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    201901 LatAm Insights Latin American Connections

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    33 views6 pages

    LatAm Insights Latin American Connections

    Uploaded by

    RCS_CFA
    Investment report

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    LatAm Insights (Minute eel Latin American Connections Connections are key. Fr our badies, a sound circulatory system to transport nutrients is important for healthy growth and repair. For economies, a robust logistics complex carries information, freight, and people. From the energy that powers ‘our alarm clocks and computers, to the freight that delivers, ‘our food to restaurants where we lunch, to the transit we take home, connections are all around us and ére a pivotal element. to power business and enhance quality of life. Likewise, inefficiencies bring aches, pains and suboptimal conditions for ‘bath economies and our bodies, stunting growth. In Latin America and the Caribbean (LAC), mediocre ‘governance and a high incidence of corruption have played important roles in holding back investment over the years. This has resulted in logistical inefficiencies, which have constrained productivity and competitiveness. However, the region does have pockets of strength, such as clean energy and strengthening digital connections, along with valuable potential, such as a growing workforce. Meanwiile, the political climate has begun to improve, with newly elected leaders focused on tacking graft and enhancing the business environment, While the region remains financially strapped ‘creating the right conditions could work wonders in attracting investment. LAC aspires to become a bigger player in advancing multilateralism and free trade in an evolving global economic landscape. To run, you need good circulation. A DEFICIENT CIRCULATION SYSTEM In the most recent assessment by the Intemational Monetary Fund (IMF), LAC’s stock of investment as a percent of gross domestic product (GDP) trailed all other regions at 19.0% (see Exhibit 1). It reflects, in part, a patchwork logistics infrastructure, il}suited to support the bloc’s aspiration to gain from a political stance stressing more free trade and ‘multilateralism. According to the World Bank’s 2018 Logistics Performance Index (LPI) of six developing country regions, LAC ranked second to last in the percentage of respondents rating its road system as “high or "very high quality and last {or its rail system, with zero percent expressing those views. 8S Merrill Lynch Bank of America Coporon vestments JANUARY 2019 Author "Rodrigo €, Serrano, CFA Director Exhibit 1: Prolonged lack of Investment isa lkely factor weighing on LatAris economic prospects ot) Eowgrg tnd Oneprg tors inet atin Iesrenta a 2 ” ” 8 5 soe NAN ig ia i s PEPE SLL ISLES SES LSS Sure aati Monetary Fur Data of Octobe 2018. Part ofthe problem may lie in the regions low transport density, which has resulted in large pockets of inaccessibilty. A study cited by the World Bank in 2017 revealed that Latin America's (Lat&m) road density, or kilometers of paved road per square kilometer of land, was second to last among regions at 005. This was slightly above Africa's (0.04) but ‘about one-quarter that of the next-lowest region, the Middle East (0.2). Topping the list was Japan at 5.50. Meanwhile, ‘The Economist notes that unpaved roads constitute more than 60% of the area's total, versus 46% in emerging Asia ‘economies and 17% in Europe. The bloc's rail density or kilometers of rail per thousand square Kilometers of land, was less than 5 compared to 16 for OECD countries (excluding Chile and Mexico)” The World Bank notes that LAC’s limited rall service is not seen as a substitute for road transport or even 2 complement to it, an observation confirmed by the LPI. Meanwhile, the advent of the “Digital Era” has raised public and private sector awareness of LatAm's cyber connections, * asl Aust Selgin Carada Chile, ach epulc Derma stn, Flan, force Germany Gece, Ranga lard lar ee ty ps area, Lnemboure Uesen the Netieands New Zealand Noy, Poland, Pru ‘Sank epe Sovena So Seder Sotztand Tne. he United Kingdom, ‘rd Unica Ses ‘Merl iyeh Weath Management kes axa products and senesced by Meni Lynch Pee Fane Sth xapoated INUIFAS) a gtd broker-dealer ané Member SIPC and other sbsiares of Bark of America Corporation (ROA Cp ‘re Not FDIC insured ‘May toe Value ‘re Not Bank Guranteed which are also underdeveloped, According to Cisco's 2018 Visual Networking Index (VNI), LatAm was forecast in 2017 to have the second-slowest average fixed broadband and mobile connection speeds at 11.7 and 49 megabits per second (Mbps) respectively, both slightly above the Middle East and Africa (7.8 and 44) but below the global averages of 39.0 and 8.7. Meanwhile, in 2017 the United Nations (UN) reported deficiencies in the region's equality of household internet access. While in general internet access based en income level has improved, the rura/urban divide remained wide, at 27, percentage points on average. Surprisingly the big economies of Brazil, Mexico, and Colombia were mostly to blame, all with a rift greater than 35 percentage points LATAM NOT A PRODUCTIVITY INCUBATOR ‘While insufficient capitals often cited asa reeson for LA's aling infrastructure, poor governance and corruption, which discourage investment, ie at the root ofthe problem. in our view. One need ‘not look further than Brazi’s Lava Jato or Car Wash investigation fora sense of the scope of the obstacle. Brazi's Odebrech, a corporate giant in construction has admitted paying nearly $800 milion in bribes to top-tier politicians and businessmen in over half of al Latin American countries, including Mexico, Argentina, Colombia, the Dominican Republic and Venezuela, Graft reduces confidence in political institutions. According to the Organisation for Economic Co-operation and Development (OECD), in 2015 almost 60% of Latin Americans said they were not content with the regioris democratic systems, while only 36% trusted election outcomes. Meanwhile the Inter-American Development Bank (IDB) in 2017 stated that LAC was the most violent zone in the world, estimating that the cost of crime to LAC countries, averaged roughly 3% of GDP. Lack of confidence and high levels of violence raise the rsk of political instability, Inefficient bureaucracy doesnt help. LAC ranks fifth out of seven regions in the World Bank’s 2019 Ease of Doing Business Survey. In Braz, on average It takes nearly a quarter ofthe year fora business to Prepare and pay its taxes, disbursing just over 65% of its profits. “Meanwhile it takes more than a year to secure a construction permit in Argentina just under a year. In Colombia, it takes just cover 35 years to resolve a commercial dispute inthe country’s cours. Industry structure can also be an impediment. The World Bank points to the regioris uncompetitive road transport sector, which is more concentrated than that of the US. by roughly a factor of 15 times, aising costs, ‘These shortcomings and lack of investment undercut productivity {growth and competitiveness, ultimately arresting improvements in the quality of life. Ths in tum feeds back into continued crime and violence, reducing LAC's allure for investment and leading toa vicious cycle, According to the Conference Board, LatAm's productivity growth has traled the broader Emerging Market and Developing Economies cof in all but two years since 2000 (see Exhibit 2). Meanviile the World Economic Foruris 2018 Global Competitiveness Report grades LAC fifth out af seven regional groups. In addition to highlighting weak institutions, it notes depressed business dynamism. The study asserts a strong correlation between its ranking of counties and their ablity to produce higher incornes per capita Exhibit 2: Investment and productivity go hand-in-hand, in our view Lannea —tnapre ttesandderepngtaromes — Wald —cECo Taare gente eg 3 a FPELE LEE ILE SSS IS SS Source Te Confrence Boar Oats 35 fNovebe 2018 ARE LATAM’S DIAMONDS IN THE ROUGH . Despite LACS rough edges, beneath lie valuable resources. For starters the region Is relatively young. The UN estimates that in 2017 it edged out Asia for the proportion of its population Under the age of 25, at 4296, which trailed only Africa’s 60%. Furthermore, the organization expects the blac to enjoy 2 “demographic dividend” over the coming decade as the Proportion of working-age adults grows relative to the non- working population in 2016, McKinsey Global institute (MG) also highlighted Latam's working-age population, citing it as ‘one of five key groups set to drive Future global consumgtion growth, With cities worldwide expected to produce 90% of consumer demand growth over the coming decade, MGI ranks Buenos Aires, Lima, Santiago, Monterrey, Bogota, Mexico City and Sao Paulo in its top 100 urban areas, which in aggregate are expected to account for 45% of urban consumption growth, Meanwtile, the World Bank points out that rising Financial penetration should result in higher credit usage, signifying untapped purchasing power. Furthermare, LAC's connections arerit all bad. The Economist notes that Chiles roads are seen as higher in quality than those of Belgium, New Zealand and China, Citizens inthe region are ‘also well-connected tothe electrical grid, which covers roughly ———— 96% of households, according to the World Bank. Those not hooked up are concentrate ina few countries. The sectors also graded as the cleanest of any region. In aggregate the bioc’s investment framework is well-regarded by the organization and is 2 diver behind accelerating investment in solar and wind, asthe area seeks to diversify fram hydroslectricy Uruguay’selectrity ‘and tlcom sectors score particularly well better than those of the United States and Canada, In the digtal sphere, while regional broadband and mobile connection speeds ae reatvly slow, internet penetration, or interet users as a percentage ofthe total popiation is catching up tothe OECD average. From 2007 to 2016, LAC saw a ise from 24% to S69 versus an increase from 67% to 819%6 forthe OECD cohort, shrinking the gap between the two, according to the UN, Mobile has been a driving force behind increased incusion,LAC's mobile subscriber penetration rete was higher than the global average in 2016 (70% versus 6696) and is expected to grow to 76% by 2020, compared to 72% wordwde according to GSM Associaton (GSMA). Leading the growth are Cube, Peru, Colombia, Mexico, and Ecuador, all with expected double-digit increases. Fueling the motile economy are rising adoption rates for smartphones. At 55% ofthe population in 2016, the region traled North America by 23 percentage points. By 2020, GSMA expects this gap to close to 10%, with LAC's adoption rat rising to 719% versus 619 in North America In response, the area's telcom firs have been busy ramping up 4G coverage, with Brazil in the lead. LAC's largest economy is expected to raise 46 from 10% of all connections in 2016 to 57% by 2020. The bloc as a whole has experienced impressive growth, from 0% of connections in 2012 to an estimate of just over 30% in 2078 and a projected 42% in 2020, closing the gap with the global average in the process. Cisco's VNI forecasts LAC topping global growth in mobile network speeds, with a compound annual growth rate (CAGR) of 30% from 2017 to 2022. Simultaneously, it sees global intemet protocol (IP) traffic expanding at a 26% CAGR, led by mobile data (469) and, in terms of regions, LatAm (4196). AS data flows increase, necessitating greater bandwicth, GSMA forecasts LAC to make stride in launching 5G coverage between 2020 and 2025. Coverage is expected to rise from 30 to 45% during this time. Adoption by users would accelerate once coverage reaches critical mass, with Argentina and Mexico expected to lead the way. Improving digital connections should help foster other industes ripe for growth in LAC in our view. Together with favorable demographics and expectations fr rising aggregate purchasing power, e-Commerce should remain a long-term leaer. Meanwhile Financial technology. or fintec, is a budding Industry, especially i Brazil, Mexico, Colombia and Argentina The area may offer a sacial impact investment opportunity to address LAC's underserved. According ta the World Bank, the region? ranks fifth out of seven in use of bank accounts, with almost 46% of adults lacking one versus the global average of about 32%, Beyond 2020, major LatAm economies such as Brazil and Mexico are already refining action plans or establishing associations, such as Colombia's Center of Excellence and Appropriation for the Internet of Things (lo). Use of these new technologies looks to center on ‘smart cities” and industrial applications. «SET TO BE EXTRACTED? Encouragingly with presidental elections in Braz, Mexico, and Colombia in 2018, the political cimate seems to be improving, wich may help boost investment. Brazllan President Bolsonaro was elected on a platform emphasizing the rule of law and less government involvement in the economy. In Mexico, President Obrador (known as AMLO) has also promised to reduce corruption while focusing on development, particularly in the nations impoverished southem territory. Meanwhile, in Peru, since last year’s replacement of Kuczynski~ who resigned under the weight of scandal allegations ~ President Vizcarra has clinched a popular referendum to present anti-caruntion proposals for legislative consideration and is focusing more on improving the nation’s rigid labor laws. Despite these positives, challenges remain, Mexico's AMLO has cancelled construction of the new Mexico City aitport, disappointing investors and raising uncertainty. Colombian President Duque, facing intense pushback, has been forced to retreat on his tax plan aimed at bettering the government's fiscal situation, while momentum bochind his anti-graft campaign has stalled. President Macr is bracing for a presidental election in October after scrambling last year to pul Argentina back from an economic precipice, dealing a blow to hig business-friendly agenda, Al inal the situation can be described as “two steps forward, one step back” and fluid, Globally the envionment may also benefit LAC. Tensions between the US. and China could spark a significant shift in _plobal supply chains; with potential secondary effects benefitting commodities ral and Argentina, malor producers of soybeans, ‘along with Mexico, Chile, Colombia and Peru members of the Pacific Allance trade bloc with diversified strengths 2nd resources, al stand to benefit from these profound changes. GREATER, EFFICIENT CONNECTIONS ARE NEEDED Continued improvement in the paltical imate may begin to attract greater investor interest In judicious improvements and, 2 exuding le — SS Kem _i.____ regions full potential Within urban areas, home to 60% of LAC’s population, trafic congestion has become a concem despite only 40% of the population owning an automabile, according to the World Bank In seeking to head off this intractable, growing probiem, development experts stress thinking In terms of moving people, not cars, Buenos Aires and Bogoté have introduced measures discouraging car use, such as parking and license plate restrictions while bolstering pedestrian wakways, mass transit and biecle infrastructure. Investments in areas such as the latter are cost-effective and can help create a social impact, as they ae heavily utlzed by lower-income citizens Regarding maritime and ports infrastructure, as well as airports, the Latin American Development Bank (CAF) forecasts that industrial modernization and diversification, together with a strengthening services sector, among other Factors, will require roughly $55 billion and $53 bilion in investment by 2040, respectively. For the maritime sector, CAF sees Central America and the Caribbean as the area suffering the largest gap between demand and capacity In the airport sector, roughly 70% of total Investment wil be needed in Brazil, Mexico and Colombia Many LAC governments ate likely to be hard-pressed financing solutions to these needs on their own. Falling commodity prices, which have declined nearly 70% since peaking in 2008, as ‘measured by the Bloomberg Commodity Index, have pressured ‘economic growth. To attract more investment, countries such as Argentina, Mexico, Colombia, Peru and Brazil have either strengthened or created their Public-Private Partnership frameworks. They have also depended on investments from ‘non-governmental organizations such as the World Bank, the IDB and CAF. Another potential financing trend can be seen in a Battle for influence, whereby the US¢ and China? are increasingly Investing in the region, CONCLUSION ver the years, an unfavorable political and business erwironment has hindered LAC’s ability to attract Investment, a significant constraint given the bloc’s limited fiscal resources, Deficiencies in key logistical infrastructure have added to costs, reducing the region's competitiveness and restraining econornic growth. However, uitimately investors are drawn to growth ‘opportunites, in our view. Through this lens, LAC’s shortcomings. could be seen as significant potential, especially in light of the propitious demographic trends and an improving political climate thus far. Meanwhile, as the fallout from an ongoing shift In US. Foreign policy continues, increased cooperation and steps towards strengthening globalization may bolster longer-term advantages for LAC. From a portfolio perspective, as a long-term investor itis Important to understand that asset class performance ebbs and flows. Winners today may not be afterwards: this is what makes diversification a hallmark of a sound investment strategy. In cur opinion within a strategic position in Foreign markets, LAC may provide intriguing entry points for long-term rvestors. Ina possible sig ofan improving outlook, MSCs LatAm index has outperformed the broader emerging markets space this year. {see Exhibit 3). Steps towards improving Is lglsties complex may raise the teritory’ productivity and competitiveness profile, ‘umning the region into a sprinter and contender in producing the opportunities of tomorrow. Exhibit 3: LatAm has shown resilience in the face of intense pressure on emerging markets cod Maman) = Mtn) ind — tens aetna oo _ & sa © mo Lili at REGRLRLRERLILRIR 0913 0 Sauce: Boob Cit Ivestmen fe Daa i » eterlofastructre tate atthe Unies of Syne and the Word Resources Insitute Ro Center for Sstamale Cis + Us pledges $1068 ior Cental mera souen Meno Asscated Press (Gece 18,2018 » Chinslons Are Powe Latin Aare Tech Boom loomber Saran @,2019) Markets in Review Total Ratums In USD (%)_ Total Retus in USD () Jen15, Prior One Price LeveiGT0 YTD Year eves 015 _Yesrend _yearag0 ie vei 10210235 Braaion 1037 —— Sa 1035 990, rei 1039 Hexion 1037 asi 7s6 756 Meio aris a) 81122 Colobian 1057 Tor 64861 Colonia eoug_—1o2 10278 Chean 10> 479479 4a Chile 1785 a7 aah Peavion 105 558517 480 Pers esa? L731 “Retuns fi = Nor Lacal Garengybased QT YTD Year Masi a8 2628169 tude 1s nae eM EMER 2539303032 EM sovereign 15 15 35 EM AggreRR Tong a1 41148 EM Coporate 1 110 int Developed Maret 8513838 “sapso9 pets 42a as “Europe ts gaa Total Returns in USD (3) rice Level Yo 1Yeer a rin esoas 020245 Wan13, lor One Copper 26545 02 02191 Levels per USO 2018" _Yearend_yearago “Wil Code sui) 147147142 rasan Real 3738732 “Bret Caf cost 128128 Mexian Fes 3007365 Ta86 “eld e640 07, oF at Colobin eso Fisz0s 520575 763950, Chien ese S748) 65360 6258 sauce Habre lvesont fe. aaa of ay 15,209 erwin Sl 353337 321 —_Pastperfrmance sno guarantee ef fature resus Economic & Market Forecasts Pee nee Real GDP growth (8) mies Consumer Pie Infiton, 6) ow BOWE 2019 2020 TOIGE 20196. DOE 20182019 ——*20208 Lam oy 13 ZL “1 3, a 2 = Beal 15 35, 30) 37 36 50 70 00 wexcs 20 10 49 a5 525 825 650 Degen 25 19 38 aa a0 200 3000. Colonia 26. 32 33 35 “425 5 500 Gile 38 34 24 30 275 375 425 Venera 200) 80 = = s = = : Gobal 38 35 2 7a 30 aaa a0 rer US. 25 25 2a 15 2 238 2a 7 ‘enegighiies a5 35 rT 33 39 666 535 B10 Dawasofaruay 1.2078 * Lahm Clegept uss end. pfod ifain exientina and enn Cenalbankaget at een here lable shore senha tisnopasblete est n anid Pease otetht these lator when eng sha em peromance resis nfs wth than one yee and prance) Tisch ‘emnperiomare mj not beached oe ge ee prs emer Frac reas rere ted ard shalt bere on as cso ue vests LatAm in Brief 1 Brazil: Since President Bolsonaro's electoral victory, economic confidence as improved, while long-term intrest ates have fallen, assisting credit growth. BofA Merril Lynch (2ofAML) Global Research ‘epecss these developments and growth inthe labor markt to alo {orsumption to continue diving eccnomic recovery producing growth in eal GDP of 35% in 2018, versus 15% expected for ast year Pent Up demand for fied-asset maintenance should make investment a secondary growth dver, Fr sustainably inthe grwth trajectory Bolsorar's adinstration would need to adevess the countrys precarious fiscal situation, staring with scil security reform, Peru BofAML Global Research expects no hikes this year fom the ental bank current 2.75% policy at, n part due to an expected slowdown in real GDP growrh fom 49% n 2018 to 3.3% tis yer. Offsectinga projected increase in private investment, among other factors. are the effets fram lower average metal prices wer investment onthe par of regional an local goverments due to seasonality, and fscl consolidation to adhere tothe fiscal ue, which alms to reduce the county's deficit to 196 by 2021 '= Mexico: BofAML Global Research expects 2019 real GDP growth of 1.0% due to plicy uncertainty at home and abroad alongside Aightened monetary and fiscal conditions. Ching investor confidence has beere AMLO's cancellation of Mexico Citys new apport, the potential for US. Congressional resistance tothe US -Canada-Mexico ‘race agreement nits current form, and US-China trade tensions Meanwhile, Basico is expected to keep its palicy rate at 825% ‘throughout the yes, while the governments primary fiscal surplus of 1% of GOP should act to iit overall government expensiture. On. ‘watch are the economic effects ofthe US. government shutdown and fuel shortages in Mexico, as AMLO has cracked down on fuel theft. 1 Colombia Tax hikes for consumers may presen a downside risk fer BofAML Global Researctis base case for 2019 real GDP growth of 32% Tax ets for businesses, which would aise investment and boost growth wort kickin uni 2020. Fiscal policy uncertainty could persist iol prices remain lo, gen the country’s restrictive Fiscal rule together with te recently passed but watered dow tax reform, INDEX DEFINITIONS ‘Bloomberg Commodity Index: The Blomberg Comes nex reflects commas ftues price moverants.t isa franc benerark designed to roid lqi and cversifod exposure tophyscalcemmossties i futures etc Th ines eles annual) weighted wo hid by adingvelome adored by ward podiction na weight cps are pple the commacity. stor an geup level for eherfaton Rol er plea ocr from th-10ch busines ay basen the rol schedule. 'MSCLatin America nex: The MSC EM atin Aerie ree Na weighed ety nde coving thereon vas dope ith base ue of 10 asf December 31 1987, ‘Msc1Bral Inde: The WSC Bol inde ia fee Most eg en nde covering county was developed with base valu of 10035 of Decerber 31,1987 MSCI Mexico Inder The MSO Mev Index ee ont weighted uty inde covering he count ews deoped wth abs vale of 100s of December 311967 MSC Colombia Inde: Th MSC Clombi ners free fas weighted aut index covering he county as eloped witha base vue of 100s December 311852, [MSCI hile Index: The WSCC Index freeos weighted equ index covering the county was derloped wih a base vale of 100as of December 311987. SCI Peru Index The MSC Pervndex i ee Poat weighted exude covering the county twas devlped with abuse valu of 100 as of December 311992, EM Asia: The SCI EM Asa Index free loa weighted equity index covering EM Asia twas deoped ith base vale of 100s of December 31,1987 EM EMEA: Th MSCl Emerging Europe, Middle Est nd Ai Inde isa feet weighed egy index The index was deroped withabase lie of 100 anda base dte of Decemier3t of 1938, " EM Aggregate: Te MSCEW (Emerging Mares Inde a eee weighted emt index that captures ge and mid cap representation across Emerging Mares (EM) cours The inde coves approximately 85% of there float used marke

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