Several Latin America sovereigns are on the cusp of reaching investment grade. The region has seen a surge in credit upgrades over the past five years and economic stability has increased substantially. Of the seven major LatAm countries two are investment grade (Chile, Mexico) and three are on track to reach investment grade (Brazil, Colombia, and Peru) before the end of the decade. The other two countries (Argentina and Venezuela) are unlikely to reach investment grade before the end of the decade. The improvement in creditworthiness and the increase in economic-financial stability are structural in almost all countries.
LatAm of course remains more sensitive to external shocks than other EM regions due to its lower degree of creditworthiness and/ or higher dependence on commodity exports. But even the riskier countries like Argentina and Venezuela have taken advantage of the export windfall and have reduced the level of their external liabilities. Governments have also taken advantage of higher growth to improve their fiscal position and to reduce (or at least stabilise) their debt. Perhaps most importantly, most governments have committed themselves to a stability-oriented medium-term economic policy. Again, Venezuela (and to a lesser extent Argentina) are the exceptions. Populism continues to lurk in the background in several countries, but is unlikely to affect the outlook until the next round of major national elections towards the end of the decade. Even if the external environment were to deteriorate, a combination of adequate policy response and improved fundamentals would limit the economic and financial fall-out. LatAm has changed fundamentally.
Latin American capital markets are gradually maturing on the back of increased stability. On the supply side, declining external financing needs have led to increased domestic sovereign and non-sovereign debt issuance. More liquid and deeper domestic government bond markets have allowed other markets to take off, ranging from domestic private bond markets over domestic derivative markets to structured finance.
Domestic banks’ international issuance has also been increasing on the back of net sovereign redemptions. On the demand side, “strategic” real money investors are increasingly putting money into LatAm, especially investment grade countries and countries on the cusp of invest ment grade. In many cases stable domestic investor bases are emerging. Corporate governance reform has also increased domestic and foreign investor interest in local equity markets. In addition, greater economic and financial stability has lowered the cost of capital and pushed up equity market valuations. Primary equity issuance has been booming, especially in Brazil. The new markets will inevitably go through periods of increased volatility. But improved economic stability will gradually lead to deeper and more sophisticated domestic capital markets. This process looks irreversible, at least in those LatAm countries that are on the cusp of investment grade.