Working paper 76 latam what's after de world cup by Andbank

ANDBANK RESEARCH Global Economics & Markets

Alex Fusté Chief Economist alex.fuste@andbank.com +376 881 248

Working paper - 76 LatAm – What’s after the World Cup? Mexico, Brazil, Chile, Peru, Argentina … Economy & Markets July 15, 2014

Corporate Review

Mexico – Has Mexico turned the corner?

Activity. GDP growth accelerated to 1.8% y/y in Q1 (from 0.7% in 4Q) The Drivers: The improvement was driven by stronger exports, while the slump in investment eased (see chart 1) Projections? The US manufacturing index and GDP is consistent wit Mexican manufacturing growth accelerating in the coming months (see chart 2)

Rates. BANXICO: We expect policymakers to leave their benchmark interest rate unchanged at its historic low of 3%. We see two good reasons for this: (1) Inflation –that has begun to rise again and seems to remain above the center-point of the 1-3% target range- should drop back early next year as the impact of indirect taxes falls out the annual comparison. (2) Economic growth has been weak for the past 18 months.

Market implications. Fx: Moderately Bullish. Target at 12.75. Current 12.95 Bonds (local): Neutral-Bullish. 10yr yield Target 6.00%. Current 5.70% (4.7% return in hard currency)* Equity: Bullish. Target IPC at 45.500. Current 43.773 6

GDP GROWTH - US vs MEXICO

8 6

4 2

-2

-2 -4

-4 -6

-6 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

-8

(% 1 YR ) MEX - Eco nom ic Activity Ind ica tor (as a P ro x y fo r GDP ) ( Right) (% 1 YR ) U S - GDP (Le ft) Andbank, INEGI, US Bureau of Economic A nalysis

* Projected 1 Yr return of investing in the local currency bond and then translated into hard currency. We thus consider: coupon, price and Fx return.

©FactSet Res earch Sys tems

Corporate Review

Brazil – Stuck in the slow line

Activity. The economy has continued to struggle in Q2. After a weak Q1, the business surveys suggest that output is stagnating -headline PMI falls to 50-, but the hard activity data paint an even weaker picture – with manufacturing PMI falling below 50 again and IP contracting 5% y/y - (see chart 1) The GDP breakdown shows that “The fall is broad based”. Industrial production contracted in April (0.4% m/m and near 5% y/y). At the same time, consumer spending (so far the engine of Brazil’s economyseems to be faltering (-0.1% m/m in April making the annual rate of sales growth to slow sharply at just 2% pace).

Market implications: Brazilian assets have continued to rally over recent months, helped by a continued improvement in global risk appetite. In our view, many of the vulnerabilities that put Brazil in the spotlight in 2013 still remain: (1) there is no sign that weaker growth is reining in the large Current Account deficit, or (2) Inflation has continued to edge up, now at 6.52% y/y, breaching the upper bound of the 2.5%-6.5% target range. CPI will remain high as the CB will be reluctant to raise rates again ahead of elections in October. Fx: Bearish. Target at 2.40. Current 2.22 Bonds (local): Neutral. 10yr yield Target 12.00%. Current 12.13% (4.5% return in hard currency) Equity: Neutral. Target Bovespa at 52.317. Current 53.426

BRAZIL - INDUSTRIAL PRODUCTION

20 15 10 5 0 -5 -10 -15 -20

CURRENT ACCOUNT BAL ANCE - BRAZIL (m ont hly d a t a )

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(% 1Y R ) Ip, To ta l Indus try, 2002 =100 , I nde x - Bra z il (Le ft) Andbank, IBGE

* Projected 1 Yr return of investing in the local currency bond and then translated into hard currency. We thus consider: coupon, price and Fx return.

©FactSet Res earch Sys tems

20 0

-20

-40

-60

-80

-80 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 BOP, Current Account, Cumulative 12m (US$ bn)

Andbank, Central Bank of Brazil

©FactSet Res earch Sy s tems

Chile – Chinese slowdown weights

Corporate Review

Activity. Economic growth has continued to slow. Our GDP trackers point growth of just 2.3% y/y in Q2 -down from an already low 2.6% in Q1-. (see chart 1) The slowdown appears to have been broad based, with retail sales growth moderating to 1.6% y/y (its slowest pace since 2009) and industrial production contracting by 4.2% y/y in April. On the positive side , the slowdown in domestic demand has trimmed the import bill, narrowing the Current Account deficit (see chart 2).

Rates. Central Bank: The economic slowdown automatically would call for further interest rate cuts (the Central Banks has recently cut rates to 3.75%) but, although inflation has moderated to 4.3% y/y in June (from 4.7% y/y in May), it is still some way above the 2-4% target range, and will likely remain above this range until 1Q15. As such, we think rates to remain on hold at 3.75% during 2014 (with the next rate cut during the 2015, maybe until 3.25%-3.50%).

Market implications. Fx: Moderately Bullish. Target at 520. Current 553 Bonds (local): Bullish. 10yr yield Target 4.50%. Current 4.57%. (6.34% return in hard currency) Equity: Bullish. IMA CE C Ac t iv ity da t a - Ch ile ( G DP Tr a c k e r )

14 12 10 8 6 4 2 0 -2 -4

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14 12 10 8 6 4 2 0 -2 -4

(% 1YR) Monthly Indicator Of Economic Activity (2003) (Imacec) - Chile

Andbank, Central Bank of Chile

* Projected 1 Yr return of investing in the local currency bond and then translated into hard currency. We thus consider: coupon, price and Fx return.

©FactSet Research Systems

10 8 6 4 2 0 -2 -4 -6 -8 -10

CURRENT ACCOUNT - CHILE

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10 8 6 4 2 0 -2 -4 -6 -8 -10

(MO V 2Q )C urre nt Acco un t a s a % o f GDP Andbank, Central Bank of Chile

©FactSet Res earch Sys tem s

Corporate Review

Peru – Reforms versus populist spending!

Reforms. The fact that the Peruvian government has responded to weaker economic growth with reforms rather than populist spending is positive. GDP pace has slowed to 4.5% in the 1H2014, due in large part to the ending of commodities boom. The commodities boom drove growth in two ways: (1) It attracted large foreign investments into mining projects, and (2) lead to large improvement in the terms of commerce that helped to fund domestic demand. The reforms are aimed at boosting business investment via two main channels: 1. Introducing new tax incentives. i. The introduction of a “lock-in” tax rate for mining firms on investments of $500m ii. One of the major reform will be a “tax amnesty” allowing firms and individuals to write-off debts owed to the state-owned pension and the healthcare systems (ONP & EcSalud). According to the Finance Ministry this will benefit 180k taxpayers and write-off around $7.1bn 2. By cutting red tape i. A reduction in the time that state agencies have to approve projects. ii. Allowing permits to be granted at different levels of government. iii. A reduction in the maximum penalties that the OEFA (the environmental regulator) can impose for environmental infringements. iv. Measures to streamline the public-private partnership (PPP).

The assessment. The positive: 1. Peru’s economy seems to be at full capacity –inflation is at 3.5% y/y in June -above the 1%-3% target range-, unemployment has fallen to historic lows, and current account deficit is large-. Stimulus spending would be more likely to add to these imbalances. By contrast, supply-side measure are more prudent and creates lasting benefits. 2. Policymakers estimate that these measures could add 1.5-3.0% pts to GDP growth in the coming years. As such, The government expects now growth to return to 6-7%. In our view, this may seem too optimistic, but after this the GDP pace could remain at a consistent 5% for the coming years.

Corporate Review

Peru – Reforms versus populist spending! The negative aspects: 1. It will take time for these supply-side reforms to feed through into stronger economic growth –Mining projects take time to generate returns-. 2. The reforms will do nothing to reduce the economy’s reliance on the natural resources sector, keeping Peru vulnerable to swing in commodity prices. This will make the anti-cyclical policies to gain importance. 3. Rising commodity exports will put pressure on the real exchange rate (this could erode the competitiveness of local firms)

Market implications. Fx: Bullish. Target at 2.65. Current 2.78. Bonds: Bullish. 10yr yield Target 5%. Current 5.20% (11.7% return in hard currency) Equity: Neutral-Bullish. Reforms could add 1.5-3.0% pts to GDP growth in the coming years but it will take time for these supply-side reforms to feed through into stronger economic growth

GDP - PERU

USD/ PEN (USDPEN-FX1)

2 .7 7 9 - 0.0 0 2 -0 .0 7 % 0 5 :03 :1 0 P M P E N

2 .8 5

2 .8

2 .7

Ju l-1 2 - J ul-1 4

2 .7 5

2 .6 5

-2

2 .6

-4

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2 .5 5

(% 1YR ) R e a l GDP , T o ta l, 1994 Prices , M il P EN - P e ru T re ndline : Ave ra g e

Andbank, Central Reserve Bank of Peru

* Projected 1 Yr return of investing in the local currency bond and then translated into hard currency. We thus consider: coupon, price and Fx return.

1 0 /1 2 1 /1 3

4 /1 3

7 /1 3 1 0 /1 3 1 /1 4

4 /1 4

7 /1 4

Corporate Review

Argentina – Strong markets vs weak economy

Judicial Process & negotiations. The month has been dominated by the US Supreme Court’s ruling that prevents the Argentine from servicing the bonds issued in 2005 and 2010 as part of a restructuring. The decision raised the prospect of a fresh default but with the government showing willingness to negotiate with the holdouts, asset prices have since recovered. Equities also recovered. We hope that negotiations will finally materialize and will serve to avoid a technical default.

Activity. Again, in technical recession: While debt dispute has grabbed all the headlines, little attention has been given to the dire economic data. 1Q data confirmed that the economy slipped into a technical recession (0.8% q/q), and accelerated the pace of contraction (-0.5% q/q in 4Q13).

Market implications. Fx: Bearish. Target at 10. Current 8.14 Bonds: Bullish. Bonar 24 (USD-Local law) Yield at 9.48 and Global bond 17 (USD-NY law) Yield 9.55% Equity: Bullish. Argentine ADR in USD

G DP - ARG ENTIN A

2 0

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(% 1Q) GDP, T otal, 1993 Prices, SA, ARS - Argentina (Right) (% 1YR) GDP, Total, 1993 Prices, SA, ARS - Argentina (Left)

Andbank, Ministry of Economy

70 60 50 40 30 20 10 0 - 10 - 20

ARGENTINA - MONETARY BASE Monetization of deficit continues, but the increase in the money base does not flow into the economy at the same pace

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70 60 50 40 30 20 10 0 -10 -20

(MOV 1Y , % 1YR) Mo ne ta ry Bas e (MOV 1Y , % 1YR) M3 Andbank, Central Bank of Argentina

Corporate Review

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