OUTLOOK ’19: LatAm to see consequences of historic elections

HOUSTON (ICIS)–The major economies of Latin America will see the consequences of a momentous 2018, in which Brazil and Mexico held historic presidential elections and Argentina fought a financial crisis.

This year, Jair Bolsonaro will be inaugurated as Brazil’s president. This marks the first time since the end of the dictatorship that a candidate from a minor party became head of state. Equally momentous was the collapse of Brazil’s conservative party, the Brazilian Social Democracy Party (PSDB). Its candidate, Geraldo Alckmin, placed fourth, marking the first time since 1989 that the party failed to make the run-offs.

Mexico’s presidential election was also historic. Andres Manual Lopez Obrador, known as AMLO, won a clear majority in the race. It was the first time in Mexico’s modern political history – over 75 years – that none of the major parties won the presidency.

Argentina had to secure a credit line from the International Monetary Fund (IMF) to avoid a financial crisis, following the sharp devaluation of the nation’s peso.

In 2019, Argentina will attempt to emerge from what will likely be a recession. The new presidents in Mexico and Brazil will attempt to push through radical new policies.

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In Brazil, there is growing consensus that Bolsonaro will address rising government spending, especially involving pensions and social security.

Pension benefits account for 34% of non-interest spending by the federal government, according to S&P Global Ratings. The social-security deficit accounts for the entire non-interest deficit of the general government.

The challenge for Bolsonaro’s administration is to build a legislative coalition that will pass pension reform and other measures to control government spending. Much of this spending is mandated by the Constitution, making it even more difficult to change.

Working in favour of Bolsonaro is the fact that he is from a different party, allowing him to make a fresh start and attempt reforms. The consensus that something must be done should also help.

Bolsonaro’s victory did increase business confidence, in part because of statements he made during his campaign and because of his economics advisor, Paulo Guedes. Guedes, who was trained at the University of Chicago, favours classical liberal economic policies that would open up Brazil’s markets.

Bolsonaro himself has pledged to pursue classical liberal economic policies and to privatise state-owned companies.

This could revive earlier plans for Petrobras to sell majority stakes in its refineries.

However, it is unclear how committed Bolsonaro is to privatisation or even to liberal economic policies.

During his time as a legislator, Bolsonaro voted against all proposals to liberalise the economy, wrote Paulo Sotero, director of the Brazil Institute at the Wilson Center, a US-based think tank. Bolsonaro also opposed the 1994 Real Plan, which Sotero said stabilised the nation’s economy.

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Mexico’s new president, AMLO, wants to reverse the country’s chronic decline in oil and gas production while making the country self-sufficient in gasoline. He wants to rehabilitate all six of the country’s refineries and build a new one in Dos Bocas, Tabasco state.

If AMLO is successful, then the new projects should reverse the decline in feedstocks that has caused Mexico’s petrochemical plants to run below capacity.

All of Mexico’s crackers rely predominantly on ethane as a feedstock, and most of that ethane is extracted from the associated gas produced from oil wells. The decline in oil production has caused a shortage in ethane, and Mexico now imports the material overseas from the US.

Because Mexico’s crackers rely so heavily on ethane, its petrochemical industry is especially dependent on the nation’s refineries for propylene and aromatics. The wretched state of Mexico’s refineries has caused these products to be in short supply.

Although AMLO has been consistent in his support of the energy industry, his other policies could discourage the investment that Mexico will need to increase oil production and repair its refineries.

AMLO has adopted plebiscites, using the results of one of these votes to cancel an airport expansion project. The prospect of referendums cancelling contracts and dictating government policy could discourage investors from putting their money in Mexico.

Throughout his campaign and into his candidacy, AMLO has expressed antipathy towards the energy reforms adopted by his predecessor, Enrique Pena Nieto.

These reforms allowed companies other than state-run Pemex to produce energy. The intention was to attract outside money to Mexico’s energy sector.

The reforms also called for the gradual removal of the state’s involvement in energy prices. Ultimately, markets would dictate the price of fuel, opening the prospect that companies could recoup the costs of their investments in Mexico.

AMLO’s harsh words against the reforms could presage policies that could halt or even reverse them.

Already, Mexico will suspend the issuance of new oil contracts for three years.

Without outside money, it is difficult to see how Mexico will reverse its decline in energy production and rehabilitate its refineries.

It will be difficult for Pemex to fund such an ambitious programme on its own, given its tendency to post money-losing quarters.

Without funds from outside companies, the Mexican government will have to raise the money itself, burden Pemex with more debt or give up on its energy programme.

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Argentina will likely enter yet another recession after its currency weakened substantially against the dollar, leading to a financial crisis.

The weaker peso increased the burden of Argentina’s interest payments on its dollar-denominated debt.

As a result, government expenditures have increased with the rise in debt payments.

To help the country overcome the crisis, Argentina has opened a $56.3bn credit line with the IMF under a so-called standby arrangement. The money under the standby arrangement will be available through 2021.

The credit line is intended to give Argentina flexibility in cutting back government spending to a more sustainable level.

In return for the credit line, Argentina has agreed to take on reforms to balance its budget by 2019 and to reach a primary surplus in 2020, the IMF said. A primary surplus does not include interest payments.

Credit agency Fitch Ratings is assuming that Argentina will balance its budget by 2019.

Still, the challenges facing the country are daunting. Confidence has collapsed and real incomes have declined, Fitch said. Private investment will likely remain cautious.

Economic growth could face more pressure because the government is keeping interest rates at high levels and trying to cut back on spending.

In effect, Argentina is tightening fiscal and monetary policy at the same time.

In addition, the country is holding presidential elections in 2019, which adds another degree of uncertainty. Beyond 2019, Argentina faces more challenges in getting spending under control.

Fitch expects the economy to shrink by 2.7% in 2018 and contract by 1.7% in 2019. That is similar to IMF forecasts.

Focus article by Al Greenwood