Latin Finance - March/April 2010 - 17

political risk global head of EM research at RBC capital markets. He adds that they are both in favor of big government and heavy state intervention. “The longer term economic policy direction is not likely on an improving trajectory, but rather on a slowly deteriorating trajectory,” says Chamie. “Investors are giving Brazil the beneﬁt of the doubt in several areas. I believe this will slowly but surely change.” In addition, Brazil has to spend billions of dollars on extracting oil, as well as upcoming World Cup and Olympics investment. Expansive policy sets Brazil up for a necessary postelection adjustment. Fiscal policy has the potential to impact monetary policy, driving real rates higher and thereby exacerbating the strengthening currency trend. Garman notes that the government is increasingly concerned about the appreciating real, but has no strategy to deal with it. Serra should be more aggressive than Rousse on cooling the currency, and his ﬁscal policy may also reduce pressure on the real. Analysts say he could also push to make the central bank more dovish to support this. There may also be an increase in the inﬂation target to accommodate growth and a weaker currency, and there are concerns about central bank autonomy under both candidates. Investors should also worry about sector-speciﬁc policies that will directly impact corporate valuations, as well as affecting Brazil’s growth, says Garman. “The issue is, what’s the size of the upside in Brazil, and here politics will matter,” says Garman. “Precisely because Brazil is doing so well economically, the quality of policy making may drop, and it may drop in ways that are not fully priced in.” Eurasia ranks Brazil seventh in its list of top 10 risks for 2010, alongside geopolitical hot potatoes like Iran, IndiaPakistan and US-China. Serra raises FX and monetary policy concern He adds that more capital controls are a distinct possibility for Brazil. “One of the things they have to watch out for in Brazil is that they take proper action to manage inﬂows or they will start having an inﬂationary problem,” says Bill Rhodes, senior vice chairman at Citi. In addition, the way in which Brazil develops its tremendous oil potential has signiﬁcant medium and long term repercussions. Garman says the government’s proposal for oil reform could place too much burden on Petrobras. “It may be a recipe for cost overruns, missed production targets and declining return on capital,” says the analyst. There is also the issue of infrastructure investment generally, which is an urgent priority, but faces institutional hurdles. Brazil needs to overhaul legislation that allows it to spend, says Garman, who foresees a more aggressive use of state owned enterprises, particularly in developing new oil ﬁnds. This trend is likely to be strengthened by a Rousse win. “The Brazilian bureaucracy and the state has not been operating in an environment where they had money to spend on infrastructure. Now they ﬁnally have money, but these institutional ine ciencies are starting to creep up,” says Garman. Eurasia also ﬂags risk of more state intervention in mining, utilities and maybe even telecoms if she is elected. Brazil-based iron ore giant Vale is already manipulated by the state, say other analysts, who note recent government opposition to the company’s attempts to expand overseas. Overspending may aggravate debt problems. “The real question in Brazil is whether the next administration is just there to grow out of its ﬁscal problem, or whether it will improve public ﬁnances,” says Shelly Shetty, senior director for sovereigns at Fitch. With a debt to GDP ratio of 65%, Brazil is double the level of triple B peers. It urgently needs to boost growth, improve the external balance sheet and public ﬁnance, as well as broaden the tax base, Shetty adds. Kicking Drugs in Mexico Mexico has long been in desperate need of ﬁscal reform and a strategy to mitigate dependence on an ailing state oil giant. The Calderón structural agenda is frozen through to the next term, as there is unlikely to be consensus on the key issues, LatAm Political Risk Wall of worry Country Brazil Mexico Colombia Peru Main risks Change in macro, FX, industrial policy; central bank independence questioned; more capital controls Drug war affecting growth, FDI; stalled ﬁscal, labor and energy reforms; president becoming lame duck Uribe re-election; Venezuela tension rising; lack of FTA with US; state intervention in projects; more bureaucracy Populist candidate emerging for 2011 election; increased public spending; popular protest against foreign projects State Intervention For the ﬁrst time in many years, Brazilian policy makers have room to experiment since macroeconomic vulnerability has dissipated. Garman cites the 2% IOF tax on inﬂows and announced major oil reform as two recent examples of greater ﬂexibility. Source: LatinFinance March/April 2010 LATINFINANCE 17

Latin Finance - March/April 2010

Table of Contents for the Digital Edition of Latin Finance - March/April 2010