappointed slightly, we expect the central bank to continue to reduce interest rates in coming months which will support a recovery in domestic consumption.
“Strong commodity prices continue to support growth across the region and domestic economies appear poised to strengthen in the course of 2004, which should become an increasingly important driver of relative performance in coming months.”
Whatever happens it will be important to monitor how the country responds to American interest rate rises.
In contrast, Mexico has been the best performing country in the region so far this year with a rise of 14.3%. An interesting argument advanced by some analysts to explain this strong performance is the “re-establishment of the lost link” between the American economy and Mexico.
Gray Newman, the senior Latin America economist at Morgan Stanley, says: “After a disturbing period during the third quarter of 2003 when US industrial output showed a convincing upturn and Mexico’s output data continued to head south, the two series have again moved in tandem.”
China concern
It is important to remember that last year the Mexican stockmarket only gained 30% (in dollar terms) compared with a rise of 67% for the region. There was a lot of concern that the Chinese competition combined with the strength of the peso had in some way weakened the traditional link between Mexico and America. But the Mexican economy has recently shown signs of recovery in industrial production following the positive data from America.
With this link re-established the main problem for Mexico is now the pace of the American recovery. As Mr Newman says: “Without strong US export demand, Mexico’s recovery is likely to falter.”
Mr Gotto of Schroders is also slightly cautious on the country’s prospects saying: “There is the possibility of further monetary tightening in the near-term as the central bank looks to control inflation and limit wage negotiations.
“This could potentially dampen domestic demand, although we believe that the US-led recovery in manufacturing will exert a greater influence on Mexico’s economic performance. The manufacturing sector accounts for one third of Mexico’s formal labour market and the prospect of stronger manufacturing employment growth, as suggested by the recent pick-up in industrial production, should help to support consumption even as monetary conditions become more restrictive.”
Private investors should therefore be wary of extrapolating Mexico’s strong returns so far this year to the rest of 2004.
Fund agreement
Finally, Argentina is still enjoying strong returns. After nearly doubling (in dollar terms) in 2003 the Buenos Aires’ stockmarket has climbed another 13.5% so far this year. The good news is the recent agreement from the International Monetary Fund (IMF) to give the country fresh funding of $3.1 billion (£1.7 billion). But in response the Argentine government, led by Nestor Kirchner, will have to renegotiate the payment of its defaulted debt with its foreign private creditors. Currently the authorities have offered to pay only 25 cents for every dollar, an offer rejected by the IMF and the creditors which are asking for at least 65 cents.
Anne Krueger, a managing director of the IMF, says: “Consistent implementation of this debt restructuring framework will be essential for the continued support of the international community.”
