2014 – Rising Investor Risk in South America
December 20, 2014
Since protests in Brazil took its leaders and the world by surprise in June 2013, many have wondered if the political frustrations of Latin America’s largest nation might soon spread elsewhere. The safe bet is yes.
There are four worrisome trends at play in the region that together foretell a period of rising political risk. The commodity boom that has lifted every economy in South America over the last decade peaked in late 2012 and will continue a gradual decline over the next few years. China’s shift from an investment driven infrastructure economy to one more balanced with domestic consumption has slowed their demand for industrial metals. The expansion of energy supplies in North America and the mid-East will soften oil and gas prices going forward. The anticipated “levelling off” of U.S. and Chinese quantitative easing will further erode gold prices.
South American governments are vulnerable to falling commodity prices because they have learned to tax the commodity boom. Mining and energy royalties, state oil companies, export taxes and concession sales all help stuff government coffers. Since 2003, South American public spending has grown (in USD) at close to 15 percent per year, an astounding figure in a world replete with austerity. The regional spending spree was designed in part to modernize South America’s moribund infrastructure and raise productivity. Instead, South America’s competitiveness rankings have dropped, education remains accessible, but unreformed and public infrastructure achievements are, at best, mixed with too many projects compromised by nepotism and corruption. In fact, according to Transparency International, corruption is worse today across the region than it was a decade ago.
The 2003-2012 period was supposed to be the decade when Latin America caught up with emerging Asia thanks to high commodity prices, low interest rates, and favorable demographics. Instead, the region has fallen further behind. Colombia, Peru and Uruguay should be commended for remaining committed to reform in spite of comfortable times and political obstacle. However, the pace and scope of reform in Brazil, Argentina, Chile and Venezuela has proven disappointing.
Going forward, South American governments must learn to do more with less. Dropping commodity prices will shrink their tax bases. Prudent governments will cut spending (and waste) in an effort to match falling revenue streams. Others will seek new sources of taxation or the removal of costly gasoline and electricity subsidies, which have grown exponentially. Several Latin American governments have succeeded in recent years at negotiating higher royalty agreements with mining investors, but that well is running dry thanks to declining metals prices. Increasingly, governments face the unenviable choice of scaring off investors or disappointing voters.
In Brazil, rising bus fare hikes while footing the bill for the most expensive World Cup in history was too much for voters to bear. In 2011, Chilean students protested vigorously when government tried to raise tuition fees. In late 2012, when the Medina administration in the DR rammed through tax hiking fiscal reform, the middle class took to the street. Over the last decade, voters in South America have heard repeatedly that their region is enjoying a renaissance, a period of abundance but then ask themselves, why are they not much better off? That realization will become more acute as governments are forced to cut costs or raise taxes.
Further exacerbating the issue of political risk is next year’s electoral calendar. Brazil and Colombia both face national elections and both countries are vulnerable to declining commodity prices. In Colombia, most analysts focus on the Farc peace negotiations as the determinant factor of the election. However, voter frustration stems, in much larger part, from the perceived lack of fulfillment of government promises in areas such as infrastructure, education, and basic utilities.
Holding government to task through protests, investigative journalism, and a robust social media embracing middle class is largely a positive step in the evolution of Latin American democracy. Governments across the region must be more accountable in the future than they have been in the past and likely will be as Latin America’s middle class continues to expand and the median age grows.
While democracy is not at risk, the investment climate is. Governments struggle to cut costs. In countries like Brazil where it is illegal to cut government wages, cutting costs is next to impossible. Instead, governments pursue new forms of taxation and generally prefer to go after business, especially the extraction sector, ahead of consumers. Mining and energy companies can expect new rounds of negotiation from some of their host governments in South America.
John Price is the managing director of Americas Market Intelligence and a 20-year veteran of Latin American competitive intelligence and strategy consulting.
A version of this article also appears in Latin Trade.