Rating agency Standard & Poor's provides its most recent analyses on Latin America.

The terrorist attacks on the US on 11 September 2001 will generate additional pressure on Latin American economies with potential ramifications for creditworthiness.

Although a generalised selling off of Latin American bonds has not been observed, Standard & Poor's expects increased risk aversion and flight to quality to impair emerging market access to external financing, be it via cross-border borrowing or foreign direct investment. While Latin American sovereigns' ratings already incorporate their exposure to confidence-sensitive flows, the current shock, which will deepen the economic slowdown, poses a greater challenge to these countries. The heightened prospects of economic recession globally will compound the weak conditions in Latin America. At this time, no rating or outlook changes are being undertaken. As with all exogenous developments, Standard & Poor's is evaluating the capacity and willingness of policymakers to craft and implement meaningful responses.

A survey of the Latin American sovereigns' vulnerabilities centres on a few points:

  • over the short and medium term, the cost of capital for emerging markets countries could increase significantly. Although the duration and depth of investors' risk aversion is unknown, certainly those countries that need to tap the capital markets in coming months will be affected;
  • upcoming congressional and presidential elections in several countries, e.g., Argentina (single-'B'-minus/Negative/single-'C'), Bolivia (single-'B'-plus/Stable/single-'B'), Brazil (double-'B'-minus/Negative/single-'B'), Colombia (double- ‘B'/Negative/single- ‘B'), Costa Rica (double- ‘B'/Positive/single-'B'), and Ecuador (triple-'C'-plus/Negative/single-'C') will make the adoption of tough policy measures more difficult;
  • an economic recovery in many of these countries will be hampered by reduced consumer confidence, limited availability of domestic credit, weak trade prospects and unfavourable commodity prices; and
  • policy response through adequate fiscal, monetary and exchange rate measures remains key to managing the challenges mentioned above.

    Latin American sovereigns have already experienced muted investor sentiment during the past year, particularly since the Argentine crisis hit most soundly in March 2001. In most cases, investors' risk aversion has been demonstrated via a higher cost of borrowing, or, as in the case of Argentina, a loss of access to international capital markets.

    Nonetheless, risk aversion is likely to persist over the near term, leaving most vulnerable countries that face large external financing gaps relative to official foreign exchange reserves. Those countries most keenly exposed are Brazil, Costa Rica, and Panama (double- ‘B'-plus/Stable/single- ‘B'). For example, Brazil's forecasted gross external financing requirements are estimated at $80bn for 2002, or 310% of international reserves, of which foreign direct investment is expected to cover about $12bn-$15bn. Only $5bn of the medium- and long-term amortizations due are attributable to the central government, with the vast amount owed by the private sector. The government can manage its exposure, particularly in light of its $15bn IMF program. If the corporate sector fails to fulfil its financing needs, however, the value of the real, which has depreciated 37% during the past nine months, would slip further, placing additional pressure on the country's debt dynamics. Similarly, Costa Rica's exposure to the vagaries of international markets in 2002 poses some problems. Costa Rica's gross external financing requirement for the year equals approximately $3bn and reserves total $1.3bn. While Panama has a large amortization due in 2002 – $750m – of which about one-third has been prefunded, the country's stronger credit profile and market acceptance should bolster its ability to fund its financing gap. Ecuador's external financing needs are heavy. In Standard & Poor's opinion, Ecuador continues to remain dependent on access to official sources and Paris Club debt relief, a position not inconsistent with the country's outstanding foreign currency rating of triple-'C'-plus.

    Other sovereigns are relatively well placed to manage illiquidity over the next nine months. For example, the Republic of Colombia has prefunded 50% of its 2002 external debt requirements due to earlier concerns about market access and volatility during an election year. Given the mega bond restructuring undertaken earlier this year, along with the availability of IMF financing, Argentina does not anticipate accessing the external markets until the third quarter of 2002. Moreover, the single- ‘B'-minus rating assigned to the Republic of Argentina anticipates difficulties in obtaining financing. Mexico's gross external financing needs for 2002 are manageable, especially in the context of its favourable market access and debt profile.

    Flows of foreign direct investment are also likely to remain under pressure in 2002, as has been the case in some countries in 2001. Brazil received $30bn of foreign direct investment (FDI) in 2000 and a forecast $20bn for 2001. The amount received to date is $15.9bn. For 2002, Standard & Poor's now expects a further drop to approximately $12bn-$15bn. Alternatively, FDI in Mexico (double- ‘B'-plus/Positive/single- ‘B') has been extremely strong in 2001, rising to $20bn from $13bn in 2000. However, privatization in some sectors in Mexico, such as portions of the airport system, and the power sector in Peru and elsewhere, is being delayed.

    Another adverse effect stemming from the tragic events of 11 September is the prospect for an even weaker world economy than has been experienced so far in 2001. Already, the growth outlook for Latin America had been ratcheted down several times, and prior to September Standard & Poor's was forecasting GDP expansion of 1.9%. Now most forecasters expect a further aggravation of this situation. Standard & Poor's expects growth of 1.4%, although a handful of Andean nations are performing above average (e.g., Ecuador's growth outlook for 2001 is about 5%). With the exception of Mexico, current account inflows (exports of goods and services, income and transfers) do not comprise a large proportion of the activity of the larger Latin American economies. For example, these inflows account for only an estimated 14% of Argentina's 2001 GDP, and for Brazil the figure is 13%. In addition to Mexico, where current account inflows are projected to comprise a bit more than 25% of GDP this year, some smaller economies rely heavily on these flows. For example, estimates for this year show 65% of Trinidad & Tobago's (triple- ‘B'-minus/Stable/ ‘A-3') GDP is composed of current account inflows, as are 55% of Belize's (double- ‘B'/Stable/single- ‘B') GDP and 50% of Costa

    Rica's GDP. So, while the downturn in the world economy will have an unequal effect on production, growth rates in all countries will lessen to a marginal or significant degree due to lower inflows, especially from exports, compounding the drop in domestic demand. Other downward economic pressures derive from the high prevailing interest rates in many of the countries due to the credit squeeze, the need to support weakening currencies, and other related problems. Moreover, weak consumer confidence has prevailed in the region for some time, and unemployment rates are in, or approach, double digits in several countries.

    Sustained weak pricing for key commodity exports, such as a range of minerals, chemicals, and forest and food products, has also hurt many Latin American countries, a situation not likely to reverse over the near term. For example, the historical lows in coffee pricing have negatively affected job creation and the trade balances of Costa Rica, El Salvador (double- ‘B'-plus/Stable/single- ‘B') and Colombia. While oil prices have dropped substantially since mid-September, some uncertainty remains as to medium-term pricing given the military and political tensions in the oil-producing regions of the Middle East. The economies and fiscal stances of Venezuela, Ecuador and Mexico are the most sensitive in Latin America to drops in oil and gas prices. In Venezuela, oil-related revenues comprised about 50% of total revenues in 2000, for Ecuador the figure was near 40%, and for Mexico the portion was 36%. A downturn of pricing of some duration and magnitude would harm the financial performance of these countries, but particularly Venezuela.

    Alternatively, lower oil prices are a positive for those countries that are predominantly oil importers (e.g., Brazil, Chile, and the Central American countries).

    Countries whose economies rely heavily on tourism will be hard hit. In Latin America, this includes the Caribbean nations and the Central American countries of Belize, Costa Rica and Panama. In Jamaica (single-'B'-plus/Stable/single-'B') earnings from tourism equal a high 30% of current account inflows, while in the Dominican Republic (double-'B'-minus/Stable/single-'B') and Costa Rica this portion totals 26% and 13%, respectively. Given the lack of depth of most of these economies, a loss of these flows will be difficult to offset.

    The policy response to the economic downturn and adverse market conditions is critical. Standard & Poor's is discussing with policymakers their financial contingency plans should the illiquidity and stresses in the financial markets and the world economy persist for some time, which is likely. The ability of Latin American governments to garner the needed domestic political support to take and maintain appropriate economic and financial measures will be key. In 1999 Brazil, for example, faced extraordinary pressures after the real was allowed to float. The cohesion of the government and political institutions in the face of this crisis allowed the passage of reform. Standard & Poor's believes that the 2002 election complicates the passage of fiscal reform and narrows the latitude afforded Brazilian policymakers to stabilize the fiscal deficit.

    Presidential elections are also slated for Colombia in 2002 and contribute to this country's already limited fiscal flexibility. As a result of lower-than-budgeted revenue in the first half of 2001, Mexico has enacted spending cuts of $1bn to maintain its commitment to a (reported) deficit of 0.65% of GDP. Economic activity over the next six months will probably be lower than already experienced, and it is likely that the government will have to cut expenditures further to reach the targeted deficit. This will be particularly painful in light of President Vicente Fox's campaign promises of increasing social expenditure. Other smaller countries also have varying levels of political capacity to make difficult policy decisions. For example, the political cohesion in Barbados (single- ‘A'-minus/Stable/ ‘A-2') should allow a timely and meaningful response to adverse developments. On the other hand, the government of Panama, which has no working majority in Congress, will find it difficult to adopt some critical measures such as tax reform, which are necessary to solve its fiscal and debt situation. In Peru (double-'B'-minus/Stable/single-'B'), the capacity for the new administration to respond in a timely and adequate manner to crises of this type remains untested.

    Standard & Poor's has lowered its long-term sovereign credit rating on the Republic of Argentina to triple-'C'-plus from single-'B'-minus, and affirmed the ‘C' short-term sovereign credit rating. The outlook remains negative.

    The downgrade reflects the increasingly severe economic and social challenges Argentina faces in balancing the federal budget. Low tax revenues for September and the likely need for $900m in additional spending cuts highlight the mounting challenges the government faces in implementing its fiscal program.

    Standard & Poor's believes that despite the commitment of the federal government, prospects for achieving the ‘zero deficit' budget goal for 2001 and maintaining budgetary austerity in 2002 while ensuring timely debt service has continued to wane since the policy was announced on 11 July, 2001. Thus far, the Republic has met its monthly budgetary objectives in part by accumulating arrears of $480m of transfer payments due to the provinces.

    Low consumer confidence, the severe local credit crunch, and the global economic slowdown have resulted in continued negative GDP growth, industrial output and tax collection trends. Although the reported year-over-year 14% drop in revenue collections in September incorporated some one-time effects such as increased valued-added tax reimbursements and pension contributions, the decline is significant and confirms the battered economy shows no signs of stabilising.

    Thus, all efforts to balance the budget must continue to focus exclusively on further spending cuts. Growing internal challenges lessen the government's budgetary manoeuvrability. Moreover, given these pressures, Standard & Poor's view is that, regardless of the outcome of the legislative elections of 14 October, Argentina is increasingly likely to have to restructure its debt.

    Due to the ‘mega-debt exchange' undertaken in June, the government's near-term debt servicing burden is manageable, assuming balanced fiscal operations. Additionally, while Argentina can cover its financial needs without accessing international capital markets for almost a year, internal debt (Letes) must continue to be rolled; given domestic market dynamics, the risk of an inability to do so still remains low.

    Argentina's ratings could be lowered again if political, economic and social factors frustrate the government's efforts to keep the fiscal situation under control. Following heavy outflows, private-sector deposits stabilised when the IMF announced additional financial support. However, these flows are confidence-sensitive and renewed outflows would place the economy under additional strain and further undermine prospects for growth, as it severely impairs domestic credit.

    Local currency Foreign currencyBB+/Negative/B BB-/Negative/B

    Brazil's ratings are constrained by:

  • a high fiscal debt burden. The general government interest payments burden is very high, projected near 10% of GDP in 2001, or about 30% of revenue. The projected increases in these ratios since early 2001 reflect the structural vulnerability of domestic debt: its sensitivity to interest- and exchange-rate movements. The decline in rollover risk since 1999 is an important improvement, but the debt is still relatively short term. Reported gross general government debt of just over 70% of GDP in 2001-2002 excludes some off-budget obligations (or ‘fiscal skeletons');
  • external financial vulnerability. Brazil's gross financing requirements of 300% of reserves in 2001-2002 remain among the highest of rated sovereigns, as does external debt net of liquid assets projected at around 290% of current account inflows (CAI) in 2001-2002. Net external public-sector debt, however, is much lower-at 82% of CAI; and
  • structural economic weaknesses, including a distortionary tax regime, fiscal rigidity, and social and income inequalities that undermine Brazil's competitiveness.

    Factors supporting the ratings include:

  • a macroeconomic framework that includes a floating exchange rate, a commitment to an inflation-targeting regime, fiscal consolidation, and progress on structural fiscal reform. The general government primary (non-interest) surplus averaged 2.5% of GDP in 1999-2000, and is projected to increase further in 2001-2002 to at least 2.7%; and
  • support of Brazil's prudent fiscal policy – not only by the executive branch of government, but also by congressional and local government officials across party lines – underpinned by fiscal responsibility legislation

    The negative outlook reflects Standard & Poor's view that the government authorities have reduced room to manoeuvre amid a challenging domestic and external environment. The need to service the large fiscal debt burden makes ongoing fiscal adjustment crucial. The government has tightened its primary budget surplus target on several occasions in 2001. However, given the structure of Brazil's debt, the depreciation of the Brazilian real, and the need to maintain interest rates at high levels to meet next year's 3.5% inflation target, Standard & Poor's projects a general government deficit of some 7% of GDP in 2001 – twice that initially projected in early 2001. The approach of the 2002 presidential elections could complicate difficult fiscal and monetary policy decisions and trade-offs in the forthcoming year.

    Brazil's ratings could come under downward pressure if the government's commitment to structural reform and policy responses to economic conditions falter or prove to be inadequate. This could be evident if general government deficits remain near current levels; if the economic team faces internal political opposition that inhibits prudent policy responses; or if the constraints on energy supply threaten Brazil's medium-term growth prospects. Conversely, Brazil's credit standing could stabilize if the authorities take additional steps to significantly reduce the size of the budget deficit

    Local currency Foreign currencyBBB+/Positive/A-2 BB+/Positive/B

    Mexico's ratings are constrained by:

  • an inconsistent fiscal/monetary policy mix. The relatively lax fiscal policy in 2000 – despite the higher-than-budgeted price of oil, an acceleration in aggregate demand, and a large increase in the non-oil current account – led the Bank of Mexico (Banxico) to adopt a tightening bias in monetary policy in order to reach its inflation target. This policy mix resulted in undesirably high real interest rates and an appreciating currency, hindering domestic growth and making the economy more vulnerable to negative exogenous shocks in 2001; and
  • weak public finances. The public-sector borrowing requirement (PSBR; used by Standard & Poor's as a measure of the government's fiscal stance) was 4% of GDP in 2000. The large fiscal imbalance, the high fiscal dependence on oil and the need to accommodate higher spending in the social sectors (as promised by Mr Fox in his successful bid for office) make broad fiscal reform imperative. The basic objective of this reform would be to increase tax revenue (which, at 11% of GDP, is extremely low) and decrease tax reliance on oil (oil revenue was 36% of total revenue in 2000). Tax reform is particularly important at this time in light of the sharp deceleration in growth and the fall in oil revenue. It would allow the government to address fiscal weaknesses, bring down the PSBR to 3.7% of GDP, as projected, and improve the fiscal/monetary policy mix.

    The ratings are supported by:

  • the election of President Fox and the orderly transfer of power to the Partido de Accion Nacional (PAN) from the PRI (Partido Revolucionario Institucional), which dominated national politics for seven decades. In Standard & Poor's view, this represents a positive move toward democratisation and the rule of law;
  • rapid growth in the last few years has allowed for a reduction in the general government external debt to 11% of GDP in 2000 from 15% of GDP in 1999, a fall in the internal debt (including bank restructuring) to a projected 26% of GDP in 2001 from 30% of GDP in 1999; and an improvement in the debt/maturity profile; and
  • real and financial-sector integration with the US through the North American Free Trade Agreement (NAFTA). Tighter North American integration has raised Mexico's trend growth rate and lessened its vulnerability to shifting investor perceptions.

    The November 2000 affirmation of Mexico's ‘BB+' long-term foreign currency sovereign credit rating with a positive outlook reflected Standard & Poor's expectation that the Fox administration would improve the macroeconomic policy mix by tightening fiscal policy (so as to take pressure off monetary policy). This would bring interest rates down, revert the deterioration of the non-oil current account, and create the basis for sustainable and equitable growth.

    While the fiscal/monetary policy mix deteriorated in 2000, integration with the US economy allowed Mexico to benefit from the economic boom in its neighbouring country. At the same time, the situation of the banking system improved, although credit to the private sector was still negligible by year-end.

    Growth in the real sector deteriorated in the first quarter of 2001, despite the strong performance of the financial sector. The latter was the result of large portfolio investment inflows attracted by high real interest rates, which contributed to a further appreciation of the currency. Within a tighter fiscal framework and concerned about the stability of these capital inflows and the impact of high real interest rates on the corporate sector, Banxico loosened monetary policy in May; interest rates have since fallen several percentage points from their peak in the first two months of 2001.

    The new economic team, led by Minister of Finance Dr Francisco Gil Diaz, has made significant efforts at both improving the tax and customs administration and increasing the tax base.

    Given the sharp deceleration in growth and the concomitant fall in tax revenue, however, the government will have to cut expenditure, beyond what was originally budgeted, to reach its target for 2001. For this reason, it is even more imperative that Congress pass tax reform – even if in a less-ambitious form than that presented by the government.

    The adoption of tax reform will improve fiscal weaknesses and the fiscal/monetary policy mix, decrease the budget dependency on oil exports, and allow for the social spending necessary to improve the well-being of 40 million Mexicans living in poverty.