The new year
2014 has seen a major retreat from emerging markets as investors sold both what
they should and what they could. Having started with political turmoil in
Thailand and Turkey, the current train of worries has caught up with economic
basket cases like Argentina and Venezuela and policy sinners like Brazil.
A rising tide
lifts all boats, and during the last decade and a half, there were not one but
two powerful tides: ample global financial liquidity and booming demand for
commodities. Under such conditions, even lead-bottomed boats happily
bounced in the waves. But commodity demand slowed abruptly with the
advent of the Great Recession, and liquidity is no longer gushing except
perhaps in Japan.
In retrospect,
where did investors who bet on the lead-bottom boats go wrong? In particular,
where did political risk analysis err?
One big mistake
was failing to recognize the true goals of some incoming government
leaders. Hugo Chavez, like Lenin and Mao Tse-tung before him, was driven
by a strong ideology and was bent on thoroughly and irreversibly transforming
society. To these men, issues such as falling GDP, foreign trade and
international investment flows were of little concern. That is why the
first would decapitate PDVSA and expropriate local and foreign companies, the
second repudiate Russia's foreign debts and the third would carry out the
Cultural Revolution.
These leaders
were willing to incur international isolation, and even welcomed it, as a
necessary condition to reach their primary objective. In the case of
Venezuela, it is interesting to note that a handful of very prominent local
businessmen recognized this and took appropriate defensive measures early on,
while most major industrial and portfolio foreign investors didn’t.
To better
understand incoming leaders' goals, it is very useful to read their writings,
particularly those written in their youth[1][1].
Often, these writings are dismissed as erreurs
de jeunesse[1][2],
but when one considers the examples of Hugo Chavez and others, these men have
been remarkably true to their youthful aspirations. Budding emerging
market investors, when a new charismatic and/or transformational leader is
elected, DO look up his writings, whether these are one year or two decades old!
Culture and
history also play a strong role in appraising political risk. For
example, communist China and the Soviet Union were able to create new
structures that provided stability if not efficiency. These structures
were often based on similar ones that existed under prior regimes.
Venezuela, by contrast, has been unable to do the same.
Another useful
warning sign of future trouble is financial and economic policies that work at
cross purposes or governments that believe they can micro-manage their way to
prosperity. When policies start looking like a Cubist portrait,
beware! Examples include manipulating foreign exchange rates, inventing
subsidies of all kinds, introducing price controls, and of course decreeing
expropriations. The problem with these is that they scare away private
capital, without providing any substitute as government bureaucracies have
neither the financial nor the human resources to step into the void which they
created.
Where do we go
next? The truth is that, most developed and emerging countries will wait
until the very end before making reforms. Their governments will also
weigh their chances for survival, remembering Alexis de Tocqueville’s
observation that “the most dangerous time
for a bad government is when it starts to reform”. Eventual success
will be depend on abilities, ideologies, culture and closeness to the abyss.
Brazil
Its vastness,
its large population and its culture of moderation make it resistant to
extremism. While the Lula government represented a turn to the left and
adopted populist rhetoric, particularly in foreign policy, it didn't yield
to revolutionary temptations thanks to its trade union roots: unions fight to
improve the standards of living of their members, they don't trash the
productive apparatus. That historical link weakened somewhat under his successor,
Dilma Rousseff.
With the drop
in commodity prices and investors’ new risk aversion, the government must take
corrective measures to control public spending, reduce public debt and
stimulate growth. Recent popular demonstrations again lavish World Cup
expenditures will further drive that message home. Finally, the
government activism in the economy, particularly in Petrobras and the electric
sector, has proven disastrous: Petrobras, once again, has become a
bloated outfit with massive debts, a stagnant production and a crashing stock
price[1][3].
The electric utility sector, which is very reliant on hydroelectric power plants[1][4],
is operating near full capacity and subject to more frequent and massive blackouts.
There already
is a change of attitude (with President Rousseff first trip to the Davos WEF);
some policy changes are forthcoming ahead of next October general elections,
bigger ones will come afterwards whether Ms. Rousseff and the PT win or
lose. It is clear that the popular support which President Lula and the
PT enjoyed has since waned, that reforms are both needed and demanded. I
believe that they will materialize.
Venezuela
This is by far
the biggest problem in the region. The charismatic Chavez has been
replaced by a man of little charisma, authority and apparent talent. Much
has been written about the government’s disastrous economic and monetary
policies, the growing criminality and the accelerating breakdown of public
institutions and large economic units. Cuba, which plays a major role
with its extensive intelligence and security presence, is keeping a low profile
for now.
The
deterioration of the economy has accelerated so far in 2014, the acute shortage
of dollars is evident and the government has responded with what are
essentially threats rather than clear policies. China, already a major
creditor[1][5],
seems to have said “no mas”. In
the very short term, one can expect the government to further squeeze the local
private sector and to enter into selective default, paying its foreign
sovereign debt and little else.
Current
policies will lead to an economic collapse. Can this be avoided?
The opposition seems discouraged and in any case is ineffective; after all, it
has understood that it can’t defeat Chavismo through elections. The most
interesting commentary on Venezuelan politics has recently come from 94 year
old Luis Miquelina. A former communist, supporter of Fidel Castro, he was
an early supporter of Chavez serving as his justice and interior minister; he
also served as a senator and president of the Constituent Assembly of 1999.
In a recent
interview, Miquelina said the following:
- -Venezuela is now an
appendix of Cuba, which is unacceptable,
- -The current communist
government has destroyed the productive apparatus and private property rights,
and it has displayed corruption without limit,
- -There is no exit via
elections as these have proven to be fraudulent; the fight must be brought to
the streets,
- -The army is as much a
victim as the civilians and both must join forces,
- -There can’t be
negotiations with the government unless it is on the basis of rough equality of
power.
Interestingly,
the response to this blunt piece has been dead silence from all sides.
Although the
situation could turn volatile quickly, a popular revolt looks unlikely right
now. Nevertheless, the current regime could try to preempt this
eventuality by vesting governing powers into more capable hands. But who
has the credibility and power to reorganize inefficient public institutions and
companies, to renegotiate the onerous oil deal with Cuba, and to convince the
population to accept painful reforms? I think that Chavismo will give it
a try, perhaps attempting to co-opt some in the opposition, but in the end
there will have to be a collapse before there can be a revival.
So when you
look at the region, as I did through our last four posts, you will probably
share my conviction that Latin America will make headlines throughout
2014. You may also share my guarded optimism that the balance will tilt,
by a small margin, towards the positive.
[1]
These are not always easily available.
[2]
Litterally, errors of the youth.
[3]
Some 78% fall since the recapitalization of the company and the new
deep-offshore regulations were announced in 2009.
[4]
Brazil is also suffering from a dry spell which is affecting the water
reservoirs.
[5]
For about US$20 billion repayable in oil.
