There are risks and opportunities when trading in the emerging markets. We look at two regions – Latin America and Africa – and ask local experts to assess what treasurers can expect, asking how best to prepare for continued trading in each.
The current political and economic situation across Latin America (LatAm) is such that Jose Luis López-Sors, Head of GTB Americas, BBVA, finds it problematic to pin down a precise picture of regional opportunities for corporates. The lack of current clarity, it seems, is in part a mark of the heavy influence on the region by its northern neighbour.
Indeed, with the US seemingly in the throes of ending its current growth cycle, increasing the possibility of a recession there, López-Sors says countries closely linked to its performance, such as Mexico, are holding their breath. Yet in parts of South America, where for example the commodities cycle plays a huge part in the economy, a more positive outlook prevails, for now. “Overall, I’m positive,” he states. “There are growth opportunities in the region but most will have to watch very carefully what is going on in the US.”
With that in mind, he also draws attention to some notable home-grown risks. In particular, the fallout is ongoing from the highly damaging oil industry bribery affair in Brazil that went right to the top before being exposed as an international scourge. “If those cases continue at length, they present a serious growth risk that we have to follow,” says López-Sors.
Another grave risk he highlights is the possibility of more interest rate hikes in the US. If rates do rise, it will affect many LatAm economies, especially through the ensuing FX volatility which he refers to as a “nightmare” for the region’s corporate community.
Political risk is always a concern and upheaval in Venezuela is testament to this. However, troubled leadership changes in the biggest economies of Brazil and Mexico have settled, and although there are elections due in 2019 in other countries, López-Sors is generally confident that there is “not too much to worry about” over the ensuing 18 months.
Despite the uncertainty, López-Sors is keen to point out that the region is also one of commercial opportunity. One of the major beneficiaries of the pockets of economic growth seen in LatAm is the consumer sector, with a burgeoning aspirational middle class emerging. Commodities players – especially mining, fishing, and oil and gas – have been performing well too. Although mining has been impacted by adverse weather, the sector is generally “fruitful”, he notes.
From a purely business perspective, that fruitfulness can be attributed to reduced volatility in the last few months. “This is important because volatility is one of the main killers of growth,” says López-Sors. “Towards the end of 2018, we were expecting a very volatile market. The US Fed was still hiking rates, we’d seen political change in Mexico and Brazil, ongoing turmoil in Venezuela; 2019 was viewed in a very pessimistic way. But during the first three months we have in fact seen stability both in the fixed income equity market and especially in the FX market.”
Despite LatAm having no common currency, no unified central banking view and a broad sweep of regulatory approaches, many corporates are nonetheless regionalising their treasury activities to gain cost and operational efficiencies, says López-Sors. Indeed, a number of multinationals have been setting up shared service centres or centralising vast portions of their treasury operations regionally. Colombia, Panama, Costa Rica, Argentina and Brazil are among the main beneficiaries of related investments as corporates alight here with the promise of lower-cost locations and a large talent pool of treasury services and operations.
With the long-standing NAFTA agreement between the US, Canada and Mexico being revised into the US, Mexico and Canada Agreement (USMCA), it potentially ends a period of uncertainty for Mexico. NAFTA is still in force but when and if USMCA becomes official, most current NAFTA rules and procedures will remain in effect.
Whilst it may not change how corporate treasurers interact across the region, it at least signals further FX stability, helping certain economic flows to remain steady (notwithstanding the burden of any serious geopolitical challenges). Mexico’s steel and automotive sectors, where it intersects Asian trade, may be affected, but the overall impact of the change will be “very limited”, says López-Sors. “I’m not expecting it to be an issue.”
The role of technology in enabling the growth of any developing economy is critical. In LatAm, one of the challenges is to reach the huge numbers of the population that currently do not have access to banking. With it taking up to four weeks to open a personal account in many countries, one of the main bottlenecks is regulation.
Correspondingly, one of the main costs for banks is processing cash. However, says López-Sors, whilst the region’s regulators and tax authorities talk of helping, in most countries, a transaction tax is levied on every account movement. This has the effect of promoting the cash economy which in turn is making the transition to digital banking a very slow work in progress.
As certain LatAm economies develop, their weak infrastructure and energy sectors are becoming a brake on growth. Both need a huge amount of investment but whilst this presents “vast opportunities” for players in these sectors, the risks this creates for their treasurers is substantial as they source funding.
“The more that can be financed, the less equity is risked; improving financing when entering these economies is critical,” says López-Sors. “And where a business is investing money in an emerging economy, whether through equity or debt, it needs a strategy that allows for hedging as much FX and interest rate risks as possible.”
Interest rate hedging is relatively expensive in LatAm compared to the US. Of course, for currency hedging, the cheapest way is the natural hedge, if it’s available. However, López-Sors says the region’s FX markets are “very deep” with a lot of liquidity enabling every currency, except Venezuelan Bolívar, to be hedged. “It may be pricey, but at least treasurers can hedge all their exposures and in this market that is a very positive point.”
When entering the region, the corporate has to start a clear business programme for the target country, and be able to trust that it can be executed, says López-Sors. He says that it will also be essential to closely study local regulations; these can be very challenging not least because there is very little, if any, common ground from one country to the next.
This may affect the decision as to where treasury management activities will be established, as will the availability of appropriate skills. Whilst some corporates base their location decisions on internal legacy factors, there is an increasing tendency to establish treasury centres in the biggest countries. This puts Brazil and Mexico ahead of other strong contenders such as Chile, Panama, Argentina and Uruguay. Although López-Sors says the latter is “flavour of the month”, with a relatively stable economy, high standard of living, strategic location and free trade zones, Brazil is arguably the most complex location from a regulatory perspective making it a good reason for establishing a regional centre here. “You can manage other countries from here, but it’s very hard to do it the other way round.”
For foreign multinationals seeking advice on entry into LatAm, it makes sense to talk to the international banks operating in the region, says López-Sors. Regional bodies are also a good a source of information. The Latin American Trade and Investment Association (LATIA) covers 19 LatAm countries, coordinates and promotes the region’s economic sector, and aims to attract foreign direct investment, boost exports and promote the internationalisation of LatAm companies.