Cry for Argentina

by Jay Salomo

Suddenly, it looks like Eva Peron all over again.

In November 2001, flamboyant Argentine ex-President Carlos Menem was freed from a six-month house arrest (inside a friend’s Buenos Aires mansion) after the Supreme Court ruled there was no conspiracy during his administration to smuggle weapons to Croatia and Ecuador.

Menem still heads Argentina’s opposition Peronist Party, and has declared his innocence since the day he was arrested… just hours after he married a former Miss Universe from Chile who is half his age

It’s all very juicy and titillating, but hardly the most important news in a nation with a basket-case economy. Argentina is such a basket case, in fact, that default looks almost unavoidable.

Many persons of a certain age around the globe had just shed the old notion that all of Latin America was doomed to endless "banana republic" status. In fact, not only was Argentina one of the continent’s fastest-growing economies in the 1990s, it had also started to earn great respect among the more highly developed nations for the strength and creativity of its turnaround.

Unfortunately, that growth was based largely on a currency scheme in which the peso is pegged by law at parity to the dollar. But capital has fled from emerging economies since 1998, and Argentina has been trapped in recession. In turn, the really quite manageable public debt of US$132 billion has become unpayable, and the modest fiscal deficit (largely derived from the transitional cost of pension reform) unaffordable.

Boom to bust

Since June 2001, President de la Rua has had to deal with exhausted credit. The drastic austerity plan he devised aimed at cutting spending with declining tax revenues. But it has not worked.

In the third quarter, the economy shrank by as much as 12% at an annualized rate. A run on the banks resulted in US$8 billion fleeing the country in July and August. In turn, the president persuaded his congress to approve a plan to balance this year’s budget, partly through cuts of up to 13% in public-sector salaries and pensions.

Balance was achieved in the third quarter, but the cost is unsustainable.

Recent domestic and international agreements that may offer short-term solutions are being challenged, and the Emerging Markets Creditors Association seems determined to pursue a lawsuit in New York. The ECMA believes that the operational debt-swap is setting a bad precedent, one in which Argentina treats different lenders unequally.

So, with the need to deal with US$1.4 billion in late 2001, the government’s determination to avoid both default and an adjustment in the exchange rate seems doomed.

Even more depressing is that the root of the woes, according to some, goes back to the loose fiscal policy of Menem’s second term, when public debt rose from 40% to 50% of GDP. But the more likely culprit is the pounding the Argentine economy took from abroad: weak prices for the nation’s agricultural products (as well as developed-world trade barriers against them), Brazil’s devaluation, and (especially) the drying up of capital flows to emerging markets since 1998.

Finally, many contend that President de la Rua’s government itself has fueled the situation with too much meddling and too little explaining.

In 2002, the country will have a national election and Menem, the Peronist, will be back. And he’ll have the rest of the world to blame for his country’s sour economy. But, in the finest Argentine tradition, at least we’ll have his pretty new wife to look at.

Last Samba in Rio?

Brazil is the kind of nation you want to succeed.

And, with those beautiful beaches, you’d like to be there, once in a while, to share in its success.

Everything was going along pretty well in the land of carioca and capoeira. Even the disasters in neighboring Argentina seemed to cause little havoc in Brazil.

Until 2001, it was axiomatic that a crisis in one part of Latin America would spill into the rest. But evidence mounts that investors are starting to differentiate between the bond, stock and currency markets in the region.

This still-developing nation, with all its mineral wealth, is not immune from major events in the developed world, especially in the United States. September 11 has begun to take a toll in Brazil, particularly in dwindling capital flow, and the low savings rate throughout Latin America exacerbates the problem.

And so, while 2002 hardly looks bullish for Brazil, things seem relatively bright, and those beautiful beaches account in large part for the "partly sunny" forecast. Domestic tourism, amazingly, has actually plugged the holes created by foreigners from the North unwilling to make the long trek to Rio, Bahia and the rest of the nation. And the number of visitors from the U.S. and Europe has fallen only marginally since October, with the slack more than taken up by big increases in visitors from Uruguay and Argentina.

Aftershocks

But a major irritant could come from the demise of Enron. Nowhere will the fallout be felt more acutely than in Brazil. Much of the recent Brazilian "miracle" came from the dramatic privatization plan of recent governments, especially that of current President Cardoso. Enron was an enthusiastic investor in Brazil’s energy industry. Unfortunately, approximately 20 Brazilian gas distribution companies, natural gas pipelines and electric utilities will be part of the pool of the troubled company’s saleable assets.

Perhaps Cardoso is breathing a small sigh of relief, since two of the key companies in his country have not been privatized: Banco do Brasil and oil giant Petrobas. Recent indications that Cardoso might find it politically, if not economically, rewarding to spin off Petrobas could well be stopped by the gloomy fallout from Enron.

Possibly the most troubling element for 2002 in Brazil is a national election which, at this early stage, is dominated by the left-of-center opposition Workers’ Party (PT) and infighting between the three biggest members of the ruling coalition.

Brazilian presidents, while elected for four years, generally serve a second term, and Cardoso’s successor will loom large for investors if he (or she) is too far to the left. Unfortunately, indications are that were the election to be held today, the winner would not come from the coalition.

Cardoso is determined to maintain sufficient popularity to choose his successor, and since current polls show voters would not go along, this government might take a leftward course in its waning months.

But the wild card in the race is Roseana Sarney, easily the most conservative of the potential candidates and perhaps the first female president come October.

Despite her outspoken admiration for Margaret Thatcher, increasing numbers of Brazilian voters see her as an attractive alternative to the leftists and an increasingly disliked center coalition.

Cardoso’s attempts to be a vigorous "lame duck" and the huge uncertainties of the election demand a wait-and-see attitude toward Brazil, tempered with the knowledge that this huge nation has a future as sunny as its beaches.

Where angels fear to tread

Many investors may feel that the level of uncertainty in Brazil would be more than enough reason to stand clear. To the contrary, such chaos is exactly the sort of circumstance that should attract a bold trader’s eye–and cash.

This was precisely the rationale that led us to reenter the Brazilian market with a reiteration of our Brazil Fund (BZF:NYSE) buy in the 247profits e-Dispatch of September 17 for a quick 20% gain.

Bold traders also stood to rake in over 75% if they repurchased our Brazil telecom play, Tele Centro Oeste Celular (TRO:NYSE), at the same time–a pretty profit indeed for braving such rough waters.

Fox and friend

Although many of Mexico’s problems seemed likely to be solved thanks to the obvious friendship that has developed between George W. Bush and Vincente Fox, the terrorist attacks on the World Trade Center and the Pentagon has the potential to cause huge trouble for the Mexicans.

In August, many felt that our Southern neighbor was the most important focus of Bush’s foreign policy, especially considering the apparent hostility between him and the Europeans. Plans were afoot for an immigration policy that would please Fox (and haunt America-firsters), and even the thorny trucking issue seemed capable of settlement.

Congress now appears likely to settle the trucking controversy, but investors should be more than a little wary of too much short-term ebullience over Mexico.

A particularly difficult problem might arise from Fox’s noble effort to open up the record of political brutality in past Mexican administrations. No matter how much progress has been made towards more stable democracies south of the border, gangs of thugs and assassins remain in place, ready to strike if the power structure becomes too threatening.

Americans certainly wish Fox well in his attempt to set the record straight and see that it is not repeated, but with terrorism a worldwide concern, his timing is somewhat suspect.

The more pressing issue for Mexico, though, is where it stands in the Bush hierarchy, particularly since the best friends du jour seem to be nations in Europe and the Islamic world that are critical in the current war on terror. It’s hard to believe that Mexico will now receive the amount of financing or political support that was headed its way prior to September 11.

No Latin American nation is more vulnerable to the American economy than Mexico–and the downward trend in the U.S. was obvious even before the actual figures were in. By American standards, Mexico is already in a recession, and has been for all of 2001. Manufacturing declined nearly 1% and retail sales slipped 2.7% in recent months. Even worse for Fox, who promised to create 1.4 million new jobs in the first year of his administration, the figures show that at least 250,000 Mexicans have lost their jobs.

And the lack of American tourism hits especially hard in Mexico.

After expanding 6.9% in 2000, the Mexican economy seems headed for zero growth in 2001. And, despite three budget cuts, the government has announced that it will overshoot this year’s fiscal deficit target by a small margin.

Mexico has signed free trade agreements with countries ranging from the European Union to Ecuador in recent years, but they couldn’t shelter it from a U.S. slowdown even if the other partners were humming along (which they clearly are not).

The wild card, of course, is Mexican oil. Obviously, lower prices hurt badly in the short run. But a creative analysis of a seemingly grim situation (like US$11/barrel) shows that cheaper oil will help an American recovery. If that is true, Mexico could actually benefit in the mid and long terms.

While a decrease in American investment seems likely in 2002, the progressive Fox administration and the once-upon-a-time huge interest from Bush almost guarantee that those looking for attractive long-term foreign investment should not write this nation off.

The pieces are in place for a huge Mexican recovery.