Latin America: will Trump undermine an improved business environment?

Latin America is currently experiencing the retreat of the left, both in the jungle and at the ballot box. In 2016, Colombia’s peace agreement with the Fuerzas Armadas Revolucionarias de Colombia (FARC) – aka the revolutionary Armed Forces of Colombia – drove the final nail into the coffin of left-wing extremism in the region. The demobilisation of the region’s largest guerrilla group coincides with the ebbing of the left-wing so-called ‘Pink Tide’, which came to dominate the political landscape across Latin America during the 2000s.

As these movements have proved unable to deliver the economic growth required to foot their administrations’ ever-increasing social spending bills, voters are turning to alternatives that promise to maintain progressive social policies while introducing pro-market reforms. The growing trend towards centrism, however, is far from consolidated and the rise of populism and trade protectionism from a belligerent Trump administration in the US could fuel a revival of the left south of the Rio Grande.

Swing of the political pendulum moderates

Latin America’s political landscape has been historically dominated by sharp turns from the right to the left and vice versa. The political pendulum has often swung in conjunction with economic and/or social crises. As the Pink Tide struggled to maintain economic momentum, the rise of centre-right or right-wing parties appeared to confirm the continuation of the swings.

However, as democracy has become more entrenched in the region, voters have increasingly demanded that new governments do not eliminate outright the social programmes implemented by their predecessors. Instead, the new administrations have generally pursued a moderate middle ground that entails opening up to foreign and private investment, while maintaining strong state presence in social policy and focusing on the reduction of poverty and inequality.

In 2016, Peru offered an example of how the handover of power from president Ollanta Humala’s left-wing government – ousted after five years in power – to Pedro Pablo Kuczynski’s centrist model changed little for markets and foreign investors. In Colombia, the FARC’s demobilisation and reintegration to civilian and political life this year will not push a quintessentially stable and right-of-centre electorate towards the throngs of left-wing populism.

However, by reducing the threat of terrorism and opening up large swathes of Colombia to public and private investment, the peace agreement will inject new dynamism into the economy and provide the financial resources needed to tackle structural underdevelopment, poverty and inequality. Infrastructure and telecommunication projects will spearhead development, laying the groundwork for the expansion of other industries, such as mining, agriculture and retail.

Strikes and demonstrations remain top threat to business operations

In Pink Tide nations – principally Venezuela, Bolivia and Ecuador, and to a lesser extent also Brazil and Argentina – the combination of fiscal profligacy and the end of the commodities super-cycle has resulted in a steady widening of their current account balance. Indeed, Verisk Maplecroft expects countries where populist left-wing governments are failing to experience a significant deterioration in their risk score in the firm’s Civil Unrest Index (CUI) over the next two years.

In Venezuela, a deep political and economic crisis will ensure that the high level of disruption created by mass protests and violent confrontations will continue in 2017. The risk of disruption will also remain high in Ecuador; while Evo Morales’ open defiance of the electorate’s opposition to him seeking a further presidential term will drive a deterioration of stability in Bolivia.

In all three countries, the business environment will worsen before it improves. In Ecuador and Bolivia the transition to centrism is expected to be more gradual and to occur through several electoral cycles. Nonetheless, a rise in the number and frequency of social and labour conflicts will periodically disrupt operations. The escalation of demonstrations into violent confrontations will remain characteristic of Venezuela as the Partido Socialista Unido de Venezuela (PSUV) government adopts evermore radical and erratic policies in a bid to cling to power.

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A more pressing concern for investors, however, is the increasing risk of disruption to business in South America’s two largest economies: Argentina and Brazil. The CUI for the first quarter of 2017 shows deterioration in the score of both countries. This is because the respective administrations of Mauricio Macri and Michel Temer have so far failed to deliver economic growth.

In Argentina, inflation remains the president Macri’s main headache, while in Brazil unemployment will not peak until the third quarter of 2017 at the earliest. Therefore, the wave of optimism that dominated the countries’ political shift away from populism in 2016 – and put downward pressure on civil unrest risks – is quickly dissipating.

Nonetheless, political parties in Argentina and Brazil will increasingly prioritise long-term economic development over electorally motivated short-termism. In both countries, we can expect the liberalisation of markets where investment was curtailed by the previous administrations. Energy, telecoms and infrastructure will benefit most from the streamlining of competition legislation and a reduction in resource nationalism to attract investment.

Reforms to the burdensome tax and social security systems will reduce operating costs for business across all sectors. However, governments will have to maintain some highly expensive social spending programmes in order to keep social conflict risks in check. Such reforms will limit the pace of growth, but ensure that economic expansion is less volatile by keeping social spending within governments’ means and by maintaining macroeconomic stability.

The Trump effect

To the North, last November’s election of populist Republican Donald Trump is already beginning to put pressure on trade flows between the US and its key trade partners, particularly Mexico. The degree of disruption will be entirely dependent on how extreme Washington’s chosen policy path is and the response it elicits from Mexico City. But even if Mexican president Enrique Peña Nieto succeeds in moderating the White House’s position regarding the North American Free Trade Agreement (NAFTA) and the wall on the bilateral border, Trump’s belligerent rhetoric will strengthen anti-US sentiment south of the border.

Anti-Americanism is a quintessential feature of Latin America’s left-wing movements, with the US almost always blamed for the region’s underdevelopment and high inequality levels. In Mexico, Trump’s rhetoric is driving up support for the two-time left-wing presidential runner-up Andres Manuel Lopez Obrador, who stands a better chance of reaching the presidency in 2018 than ever before.

US policy could also provide a lifeline to populist left-wing leaders in South America, where centre-right, pro-US governments are racing against the clock to restore macroeconomic order before major elections. Faster monetary tightening in the US could put downward pressure on the economic recovery of Argentina and Brazil by increasing financing costs. The electorate’s shift towards moderate alternatives is far from consolidated in either country; if White House policies contribute to slowing down economic recovery, the revival of left-wing populist parties cannot be ruled out.

 

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