Perhaps the most interesting market in Latin America is Colombia, where improved security is allowing consumption and investment to grow at rates not seen for decades.
The Brazilian equity market continues to benefit from high global liquidity growth and strong global demand for raw materials. A record-high trade surplus and a solid current account are helping the country to reduce its external vulnerabilities gradually. Thanks to the strong currency and only a slow recovery in domestic demand growth, inflationary pressures have been absent in recent quarters. This should enable the central bank to cut interest rates further as real rates still exceed 10 per cent. We believe Brazil’s risk profile does not justify real rates above 7 per cent.
The current level is not only keeping economic growth far below potential, it is attracting capital, which is keeping the currency stronger than needed. Since President Lula’s re-election in October, there have been modest tax reform initiatives.
Although we do not expect much from the second Lula administration in terms of structural reforms, some progress could be made on the tax side. This would be a major positive for the growth outlook since the rigid tax system and the tight fiscal policy stance are restraining investment growth. We forecast 4 per cent GDP growth in 2007.
In Colombia, dramatically improved security and the quick fiscal adjustments by the first Uribe administration have restored confidence. Growth prospects are back at the levels of the 1970s and 1980s, before the drugs war and poor macroeconomic policies pushed the economy into an eight-year slump. Risk has come down substantially. Total debt repayments and the current account deficit are fully covered by foreign direct investment flows.
High oil and commodity prices should sustain a trade surplus despite strong growth in domestic demand. With inflation well within the central bank’s target range, interest rates should remain low, fuelling the credit-driven consumption boom further. Improving liquidity in the equity market has put Colombia back on the map for global investors, which should boost flows in the next few quarters.
Maarten-Jan Bakkum, strategist, Emerging Markets Equity Team at ABN Amro Asset Management.
