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Once, the first whiff of political instability in Latin America would have had investors crowding the exits. Now, hungry for returns, they are disregarding the risks posed by a wave of radical populism that is sweeping the region.
After a bumper 18 months in which bond yields have fallen to historic lows, investment banks ? including some that quit the region in the wake of Argentina?s economic collapse in 2001 ? are back with a vengeance. They are competing fiercely for corporate business and are gung-ho about new opportunities, such as the sale of Brazilian or Mexican bonds denominated in historically weak, but now stable or appreciating, local currencies.
The optimism was palpable at this week?s meeting of the Inter-American Development Bank in Belo Horizonte, Brazil, where bankers and fund managers were clearly happy to disregard the volatile political mood.
It will be manifest again on Sunday when voters go to the polls in the first round of elections in Peru, where Ollanta Humala, a radical nationalist, is widely tipped to emerge as eventual victor. He has promised an end to ?neo-liberal? policies and regularly attacks foreign companies. But the prospect does not greatly trouble fund managers: they see little chance of his defaulting on his country?s debt.
Hugo Ch?vez, Venezuela?s radical anti-American leader, may be deploying revenues from the western hemisphere?s largest oil reserves in order to sow the seeds of what he calls ?21st-century socialism?. No matter: the country?s oil wealth is seen as buttressing solvency.
For portfolio investors, countries such as Bolivia ? where Evo Morales, a radical indigenous leader who won a landslide victory at polls in December, has confirmed plans to nationalise the gas industry ? are too small to count. But of late, radicalism has been spreading beyond the Andes. In the last few months N?stor Kirchner, Argentina?s radical president, has nationalised a foreign utility, imposed price controls and sacked Roberto Lavagna, his
market-friendly finance minister.
Last year his government negotiated a deal to restructure defaulted debt. So draconian were its terms that it seemed guaranteed to exclude the country from fresh borrowing on international capital markets. But nothing, it seems, can dim investors? enthusiasm: less than a year later, many are willing to lend it money at a fraction of the rates they charged a few years ago.
And in Brazil, leftwing president Luiz In?cio Lula da Silva is maintaining his commitment to conservative fiscal and monetary policy ? although that is starting looking more threadbare following the resignation last week of the fiscally orthodox Antonio Palocci as finance minister amid the latest of a series of corruption scandals.
With Mr Lula da Silva facing an election this year, the appeal of easing spending controls could increase, especially since his economy has grown at only around 2 per cent a year since his election in 2002. ?It is a perfect time for populism. It will be more and more difficult for Brazil to resist,? says Christian Stracke, analyst with the independent Credit Sights.
Yet such dangers seem lost on a market determined to see any sign of weakness as a buying opportunity. Mr Palocci?s departure triggered a decline in the value of the Real. But by the weekend it was as if nothing had happened. ?Everyone feels they need to be here,? says one investment banker. ?It?s sexy. It?s one of the Brics? ? a reference to Brazil, Russia, India and China, the four emerging-market economies whose rise is forecast to change the shape of the world economy.
The leftward trend is not universal. Centre-left Chile and centre-right Colombia ? where Alvaro Uribe is expected to win a second term as president next month ? continue to pursue pragmatic, market-friendly policies and social reform. But the phenomenon of radical leaders promising to solve the region?s chronic problems of social exclusion and poverty appears to be spreading. Andr?s Manuel L?pez Obrador, the socialist former mayor of Mexico City, is on course to win the Mexican presidency this year and Daniel Ortega, a 1980s b?te noire of the US, is well placed in Nicaragua. Ecuador, too, may shift to the populist left in November elections.
Markets expect Mr L?pez Obrador ? like Mr Lula da Silva ? to pursue careful macroeconomic policies in a country tightly integrated into the North American economy through migration ties and the Nafta trade accord. Ecuador and Nicaragua, meanwhile, are too small to worry investors.
Vitali Meschoulam, a Latin American analyst at HSBC in New York, explains: ?Right now nobody cares.? He adds: ?There is so much money [and] these are issues that affect development prospects in 2007 and 2008.?
What explains this apparent complacency? Latin America ? perhaps more than any other region in the world ? has been a beneficiary of new patterns in the global economy: notably Asia?s rapid economic growth and high savings rates that are helping to sustain a consumer spending boom in the US. Asian manufacturers are selling the products they make to US consumers, with demand in part sustained by low interest rates and plentiful credit. Asia?s willingness to invest its savings overseas, in US Treasury bonds and other assets, helps explains why liquidity has been so ample.
Latin America profits from this in several ways. First, Asian ? and especially Chinese ? demand for raw materials means prices of those are high. China?s steel industry has been sucking in Brazilian iron ore. The country?s spending on power plants and other infrastructure has forced up the prices of copper from Peru and Chile. And Brazilian and Argentine farmers have found a growing market for their beef among the aspirant middle classes of China?s burgeoning cities. Chinese farmers are importing South American soya beans to make animal feed.
US growth is helping revive the manufacturing exports of countries such as Mexico and the smaller economies of Central America and the Caribbean. Latin American and Caribbean migrant workers in the US are doing well. Remittances sent back last year rose 17 per cent to $53.6bn (?30.6bn, ?43.6bn), according to a study published by the Inter-American Development Bank. Finally, the combination of a growing global economy and relatively low interest rates is boosting global liquidity and means investors are anxious to secure the returns available from higher-yielding markets.
As a result of all this, Latin America has recorded three successive years of current account surpluses, its best performance for at least half a century. Reserves have been increasing and dollar debt has been repaid.
According to Latin America Consensus Forecasts, Brazil has reduced its long-term external debt from 40 per cent of gross domestic product in 2002 to an expected 13.5 per cent in 2006. Over the same period, Argentina will have brought down its debt from 118 per cent to an expected 42.5 per cent. Chile, Peru, Mexico and Colombia have seen falls that are similarly dramatic.
Rating agencies have been upgrading Latin American creditworthiness. The view is now widespread among bankers that Brazil ? on the brink of bankruptcy in 2002 ? could be rated as investment-grade within a year or two. That would allow mainstream pension funds to buy its assets and further reduce borrowing costs.
Walter Molano, at BCP Securities, a Connecticut-based brokerage, is particularly bullish. ?Unless there is a major change in Asian demand, there is no need to lighten up or put on short positions. We are in a new era for the emerging markets,? he told clients last month. ?Latin America is on fire. Credit conditions are improving, and we expect a round of upgrades after the presidential elections. This is the reason why capital continues to pour into our asset class.?
It all creates a propitious environment for leftwing leaders elected on a platform of increasing social spending. Taxes from exports and savings achieved from lower borrowing costs mean governments can meet their pledges to voters without threatening macroeconomic stability.
Venezuela?s Mr Ch?vez ? who has directed $17bn into special social funds during 2005 and 2006 ? is a special case since his country is awash with oil. But social spending has been increasing elsewhere, too. Take Brazil, where Mr Lula da Silva has extended a system of monthly welfare handouts to cover about 8.5m people, yet he has still managed to balance the budget. Even Mr Morales in Bolivia, the poorest country in Latin America, is so flush with funds from higher gas and mineral prices and new taxes that he has been able to create 4,500 jobs for teachers and 1,000 for doctors in his first two months in office.
To some, it all adds up to a redefinition of populism ? one that couples a strong welfare system with fiscal restraint. Says Mr Meschoulam: ?You can have your cake and eat it. You can have social programmes and pay back the debt.? He goes on: ?Maybe this is a different type of populism to what we have been accustomed to. It is constrained and responsible.?
Plenty of evidence exists to suggest, however, that leftwing governments ? whether radical populists like Mr Ch?vez or more moderate reformers like Mr Lula da Silva ? are being lulled into a false sense of security about the strength of their economies and are failing to undertake structural reforms needed to boost efficiency in the long term.
One problem is that Latin American governments are failing to diversify, remaining heavily dependent on raw materials exports and extremely vulnerable to adverse external events. In addition, the drive to reform notorious public-sector black spots ? such as Mexico?s inefficient electricity industry or Brazil?s burdensome public pension systems ? has lost momentum.
More generally, too little of the surplus money is being invested. Chile is an exception: it has used revenue from the commodities boom to build funds that can help protect against future downturns or finance investments in education and technology. In Brazil only a tiny fraction of last year?s 9 per cent increase in real public spending was invested in infrastructure such as roads, bridges and railways.
All of this is undermining growth and means the gap between Latin America and its emerging-market rivals in Asia and eastern Europe is widening. Last year Latin America grew just 4.2 per cent ? and that was inflated because Venezuela and Argentina are recovering from recession.
Many in the market believe that the effect of the emergence on to the world economic stage of China and India will provide permanent insulation from a future downturn. Equally, though, it is possible that a strong cyclical upswing may be exaggerating the extent of the secular realignment taking place ? as happened with the enthusiasm for internet technology in the late 1990s.
?We just don?t know how robust it is,? says Mr Meschoulam, who suggests that there are also parallels between the current enthusiasm for emergent Asia and the idea that the triumph of democracy in the Soviet Union and eastern Europe had ?ended history?. ?They may be right but I just haven?t seen the evidence,? he says.
Javier Santiso, chief development economist at the Organisation for Economic Co-operation and Development in Paris, says Asian demand for commodities offers Latin America a ?historic opportunity? but that most of the region is ?simply surfing the wave?. And he has an ominous warning: ?Sooner or later the wave will stop.?
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