As street protests spread across the region, is Latin America approaching a tipping point?
Civil unrest across Latin America has led to speculation in some quarters that the region is heading for its own ‘Arab Spring’. Ostensibly, both Arab and Latin-American protestors share grievances, including poverty, weak institutions and a lack of opportunity. Declining living standards have certainly been the driving force behind recent protests in Latin America. Across the region, governments have been forced to slash expenditure against a backdrop of stagnating global and domestic growth and lower commodity prices. However, one important differentiator between the ‘Arab Spring’ and the protests in Latin America is that the latter are taking place in democracies.
We think the comparison to the ‘Arab Spring’ could be misleading. Arguably, the situation in Latin America has more in common with the political polarization in Greece and Italy, and the frequent flip-flopping between left and right-wing governments, in the 40 years following World War Two. In most major Latin American countries, provided they remain functioning democracies, we expect governments to continue to oscillate between right-wing and left-wing, unless or until another commodity boom enables governments to dramatically increase spending.
If History is Any Guide…
Latin America has higher levels of economic informality (enterprises unregulated by the state – in effect a black economy) versus developed economies, where the tax base is more robust and more varied. While Latin American economies generally have lower levels of government debt, given this weaker tax base, and in the absence of a surfeit of primary industry revenue, expenditure funding is likely to come from increased borrowing.
Typically, when left-wing parties gain power, they pursue expansionary policies which may boost economic growth, at least initially. There is then a propensity for expenditure to become mandatory or constitutional. In a jurisdiction with a lack of transparency, mandatory budgets are ripe for graft – meaning corruption or rent-seeking. Over time, the debt, or debt trajectory, becomes unsustainable and the threat of default looms. The sovereign ceiling – the concept that no company in a particular country should borrow at a rate lower than the sovereign which has the power of taxation – pushes up corporate borrowing costs. Companies can then struggle to access credit, or roll over debt obligations that they do not have sufficient cash to cover, and reach a crisis point.
An alternative scenario is that a corruption scandal, similar to those witnessed recently in Brazil, precipitates a change in government when the temptation to syphon mandatory budgetary expenditure becomes too much.
Swings and Roundabouts
As the political cycle turns, a right-wing or market-friendly ‘new broom’ enters the presidential palace. At this point, we see government borrowing costs contract, perhaps with the help of an International Monetary Fund (IMF) package, and we see a better functioning of the government and economy. This typically comes with an austerity package and the removal of subsidies, while the government becomes involved in a constitutional battle to remove the mandated expenditure of previous budgets in order to reallocate resources. This creates disruption and uncertainty, and, before long, there is sufficient dissatisfaction to ensure the right-wing government gets booted out and the left-wing party wins power again.
The Root Cause
We would argue that income inequality is the root cause of Latin American populaces’ persistent dissatisfaction and ongoing political turmoil. A ‘Gini coefficient’ (a measure of income inequality) above 50 is considered high, and an academic rule of thumb suggests that bouts of civil unrest are to be expected when it breaches this level. According to the CIA Factbook, the Gini coefficient is above 50 in Chile and Colombia, while Brazil and Bolivia are getting close to it. To put this into context, the highest-placed western democracy is the US, with a Gini coefficient of 45, globally putting it in 41st place, and Greece is the highest European Union member at 36.7, giving it a global ranking of 86th.1
This disparity of wealth has the effect of denying large swathes of the population the opportunity to contribute economically to their fullest ability. And while these disparities persist, we should not be surprised by knee-jerk reactionary voting and the allure of populist leaders.
From an investment perspective, the importance of factoring politics and the political cycle into our decision making should not be underestimated.
1. Source: https://www.cia.gov/library/publications/the-world-factbook/fields/223rank.html#US
Photo: PONGTAP MALA-E/Shutterstock.com
Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice. Compared to more established economies, the value of investments in emerging markets may be subject to greater volatility, owing to differences in generally accepted accounting principles or from economic, political instability or less developed market practices.
This is a financial promotion. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered in England No. 01371973. VAT registration number GB: 577 7181 95. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.
Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management Limited.
Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2006 The Bank of New York Company, Inc. All rights reserved.