Changing political winds and economic reforms in LatAm
A wave of general elections for Latin America’s (LatAm’s) largest three economies is well underway. Brazil heads to the polls this weekend for the first round of voting in a highly uncertain and drama-filled election. In Mexico, President-Elect Lopez Obrador’s leftist party won the presidential and legislative election with a landslide victory in July. Finally, with Argentina’s President Macri desperately battling an economic crisis, his prospects for re-election next year are already on shaky ground. Economic and political differences between these countries are clear, with Mexico outperforming its peers in terms of growth and market performance. However, uncertainty stemming from all three elections is warranted, especially given concerns that a new political era in these countries could stymie progress in economic reforms.
The lead-up to elections in any country tends to increase economic uncertainty. New governments can, and often will, implement sweeping new economic policies that can be difficult to predict. The situation in Brazil, Mexico, and Argentina, however, is particularly interesting. All three economies experienced a bout of market optimism when their current (or outgoing) administrations came into power.1
In Mexico, outgoing President Peña Nieto pushed through historic and wide-ranging reforms to modernize Mexico’s economy and open it up to outside investment. In Brazil, President Temer replaced ousted President Dilma Rousseff following months of political scandals. His promise to consolidate Brazil’s fiscal accounts, despite being in the midst of a deep recession, momentarily eased investor concerns. In Argentina, President Macri introduced market-friendly reforms and settled with hold-out creditors from Argentina’s 2001 debt default. This enabled the country to return to international capital markets after being shut out for years.
Despite market enthusiasm for these efforts, however, follow-through has not always met expectations (particularly voters’ expectations). Consequently, approval ratings for the three countries’ current leaders have suffered. In Brazil, for example, President Temer failed to push through an overhaul of the pension system, an issue which, in conjunction with Brazil’s gaping fiscal deficit (7.8% of GDP in 2017), is weighing significantly on Brazil’s credit rating and its currency (figure 1). Furthermore, though Brazil has emerged from its 2015-2016 recession, the recovery remains sluggish.
Figure 1 - Figure - Brazil’s deteriorating public finances weigh on credit rating (in % of GDP)
In Mexico, reform of the energy sector—which faced falling production due to underinvestment—is well underway. In particular, the government has opened up the sector to private investment through several successful auctions of oil field contracts. A recent poll by The Brookings Institution, however, finds that only 27% of the public finds these reforms to be giving good results.2
Argentina has also faced disappointing real GDP growth since emerging from a recession in 2016. With capital outflows compounding problems from a severe drought, the economy contracted 15% (Q/Q saar) in Q2 2018 and the economy is likely to slip back into a recession this year. Meanwhile, inflation remains elevated at 34% Y/Y. In an attempt to support a plummeting currency, President Macri turned to the IMF to secure a stand-by-arrangement and the government has promised further fiscal consolidation. Given Argentina’s difficult history with the IMF and the austerity measures it imposed, the decision to turn to the international institution is weighing on Macri’s popularity.
What is at stake now?
In contrast with Brazil’s and Argentina’s currencies, the Mexican peso has been one of the best performing emerging market currencies this year (thanks in part to strong fundamentals). Furthermore, since the election, President-Elect Lopez Obrador has adopted a conciliatory tone and confidence has risen. Still, uncertainty lingers. Lopez Obrador has vowed to review previously awarded oil contracts and, reportedly, is considering indefinitely suspending any further auctions. However, though the president-elect was once a staunch critic of NAFTA, he has since announced his approval of the new agreement reached with the US and Canada, a sign that should ease investors’ concerns regarding his approach towards outside investors.
On the other hand, though Argentina’s elections are still a year away, concerns among market participants are already growing. President Macri’s popularity has dropped to around 40% given rising prices, a contracting economy and the implementation of further austerity measures in exchange for support from the IMF. The concern is, specifically, that voters’ disappointment in the outcome of Macri’s market-friendly reforms will turn the political tide back towards the populist policies that led to many of Argentina’s macroeconomic problems in the first place.
In Brazil, as well, investor concerns are unlikely to ebb following Sunday’s election. The two highest polling candidates, Jair Bolsonaro (31%) and Fernando Haddad (21%) are considered by market participants to be extreme candidates on the right and left respectively. If the two face each other in the runoff election on 28 October, they would currently each receive an equal 42% of the vote, with roughly 16% of voters still undecided or uninterested in voting for either candidate. The main concern for markets is whether either of these candidates will be willing or able to work with a likely fragmented congress (also elected on 7 October) to pass the badly needed pension overhaul and bring Brazil’s public finances under control. Given that Haddad’s Workers Party is against major pension reforms, and Bolsonaro is unlikely to have substantial support in Congress, some further market turbulence in Brazil is likely.
Indeed, though Argentina, Mexico and Brazil are all in different situations economically and politically, there is a common theme stoking a degree of uncertainty for all three countries. Namely, changing, or potentially changing, political winds may limit, or even undo, needed progress on economic reforms. In Mexico, the incoming president has tried to ease these concerns by adopting a pragmatic and conciliatory tone. In Brazil and Argentina, however, the uncertainty may linger for some time, leading to further market turbulence.
1 Mexico currently has a five month transition period so President-Elect Lopez Obrador will not be sworn into office until 1 December 2018.