As you reflect on our commentary on how the Russian invasion of Ukraine will affect markets globally, we want to share our preliminary thoughts as to how Russia’s invasion impacts Latin America. Overall, we believe that there is more downside than upside opportunity for the region in the very short term, especially as it pertains to worsening operating conditions; but over the medium term, and as long as there is a risk—even if minimal—of conflict escalation that could drag Europe, the US, or even China into the war, the region could benefit from its more stable geopolitical position to attract foreign investment.
Negative impacts of the Russia-Ukraine conflict
Higher inflation: As explained by our global economics team, although this conflict has not yet disrupted physical infrastructure, or the normal supply of oil and gas from Russia, global markets have already priced in potential disruption, leading to higher spot prices for both commodities. We now expect oil prices to hover around the US$ 100 mark for the remainder of Q1 at a minimum, and to potentially reach US$ 150 in the next few weeks. Gas prices increased by 40% in one day. Higher oil prices will inevitably lead to much higher energy and electricity prices in all energy-importing countries, which in LATAM are most countries except Mexico, Colombia, Venezuela, and Ecuador. Moreover, because natural gas is used as a raw material as well as fuel for nitrogen fertilizer production, companies can expect food prices to increase across the globe. Our pre-Russia-Ukraine crisis inflation forecasts were already calling for still-high inflation in 2022 (in some cases, accelerating from 2021 as in Chile and Peru, and in others, decelerating from especially high inflation last year, as in Brazil); current events suggest that inflation will now likely accelerate in all countries, and stay high for as long energy and food prices remain elevated.
Heightened FX volatility: As with any major global event that introduces uncertainty in global financial markets, investors tend to reduce their risk exposure, which benefits USD-denominated assets (aka flight to safety). This will happen in an environment in which emerging-market currencies were under additional pressure from faster-than-expected monetary tightening in the US. Add political uncertainty to the mix because of elections in Colombia and Brazil, political transitions in Peru and Chile, and lingering concerns about the Argentina-IMF deal, and you have the perfect storm for LATAM currencies to remain weak or continue to depreciate, at least in the short run.
Rising credit costs and lower liquidity: In the likely event of even more aggressive Fed hikes as the US grapples with heightened inflationary pressures, central banks in LATAM will be hard-pressed to increase their own pace of rate hikes. The hikes implemented in LATAM have not yet led to neutral or positive real interest rates (i.e., inflation continues to be higher than the benchmark policy rate), but this could change if central banks become more aggressive in their monetary tightening efforts. From a credit perspective, even if benchmark policy rates remained negative in real terms, commercial banks are likely to increase their spreads as they lend to businesses, and retail banks as they lend to consumers, as their own funding costs increase, and their risk perceptions go up. What this means is restricted and more expensive access to credit, leading to liquidity issues along local supply chains in LATAM, with small distributors and suppliers most exposed to lower liquidity in the system.
Lower consumption and reshuffling of government spending priorities: Higher inflation will reduce discretionary spending power, especially among the poorer segments of the population, for whom inflation acts as a regressive tax, especially if it concentrates on food items composing a large proportion of their household budget. Energy-importing countries will also see their energy bills go up. Some governments might try to keep consumer prices artificially low through subsidies or the temporary elimination of taxes (e.g., see Brazil’s proposal to temporarily eliminate the IPI tax), and if they do, they will either miss their fiscal targets or need to cut spending elsewhere. Based on our 2022 analysis of budgets, we believe that governments will continue to prioritize social and healthcare spending this year, with the main losers still being CAPEX projects.
Lower exports of non-commodity products: Because Europe is much more exposed than any other region to rising gas prices, we expect consumption to take a bigger hit there, reducing demand for merchandise imports and nonessentials. Lower imports from Europe could affect their main trading partners, including the US and China, leading to a global trade cooldown, affecting LATAM.
More protracted tourism industry recovery: A secondary effect that we could see from higher energy prices could stem from higher fuel prices for air transportation, leading to increases in airplane fares. In a non-inflationary environment, hotels, travel agencies, etc. would be able to lower their own prices to compensate for the extra cost of international transportation, but with these establishments dealing with higher electricity and food prices, it is unlikely they will be able to absorb the shock. We also need to consider the worsened liquidity positions the tourism industry finds itself in after more than two years into the COVID-19 pandemic.
Upside for Latin America stemming from the Russia-Ukraine conflict
Tax windfalls for energy-exporting countries: Prior to the Russia-Ukraine crisis, our LATAM team had already revised government spending up for 2022 in Colombia, Mexico, and Ecuador following higher-than-expected oil prices over the past few months. You can find more information about those revisions in the webinar we hosted last week, Revisiting LATAM’s 2022 Plans. With oil prices now hovering around US$ 100/barrel, and potentially reaching US$ 150/barrel, up from our previous expectations that oil prices would stop increasing beyond US$ 100/barrel this year, we can expect that these countries will be able to free up additional resources for government spending, which will come in handy for the Mexican and Colombian governments as they try to prop up popular support ahead of the recall referendum in Mexico and the presidential election now in May in Colombia. For Ecuador, this could mean a milder fiscal consolidation effort quarterbacked by the IMF.
Stronger performance of grain exports as well as base metal industries: Soft commodities, such as corn and wheat, have seen prices increase since the beginning of Russia-Ukraine tensions, reflecting the role that Ukraine plays as major grain exporter. An environment of higher-than-expected grain prices would benefit countries such as Brazil and Argentina, and in the case of Argentina, provide the country with an invaluable source of FX to keep the peso afloat. Surges in base metal prices as a result of a potential ban on Russia’s metal exports could benefit LATAM’s mining industry in countries such as Brazil, Chile, or Peru.
Greater scarcity of “high-yield acceptable risk” investment opportunities for multinationals: Although the notion that Latin America could attract greater foreign investment in a situation of high global uncertainty, high inflation, FX volatility, and political instability might sound at odds with how investment decisions are made, the reality is that some of the major countries that compete with Latin America for corporate investment will be operating under similar conditions, with the aggravating factor of being directly exposed to an escalation of tensions in Europe, or eventually a larger conflict involving the world’s superpowers (although we deem this scenario self-defeating to all parties involved, and hence extremely unlikely). If Latin America can maintain acceptable levels of regulatory certainty and commitment to fiscal discipline and market-friendly policymaking amid its many political transitions, it could capture investment flows that would have otherwise been allocated to other markets (including Russia itself for starters) by risk-averse investors. In a situation like this, investors would still discern between high- and low-risk countries within LATAM, likely creating a situation of winners and losers.
Our global economics team laid out a complete list of actions to deal with a more complex operating environment that certainly applies to LATAM. In addition to that list, our main advice is to position Latin America as a “geopolitical oasis” for multinationals as risk perceptions increase—even if unfounded— and focus on the region’s many strengths in relation to other emerging markets (e.g., high purchasing power, similar consumer behavior as in Western countries, and higher coverage for social services, such as healthcare, etc.); the company’s track record of outperformance in LATAM, especially if it happened during volatile times in the past; and on long-term opportunity in the region.
If you are interested in a deeper dive into these insights or need information on different countries or industries in LATAM, start your free trial today.
At FrontierView, our mission is to help our clients grow and win in their most important markets. We are excited to share that FiscalNote, a leading technology provider of global policy and market intelligence has acquired FrontierView. We will continue to cover issues and topics driving growth in your business, while fully leveraging FiscalNote’s portfolio within the global risk, ESG, and geopolitical advisory product suite.
Subscribe to our weekly newsletter The Lens published by our Global Economics and Scenarios team which highlights high-impact developments and trends for business professionals. For full access to our offerings, start your free trial today and download our complimentary mobile app, available on iOS and Android.