Ce qui est bon pour la “goose” est bon pour le “gander”

Mafalda[1]

 

Over the last few weeks, a scandal without precedent has been engulfing Brazil.  I am referring to the so called petrolão at the center of which stands Petrobras.

Several years ago, a large vote buying scheme, the so called mensalão, threatened to bring down the Lula government.  But as a top Brazilian jurist noted recently, the mensalão amounted in total to R$170 million (US$65 million) while just one Petrobras executive is being asked to return R$250 million (US$95 million) in skimmed money.

The petrolão not only involved corrupt executives pocketing huge amounts of money but a well organized conspiration aimed at channeling 2% to 3% of the value of large investment contracts to the political parties in power, the PT, PMDB and PP.  Whether all the monies received by these parties were used for political purposes or partly appropriated by individuals remains to be seen. 

This couldn’t have worked without the complicity of the country top engineering and construction firms.  The inquiry into the petrolão soon unveiled the anti-competitive practices of these firms as they colluded to raise the value of contracts and take turns in winning them.

As Petrobras executives and their acolytes were offered reduced sentences for their cooperation, it came to light that the same corrupt practices extended to capital intensive sectors controlled by the state such as electric generation and railways.

Clearly, the most serious issue for Brazil is that its economic model has turned out to be fraught with inefficiencies, waste and corruption.  Since the extent of this scandal is yet to be determined, I will stick to Petrobras.

For many years, Petrobras was the cash cow of the state.  It was not unusual for it to make investments which were not the best use of its capital; it often “deworsifed” in fields where it didn’t have a particular expertise; more than one politician or ex-government official got his pension, or part of it, paid or complemented by Petrobras.

To get it into shape, President F. H. Cardoso partially privatized Petrobras in 2000[2].  He succeeded in the face of huge opposition, particularly from the PT and its leader, Mr. Lula da Silva.  The Cardoso administration even considered changing the company name to Petrobrax to dramatize the hoped for break with the past.

And for several years, it worked.  Thanks to its technical expertise and tighter management, the company made major offshore discoveries and achieved a good level of profitability.  These discoveries were made even more valuable by the global commodity boom.

The prospects of a highly profitable Petrobras, while welcome by minority shareholders didn’t go down well with President Lula; he publicly lamented that so much of Petrobras money was distributed to foreigners in the form of dividends.  Before the end of his second mandate, his government engineered a highly controversial capital increase, the purpose of which being to increase government control over the company.  Ironically, despite the bad press this operation received, the government didn’t succeed in gaining a two thirds majority of the voting common share capital.

Greater control over the company, both at the corporate level and via new offshore oil and gas legislation proved disastrous.  Petrobras was saddled with huge investment obligations which were beyond its financing and management capacities.  As a result, it embarked on a massive debt raising program while consistently missing its production commitments[3].  The new legislation also took away Petrobras’ ability to prioritize its offshore investments, giving that authority to a newly formed government agency.

Over the last years, global liquidity, rock-bottom interest rates and high oil prices let Petrobras borrow huge sums of money, and that pactole attracted the attention of many: as the French humorist Sasha Guitry once said, “I can resist everything except temptation”. The old practice of placing well connected people within the Petrobras hierarchy took a more ominous turn: as top executive positions - division heads – were allocated among the various political parties within the government coalition, it was just a (very) small step to use this connection to siphon money out.

The solution to this catastrophic situation is to privatize Petrobras, the French way.

Manolito may think he can’t speak French, but when it come to economic culture and policy, translating French into Brazilian Portuguese is very easy.

I have always been impressed by how France and Brazil converged in that regard: both countries have a strong centralized government and administration, large public sectors, share a vision of economic dirigisme[4] mixing interference with subsidized financing; finally, both like to nurture national champions.

Now, both know that politics and national oil champions shouldn’t mix. 

For many years, Elf Aquitaine was the French national oil champion, and that brought it rewards, such as the award of foreign oil concessions. In the early 1990s, it was very close to the government and often played an active role in French foreign policy in the Middle East and Africa.  In part, this was due to its history as Elf was born from the merger of two government agencies[5].  By comparison, the second largest oil company, Cie Française des Pétroles (later renamed Total) played second fiddle; Total was also run by a no-nonsense CEO who knew how to keep some distance with the French government. 

In 1994, all hell broke loose, when the press revealed that billions of dollars had been siphoned from Elf and spent on payments to African, European and French politicians as well as executive “perks”.  The story ended badly for Elf.  Its executives were brought to court and jailed, and it was absorbed by Total in 2000. 

Brazilians will immediately see a pattern here.

Mindful of the dangers of letting politicians too close to very rich companies, Total was privatized in a way which could and should apply to Petrobras.  The basic idea was that the company would be run as a major publicly held company by professional managers not state appointees.  To that end, the state would sell its majority stake down.  At the same time, steps would be taken to ensure that it would remain an effective national champion.

The initial step was to assemble a nucleus of stable, long term French institutional investors.  In the case of Petrobras, these institutions exist and include major pension funds, large banks and insurance companies.  They could hold 10% to 15% of the common shares[6].  The government would retain a large minority ownership and the balance of the shares would be allocated to retail and institutions both domestic and foreign.

The second step entails the state selling most of his shares in the company but retaining a golden share to veto such major decisions as change of control, bankruptcy or the sale of entire divisions such as refining, exploration, etc.  Total went public in 1991 with the French government holding a 30% stake.  That stake was gradually reduced to 1% by 1996.

Golden shares were declared illegal by European courts in 2003.  But there is little risk of a similar ruling in Brazil.  Indeed, given Brazilian politics and sensitivities, and the size of the financial commitments, I think that a golden share is necessary to facilitate a true privatization.  

It would be a monumental fight, but given the staggering and pervasive degree of corruption within the company and the threat to democracy that control of Petrobras clearly entails, a real privatization of Petrobras is not only feasible but crucial.

Ask any international oil company, it will tell you that Total is still very much the French national champion, that in large international project tenders, it enjoys the full backing and lobbying of the French administration.  But it is professionally run and Division Heads are not allocated among the Socialist, Green or other political party.

Little translation from French to Portuguese is needed; if the French can do it, so can the Brazilian.

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[1] - Manolito, did you know that my mother was a French translator?  I know French too; I know how to say “Papa” in French.

  - Really? OK, how do you say it?

  - Papa.

  - Ah, that’s easy, it’s the same.

  - Easy? The same?  No way, the trick is to think in French! Try to say “Papa” but thinking it in French! Go ahead! Let’s see? Go ahead!

  - It’s useless! I’ll never be able to speak that damn language.

[2]  However, he couldn’t overcome broad resistance to an effective privatization with the state losing control over the company.

[3]  In fairness, a Lula inspired policy raising local content for heavy  offshore equipment and machinery contributed to Petrobras’ delays and cost overruns.

[4]  Faith in government economic development planning, and generally a “government knows best” belief.

[5]  The Régie Autonome des Pétroles and the Société Nationale des Pétroles d’Aquitaine.

[6]   This percentage is suggested given the huge size of Petrobras and the likelihood that a true privatization would make it much more valuable.

Brazil’s uncertain future

Having won reelection by a thin margin, President Dilma Rousseff named Joaquim Levy as her new Finance minister.  This is good news, but it will not win over skeptics yet, of which I am.  The reason is that a finance minister is only as good as the support he receives from his president, and in Mr. Levy’s case, it is half-hearted.  Even then, Mr. Levy will face widespread opposition from many within the government and the PT structure.  Mrs. Rousseff has never been a political operator by choice, nor is she the PT leader (former president Lula is).  The PT will let the new minister work only if it views it as its salvation.  Since the PSDB will not morph into the PSDB or a Brazilian version of Germany’s CDU, skepticism is allowed.

Mr. Levy comes in with a strong resume.  He is technically a Chicago Boy having earned his PhD in economics there.  He  has broad experience, having worked at the IMF, the IADB and the ECB.  From 2000 to 2003, he worked at the Ministry of Finance of then President F. H. Cardoso.  He has also been Finance Secretary of the State of Rio de Janeiro, and more importantly Treasury chief from 2003 to 2006 under President Lula da Silva.

That last job came at a crucial moment in Brazilian political and economic history.  President Lula’s election had just caused financial markets to tumble on the expectation of rising social spending and out of control public sector growth.  And markets had every reason to worry.  Mr. Lula had campaigned as an angry populist in 1988 and again in 1998.  In 2003, he succeeded President Fernando Henrique Cardoso who had stabilized the economy after two decades of crisis, yet barely avoided a financial panic in 1998-1999[1].  It was a close call but orthodox economic and financial policies prevailed in 2003, for two reasons.  First, President Lula couldn't hope to carry out his social reforms if he had a major crisis on his hands (and that was what the markets expected).  Second, the global commodity boom had not started yet and Brazil didn't benefit from an influx of foreign direct investment in mining or oil and gas, nor from the export revenues from these products.

Credit then Minister of Finance Palocci and Treasury chief Levy for convincing President Lula to adopt and stick to orthodox financial policies.

I wrote this rather long introduction for two reasons: 1) to show that Mr. Levy is eminently experienced and capable and in no way a political crony, and 2) to show that there are similarities between the economic conditions of 2003 and 2014 that led populist left wing presidents to choose economic orthodoxy.

Then and now, Brazil was facing challenges, then and now the elected president needed to (re)gain credibility.  Initially, Minister Levy will benefit from the support of both the PT leader (ex President Lula) and current President Rousseff.  But to what  

If history is any guide, Minister Levy may propose tax increases as well as cuts in public investments and even social programs.  He already suggested that the National Treasury shouldn't finance itself at 11.5% p.a. (Selic short-term rate) to fund BNDES loans at less than half that rate.  I have always found this policy highly destructive, akin to a driver stepping on both the brakes and the accelerator at the same time.  I hope he succeeds. 

Already, the Brazilian stock market has fallen in fear of potential tax increases.  Likely financial tightening will reinforce that trend.  He will also have to contend with the new Planning Minister, Nelson Barbosa, a firm believer in the government intervention (and money) to foster economic development.  As for the PT, given the already excessive level of inflation, Mr. Levy can expect a battle royale when the time comes to set minimum salary increases and social program budgets.

The current economic climate will allow Minister Levy little leeway.  Falling commodity prices have hurt the trade balance: for the first 11 months of 2014, Brazil registered a trade deficit of $4.2 billion, the worst since 1998.  In November 2014, exports fell 25% compared to their November 2013 level.  On the import side, both consumer and capital goods fell but purchases of oil derivatives and lubricants rose.

The situation is hardly better on the domestic front.  The latest forecast of the central government is for a 2014 primary budgetary surplus of 10 billion reals, or some 0.2% of GDP.  This is less than the previous goal of an 80 billion reals surplus and is contingent on amending post facto the budgetary law to, in effect, lower the bar.  The government is currently encountering difficulties in having such amendment voted and is offering congressmen supplemental discretionary budgetary allocations in exchange for their vote...Minister Levy is on record that he wants to raise the primary surplust to 1.2% of GDP in 2015 and eventually to 2%.

As if it weren't enough, Minister Levy will also have to deal with the Petrobras fallout.  That is because the company is not only overly indebted (at around $170 billion) but since it is unable to publish audited financials due to a major corruption scandal, it will likely need to borrow from BNDES.  Making a bad situation worse, falling oil prices will squeeze the company and all this will call for drastic action and reform.  Minister Levy is likely to ruffle, not to say scorch many feathers in the process.

As much credibility as the new minister enjoys, Brazil needs to make profound changes to return to sustainable economic growth.  These include shrinking the public sector, undoing the de facto nationalization of Petrobras, Eletrobras and to some extent, of Vale.  Brazil also requires a greater opening of the economy to foreign competition.  Without them, gross mis allocation of capital and endemic corruption will hold Brazil back.  Such reforms are political in nature and go far beyond the competency of the Minister of Finance.

What does the future hold for Minister Levy?

Given the mounting size of the Petrobras scandal and its likely extension to other state-controlled companies and sectors, and the revelation that these money schemes benefitted the PT so much as to call into question its legitimacy and that of President Rousseff’s reelection  (a charge already made by opposition leader A. Neves), Mr. Levy will find some initial freedom of action.  It could last a couple of years, but beyond that?

Mr. Levy’s remedies and policies, while appropriate, are the exact opposite of what the PT wants and what President Rousseff has supported in the past. He can help with emergency measures while offering deniability: after all, he is not a PT member or “even” a politician but a technocrat.  But once the worst is avoided, policy choices have to made, which by definition are no longer life and death decisions but political choices.

Perhaps the one important unknown is what former President Lula has in mind.  His health seems good, and like his Uruguayan homologue Tabare Vasquez, he may want to seek reelection.  If this is the case, and given that another commodity boom doesn't look imminent, Mr. Levy may have more time and support to reform Brazil.

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[1]  That was caused by the Asian Crisis but also by the incendiary campaign speeches of presidential candidate Lula da Silva.

Miles Gloriosus Redux

Ever since they have sat around a fire, or in comfortable candle-lit theaters, humans have enjoyed good comedies.  A recurring target of laughter has been he who indulged in hyperbole;  Plautus’ Miles Gloriosus, the Commedia dell’ Arte’s Matamoros and Theophile Gautier’s Capitaine Fracasse, one character for the ages.

For some reason, I was reminded of this transcendental “hero” when I read Argentina’s economy minister declare yesterday: “We are not going to sign any agreement that compromises the future of the Argentine people”[1].

Was the minister was referring to a demand made at gun point by a world power to grab the country’s oil and gas deposits or to blockade its grain exports lest it can set its own prices?  No, the minister was referring to his refusal to pay some $1.5billion of sovereign debt and interest thereon to investors[2] who refused to accept the “restructuring” terms imposed in 2004 by the Argentine government! 

Well, restructuring is perhaps misleading...  Before 2004, when countries were unable to repay their debts as originally agreed, they negotiated; that was in the interest of all parties.  The Brady bonds which were issued in 1990-1994 to restructure the debts of most Latin American sovereign debts[3] included an estimated forgiveness or “haircut” of 30% to 40%[4].  In 1998, Russia broke with tradition by insisting on a haircut of about 55%; there again, the eventual loss was much lower.

Argentina decided to go for a 75% haircut!  In my mind, that was tantamount to reneging on its obligations.  Why did they get away with it?  For two reasons: 1) Argentina’s was an isolated country default at the time rather than part of a wider regional or global meltdown, so that institutional creditors had more capacity to take losses, and 2) unlike in the 1980s and 1990s, Argentina’s debts were mostly in the form of bonds which were widely held - including famously by Italian pensioners - and traded; the creditors were thus in a weaker bargaining position.

Being traded at very low prices, some of these bonds were acquired by vulture funds which bet that, since under New York law, one party to a contract cannot amend it unilaterally, they stood a good chance to get paid.  It has taken them a decade, but they seem close to their goal.

Ironically, there has been much hand-wringing by states, money-center banks and even the IMF of all people, that the legal travails of Argentina are bad for the global financial system because they show that orderly restructurings are not feasible.  “Experts” have suggested including cram-down clauses[5] in the borrowing contracts; local “experts” have suggested that sovereign debtors borrow under their own laws so that they could amend them to suit their debt service ability (or willingness).

It is true that the investor base of emerging markets bonds is much broader than it was thirty years ago, making it more difficult to obtain unanimity in case contracts need to be amended.  But the application of New York law and the absence of cram-down clauses have also permitted emerging countries to borrow at very low rates.  If a debtor in difficulty proposes a rescheduling that matches its future capacity to pay, chances are that there should not be much room for arbitrage; and if some creditors opt out, they should represent a small enough percentage to be bought out.

A financial system allowing sovereign debtors to legally renege on their obligations by taking refuge behind their own laws or generous cram-down clauses cannot work: not for institutional traders (who couldn’t count on always finding willing buyers with whom to close their positions), not for investors (who would face too many unknowns to make long term commitments) nor for borrowers (who would have to pay much higher interest rates).

Finally, let us put Argentina’s cries (or bravado) in perspective: because of its defaults of 1983 and 2001, I don’t believe that Argentina has repaid any sovereign 10 year loan or bond issued between 1974 and now according to its original terms.

So the Argentine debt saga will go on for a while at least.  Over the last decade, its economy has continued to deteriorate, not just because the country couldn’t access international financial markets, but because its government practiced policies, from price fixing to expropriation and debt renegation, which discouraged investment from locals and foreigners alike and distorted the country’s economy and finances.

Nothing to brag about.

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[1]   As reported by the Financial Times on 7/31/14.

[2]   Mostly Elliott Management Corp. after they had bought them from previous creditors.

[3]   Non Latin American countries also issued Brady bonds.

[4]   Estimated because it depended on the level of future US Treasury yields and Libor rates as the Bradies were priced off them.  In reality, as US interest rates dropped continuously in the 1990s and 2000s, the eventual loss to creditors  (if they had held on to the paper) was much less.

[5]   Such clauses would permit the debtor to force new repayment terms on its creditors provided they had been accepted by a minimum proportion of them (15% to 25%).

The Standard Chartered saga revisited

Two years ago, Standard Chartered plc made headlines when it was fined $667 million by the US federal and New York state authorities for laundering, including through its New York unit, some $250 billion on behalf of Iran, Sudan, Libya and other countries in violation of American sanctions.

Going a long way to explain how the bank got into its regulatory travails was the memorable line attributed to its then Chief Financial Officer: “who these f*** Americans think they are to tell us what to do”.  Not only did the bank hide its illegal dealings, it obfuscated (before being forced to cooperate) and even threatened to countersue the NY Department of Financial Services for causing damage to its reputation!

Back in August of 2012, I wrote that Standard’s difficulties stemmed from either a culture harking back to the Indian colonial days or the need to preserve a business overly dependent on risky emerging markets (EMs).  Either way, although its stock price had then fallen in the mid 1300s[1], I felt that the conditions were not met to justify investing in the stock.

Today the stock is at 1,218p, yet I don’t feel tempted to buy. First semester 2014 net income is expected to be down 20% year-on-year[2], full year 2013 net income was down 15% from the year before, and 2012 net income was essentially flat with 2011; return on common equity has been trending down steadily since 2004[3]; loan impairments have been rising (+35% in 2013)[4].  Finally, the business risk profile of the bank remains, in my opinion, high, with close to ¾ of its loan book in emerging markets as well as almost all of its profits[5].

Culturally, and despite some senior management reshuffling since the 2012 fiasco, not much has changed according to a Financial Times article of 7/24/14 which noted “widespread criticism that the bank is run like a colonial empire” and that “arrogance at the bank has got so high”.

Criticism from large shareholders has mounted, so much so that the bank’s board felt obliged yesterday to issue a press release reiterating its support for the current CEO; and last May, 41% of voting shareholders rejected the new management pay policy.  It may well be that the bank owners will force a change in management; but that does not guarantee a change in culture.  Culture in an institution that spans vast regions and whose Country Heads are generally all powerful (because they possesses far more local knowledge than Head Office does), is hard to reshape.

More crucially, I believe that Standard Chartered is following a high risk strategy by being so dependent on emerging markets, particularly Asia.  I have some experience in this, having spent my banking career with a bank (American Express Bank Ltd) which had a similar emerging markets focus, although with greater regional diversification[6].

China and Hong Kong are the single largest business focus of Standard Chartered.  While I am sure that its country officers have good knowledge of their local customers and counterparts, I don’t think that they have a comparable knowledge of the macroeconomics or politics, because nobody really does. That is a big risk that the bank is assuming.

While emerging markets have had faster economic growth than the developed ones over the span of several decades, they also have had more crises and these have been more severe[7].  These crises have also tended to spread from one emerging market to another as individuals and institutions rush out to cut risk.

Because of their inherent leverage, banks are most exposed to financial and economic crises.  When such crises hit emerging markets, the big international money center banks can usually count on their large home businesses to absorb EMs losses; this was evidenced by the Latin American crisis of the 1980s, the Mexican crisis of 1994 and the Asian crisis of 1997-1998.  But a bank such as Standard Chartered has no large home market to fall back on, and should such an EM crisis come about, it will find that EM central banks have neither the resources nor the inclination to save foreign banking institutions operating on their soil.

So while Standard Chartered looks cheap, it remains, in my view, beset by two big problems: (1) “tainted” management team and culture, and (2) overexposure to emerging markets.  The first problem may soon see the beginning of a solution, but changing a culture takes time.  The business strategy is much more complicated (and costly) to fix, and some of the biggest macro risk factors affecting the bank are very difficult to assess.

JP Morgan has better management, a lower risk profile and better profitability, and it sells for 1.06x book value and 1.45x tangible book value.  Standard Chartered sells for 1.11x and 1.31x[8] respectively.  Is that logical?  I don’t think so.  In my opinion, STAN should probably sell at a 25% valuation discount to JPM.  This would put STAN stock price at 878p to 912p.

I remain on the sidelines, neither owning not shorting the stock.

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[1]  After recovering from a precipitous drop to 1,228p on 8/7/12.

[2]   As per management preannouncement.

[3]   Source: Bloomberg.

[4]   Source: JP Morgan.

[5]  It is estimated that close to 70% of the profits come from Asia and the subcontinent and another 25% from Africa and the Middle East.

[6]   Coincidentally, American Express Bank Ltd was sold to Standard Chartered in 2007.

[7]   Obviously, the US and Europe have just had a very severe crisis, but I would argue that it has forced them to take remedial measures.

[8]   Based on end of year 2013 tangible and overall book value.

Latin America’s long unfinished journey

In his autobiography, The accidental president, F.H. Cardoso[1] recalls an Ibero-American summit held in Havana in 1999.  At the luncheon attended by heads of state only, after copious libations, one guest suddenly stood up and addressed their host:

- “Damn it, Fidel, What are you going to do about this lousy, piece-of-shit island of yours?

Castro’s jaw dropped.

-“We’re sick of apologizing for you all the time, Fidel…It’s getting embarrassing…What are you going to do?”

Six or seven other heads of state out of the dozen present took turn making similarly heated challenges.  According to F.H Cardoso, this was all done “with relatively good humor” but the message was serious.  Castro responded with a pirouette and the conversation moved on.

Two things are fascinating about this anecdote: one is that President Cardoso, himself a Latin and a highly talented sociologist, went on to write that despite their leftist leanings, leaders such as N. Kirchner, E. Morales, and yes, even H. Chavez, would reject the Cuban model and find that they had no alternative but that of working with the capitalist free-market system.  Another is that F. H. Cardoso thought that “Chavez’ eccentricities were intended to appeal to his domestic audience and not an expression of ideology”.  He proved wrong on both counts.

Fast forward to April 28, 2014 and an article authored by Moises Naim[2] in the Financial Times.  In it, M. Naim detailed the enormous influence that Cuba has gained in the economy, external trade, internal security, social programs and the oil industry of Venezuela.  He ends up with another telling anecdote by recalling what the minister of defense of a Latin American country told him:

-“During a meeting with high-ranking Venezuelan officers we reached several agreements on cooperation and other matters. Then three advisers with a distinctive Cuban accent joined the meeting and proceeded to change all we had agreed.  The Venezuelan generals were clearly embarrassed but didn’t say a word…Clearly the Cubans run the show”.

What happened?  How did such a well informed and intelligent man as F. H. Cardoso got it wrong?  How did Cuba not only survive but attain its highest level of regional influence and power ever?  What does it say about the future of Latin America and the risk factors for investors?

In my view, one has to start with two fundamental factors.

The first is the boom in commodity demand which started in late 2003.  The following table shows how much commodity prices have risen since then:

	12/03 to 6/08	12/03 to 12/13
Copper	270%	220%
Iron Ore	340%	860%
Thermal Coal, Australia	370%	150%
Gold	110%	200%
Crude Oil, Brent	340%	270%
Beef	20%	75%
Wheat	110%	66%

In many Latin American countries, the resulting profit windfalls largely accrued to government owned or controlled companies.  This helped populist sitting presidents to consolidate their hold on power by distributing monies via subsidies and/or by greatly increasing the public sector headcounts.  The temptation to access all that money even led some governments to (re)nationalize or expropriate foreign company owners.  In sum, the commodity boom, paradoxically, helped consolidate the power of sitting, left-leaning, presidents and diminished the need to foster competitive and growing private sectors.

The second factor is one that some people are driven by a strong, unbending, ideology.  Generally, such radical views are adhered to, more or less openly, throughout adult life.  This is why it is important to research the writings of upcoming politicians, particularly those produced in their youth: such writings are often less guarded than later ones and thus more enlightening.

To ideological leaders, transforming society, even at a great cost, is more important than incrementally improving the economy; and since they already know the Truth, there is no point diluting it or delaying its coming through the vagaries of the democratic process.  It is no wonder that a liberal and pragmatic statesman like Cardoso would find such thinking alien and therefore unlikely to succeed[3].   Hugo Chavez was the best example of an ideological, transformational leader, who also was in the best position to capitalize on the commodity boom.

But commodity booms and populist leaders do not fully explain the resurgence of Cuba in Latin America.  There again, we should look at this issue on two levels:  Venezuela and the region.

Cuba had long eyed the oil riches of Venezuela, reportedly since the early 1960s[4].  That interest, together with a shared ideology and the personalities of Fidel Castro and Hugo Chavez, essentially explains the extraordinarily close association – some might call it symbiosis – between Cuba and Venezuela.  The tangible benefits for Cuba have considerable: total 2008 annual Venezuelan aid to Cuba has been estimated at about $10 billion[5].

Cuba’s regional resurgence has been helped by the financial largesse of Hugo Chavez as well as his staunch personal support; the Venezuelan president was after all from a younger generation, like Nestor Kirchner, Rafael Correa and Evo Morales; but unlike them, he was charismatic and had a big checkbook.  For those in Latin America in search of an anti-US, anti-liberalism standard bearer, Hugo Chavez was thus a fresher face and carried less baggage than Fidel Castro. 

Looking ahead, the future of Latin America is less bright than imagined during the commodity boom of the last decade, but it is not uniform across the region.

As we already noted, money from higher commodity prices helped populist leaders consolidate their hold on power.  This lever is no longer available.  But others remain: demography, where most countries have very young populations; better organization, where progressive or leftwing parties have proven more effective at rallying votes than their more conservative opponents; finally, culture, which changes only very slowly.  Add to these factors a certain anti-American sentiment, which is never far under the surface in Latin America.

As the Venezuelan Pactolus has shrunk, smaller countries such as Bolivia and Ecuador have toned down their anti-investor policies.  But large countries will not change so smoothly or quickly:  faced with critical economic and financial challenges, Argentina has made some key cabinet changes and tried to steer a more pragmatic course.  The Argentine political scene is lively and resilient, and the opposition(s) does count on recognizable leaders; while Peronism is ingrained in the culture, local conditions allow for political alternance. 

Brazil is much bigger, population-wise, and while culturally more diverse, it is less fractious.  Over time, the PT - the governing political party – has evolved, drifting from its trade union roots to incorporate more left-wing political activists less interested in working within the liberal system than in getting rid of it.  That drift, combined with poor macro-economic performance and the vicissitudes inherent to a long stay in power, have sapped its national support.  The opposition parties have brought to light a series of large and embarrassing scandals.  But while some change for the better is to be expected in economic policy, the absence of a single and popular opposition presidential candidate, and therefore of a coherent message, dampens hopes for major progress.

Colombia is facing its own challenge, namely, what to do with the FARC.  Unlike its predecessor, President Santos decided to accept a peace negotiation in Havana and has relaxed the pressure on these armed groups.  The results so far are poor: as measured by attacks on pipelines, domestic security has clearly worsened, and these attacks are taking a heavy economic and financial toll on the oil and gas sector, the most important contributor to national exports.  There is little popular support to let the FARC rejoin political life as a party, or to pardon its leaders.  Finally, it is difficult to imagine that Cuba and Venezuela, the facilitators of the peace negotiation, will want any outcome other than a favorable one to the FARC, putting them at odds with the vast majority of the population.  The economy of Colombia remains robust, but, in my view, has become more fragile.  Peace may still be found with the FARC, but I think that it will be after stepped up military efforts to improve security and weaken the rebel groups.

Chile is following its traditional contra-cyclical path, trending downward as Brazil and Argentina appear on the verge of trending up.  I have reviewed in earlier notes what is troublesome with Chilean politics today, namely a turn towards more populism, less dialogue across the aisles and economic policies which are not pro-growth. 

As for Peru, it has been the Rodney Dangerfield of Latin America, posting impressive and consistent economic growth.  A fiery candidate, Ollanta Humala has proven to be a pragmatic president and the initial skeptics (including me) wrong.  Besides its very large mining industry, Peru has developed a competitive agricultural sector and boosted oil and gas exploration and production.  Its long-term economic success is finally being recognized and should continue so long as successive governments keep finding the right balance between growth and income redistribution.

What about Cuba?  Hugo Chavez is no longer here to bolster its elderly historical leaders and Venezuela is no longer financially able to prop up its economy to the extent it did a few years ago.  Preferential oil shipments from Venezuela have reportedly been reduced by one third since 2008.  Latin American leaders have not publicly criticized the Cuban security and military interference in Venezuela, but it is unlikely that they support it, especially when there is no strong Venezuelan presidential figure to make it appear less threatening. 

Besides the potential political backlash, should Brazil and Argentina elect centrist presidents, Cuba faces a greater headache which is how it manages its symbiotic relation with Venezuela.  30,000 to 50,000 Cuban security, military, medical, IT, trade and other staff are reportedly in Venezuela.  These people live in a freer, richer country where corruption is rampant.  How will they react?  If history is any guide, from Alexander the Great to Ancient Rome to Victorian England, military victors, once they turn occupiers, tend to absorb the culture of the conquered.  Can Cuba repatriate these tens of thousands of men and women without risk?  And until it does, or doesn’t, how can it manage its close involvement with Venezuela?

Another growing headache is the continuing popular protests and their violent repression in Venezuela.  As shown on social media, this repression appears to be carried out by local police and militia units.  But if the protests escalate, there inevitably will be a risk of a loss of control by the Venezuelan government and the temptation to step up the violence.  What will Cuba do?

Finally, neither the Chavista movement nor the opposition is united, so that the political and power dynamics are fluid, to say the least.  Until it can secure an alternative path, Cuba must preserve whatever manna Venezuela sends its way, which means that, as the Venezuelan economy worsens, Cuba must get more involved into local affairs, with the attending risks already mentioned.  In the end, I believe that Cuba will join-  or fall into - the NAFTA orbit, because it is its most natural trajectory, geographically, historically, economically and strategically.  When it does, a page will be turned in Latin America.

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[1]   President of Brazil from 1995 to 2002.

[2]   Former Venezuelan minister of industry and trade.

[3]  To his credit, F. H. Cardoso stopped all contacts with Fidel Castro when the latter cracked down on dissidents in 2003.

[4]   According to British historian Hugh Thomas, Fidel Castro met with Venezuelan president R. Betancourt and asked for a $300 million loan and oil assistance package, both of which were refused.

[5]  Special Report on South South Cooperation 2010 by Carlos Antonio Romero.