Politics in Latin America: noise vs. signal

In recent years Latin America has leaned to the left. Consequently, leaders ranging from the progressive to the outright autocratic (e.g., in Cuba, Venezuela, and Nicaragua) now govern over 92% of the region’s people and 90% of its GDP. And, consensus has it, they are scaring off investors.1

However, this picture is incomplete, and it is changing too. Latin America’s flirtations with leftist regimes are a recent democratic development, as the region for centuries has been subject to ultra-conservative governments or hard-right military dictatorships. Of course, there are the above-mentioned non-democratic deviants, yet the ability of dozen Latin American nations to navigate peacefully across different points of the political compass via elections is a sign of institutional maturity that is still lacking in key Emerging Markets. Indeed, Turkey, China, Russia or Iran, to cite but a few, should not experience it anytime soon.

Furthermore, there is the need to differentiate between what is rhetoric that might scare off investors from what executive branches can accomplish in political systems featuring reasonable checks and balances. Recent evidence in larger Latin American countries is quite instructive. In Brazil, the heads of the Federal Senate and the House of Representatives emphatically have dismissed President Lula’s misgivings about the sale of Eletrobras, the federal electric power holding company that became a private corporation last year, together with his attempts to roll back part of the business-friendly legislation in key infrastructure areas such as water and sewage services. His minority coalition government, as it happens, cannot call the shots. On the contrary, it must bow to Congress authority on fundamental issues. Also, it is particularly revealing that legislators are about to pass a new long-term fiscal framework that is more demanding than the original draft submitted by the Finance Ministry.

As for Chile, the coalition government is in a somewhat less precarious situation, yet President Boric and his leftist allies pushed their luck by supporting a constitutional convention that drafted an ultra-progressive chart featuring several market unfriendly reforms. The Chileans, however, given their say in a referendum, ditched the text by a wide margin. To be sure, a process of coming up with a new constitution is underway, but this time a team of appointed experts and elected representatives, who are mostly from right wing parties with a pro-business stance, will do the job until the year-end. These institutional developments should usher in a more favorable investment environment.

In Mexico, President Lopez Obrador’s party controls both houses of Congress, but it no longer has the super majority needed to amend the constitution. In this context, institutional checks and balances signify the Supreme Court, along with the judiciary branch, striking down controversial legislation, especially when it results from a government strategy of enacting constitutional changes through ordinary bills. For instance, justices weakened important parts of the electricity reform that aimed at returning control of the country’s power market to state hands, notably via the Federal Electricity Committee (CFE).

Finally, Latin America’s political landscape is in perpetual flux. The left-wing governments of late replaced conservative administrations that came into power across the region in the previous election cycle. And this progressive wave may be ebbing already. In Peru, the radical President Castillo saw five cabinets, eighty ministers and six criminal investigations during his 17 months in office. After a failed attempt to dissolve the Congress, enact a national curfew and call on a special assembly to draft a new constitution, lawmakers impeached him in December 2022. In Argentina, President Fernandez, a populist, announced that he will not run for reelection in October, hardly a surprise decision in the face of the biggest economic and social crisis since the early 1990s, which has driven over 40% of the population into poverty. What the Argentines will decide is whether the new head of the executive branch will be a moderate centrist or a free-market libertarian.

While it is notoriously difficult to quantify political risk, there are useful metrics that can provide interesting insights.2 As for government and economic stability in the continent, save for a couple of deviants, most Latin American nations compare well to the United States, although they are still a notch below Canada (Chart I). Consequential are the effects for economic policies: budget deficits are modest - Chile actually ran a surplus of over 1% of GDP in 2022 - and public indebtedness is comparatively lower. Also, independent central banks could preemptively raise short-term interest rates to combat inflation, which is trending lower (Chart II). No surprise, then, that Uruguay and Costa Rica are already easing monetary conditions.

Evenmore consequential are the secular effects. Defying conventional wisdom, Latin America is not scaring off longterm investors, as the region leads the world in net foreign direct investments over the past years (Chart III). Pandemic issues and rising geopolitical risks are taking a heavy toll on Asia and Europe. Admittedly, there are misperceptions in more liquid markets. Most Latin American listed equities, for example, are typically trading at steep discounts, despite the reduced level of sovereign risk (Chart IV), which contrasts sharply with the valuations in some wealthier geographies such as Japan and the U.S., or even in some emerging economies like India. Arguably, divergent readings of political noise account for a substantial share of these discrepancies. Because domestic policy rates are poised to trend lower in Brazil, Chile, and Peru (future markets are anticipating cuts ranging from 100 to 250 bps until December 31st, 2023), asset prices should rise and thus correct at least part of the odd pricing in coming months, a process akin to what has already happened with their exchange rates.

1 See, for instance, “Latin America’s left-wing experiment is a warning to the world” in The Economist, dated 18-May-2023.

2 See, for instance, the Global Political Risk Index (GPRI) at https://library.eurasiagroup.net/.

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