Summary
Fundamentals sound; strong growth projected throughout region. The recent crisis in US sub-prime mortgage instruments will have only a limited impact on Latin American financial services firms and their customers. The assets of banking and insurance related firms in Latin America are held mostly in local sovereign securities with some cross-border blue chip government, bank or corporate securities. Latin American and Caribbean governments are also insulated from the credit crunch. In recent years, sovereigns have become more resilient by deepening domestic capital markets, effectively reducing their exposure to external capital. Combined with sound fundamentals – low inflation, deep reserves, and exchange rate flexibility – this has worked to deflect volatility stemming from the recent sub-prime credit crunch.
Analysis
The recent crisis in US sub-prime mortgage instruments will have only a limited impact on Latin American financial services firms and their customers. The assets of banking and insurance related firms in Latin America are held mostly in local sovereign securities with some cross-border blue chip government, bank or corporate securities.
Latin American and Caribbean governments are also insulated from the credit crunch. In recent years, sovereigns have become more resilient by deepening domestic capital markets, effectively reducing their exposure to external capital. Combined with sound fundamentals – low inflation, deep reserves, and exchange rate flexibility – this has worked to deflect volatility stemming from the recent sub-prime credit crunch.
The credit shock did make itself felt in two limited ways. First, the Brazilian real, which hit its seven-year high of BRL 1.83/USD in July, fell to BRL 1.972, reflecting nerves over emerging markets in general. The real is up almost 40% since 2005, driven by high commodity prices and global growth. The real should stabilize at BRL 1.9 by year-end.
Second, a handful of firms postponed international bond issuances to wait out the widening of credit spreads, especially for less-than-blue-chip companies. Again, the exposure was limited by access to alternative financing that guaranteed liquidity, reflecting a strengthening of the region’s local capital reserves. Latin American companies can postpone international issuances until capital markets calm down without jeopardizing liquidity or credit rating. Moreover, the liquidity of regional capital markets and banks remains strong, and issuers are moving ahead with deals in Latin American markets.
More important than the reverberations of a short-term event on capital markets is the impact of economic activity, particularly in remittance markets, overlaying solid and strengthening fundamentals in the region’s key markets. Moving into the final quarter of 2007, the focus is on strong fundamentals, rising commodity prices and weakening remittances.
Remittances grew 7% in July, reversing two months of contraction, along with a slight uptick in the GDP for Q207 to 2.8% (versus 2.6% in Q1). Declining remittance flows have been a concern in Mexico since the US housing bubble burst, given official estimates that one of every four Mexicans in the US is employed in the construction sector. Nevertheless, we expect both remittances and growth to continue an incremental but steady recovery that will push Mexico to 3.1% GDP growth by year’s end.
In Central America, a decline in remittance transfers has worried some observers. Remittances stabilize currencies by deepening reserves, and boost domestic expansion as soon as they are used to be purchase local goods. There is also some concern that the region, which is a net importer of oil, will take a hit from record-high fuel prices, combined with inflation threats in the dollarized countries when the Federal Reserve cuts interests rates in response to flagging US markets.
Nevertheless, Guatemala, Costa Rica and Panama have been in a sustained period of economic expansion, which was still strong and above consensus forecasts going into the second half of 2007. The region’s trajectory is still strong, and it would be reasonable to project regional GDP growth in excess of 5.3% for the end of 2007.
In the Caribbean, the story is in the Dominican Republic, where recovery from the 2003 banking crisis continues despite a slowdown in remittances and tourism combined with rising commodity prices. While the situation has put some pressure on the current account balance, reserves are still up, and the general economic expansion of almost 7% annually is led by the financial services sector – good news indicating a healthy rebound from the banking crisis. We predict nearly 8% growth for 2007, still healthy if slower than last year’s 12%.
