During the 1980s, many Latin American countries went on a borrowing spree that more often than not ended in disaster. Combined with misguided fiscal policies, corruption, and general economic mismanagement, debt levels soon became excessive and unsustainable. That most of their debt was denominated in foreign currencies made the burden all the more onerous, resulting in what many in the region consider a ‘lost decade’ in terms of growth.
Having learned from past mistakes, Latin American sovereigns have significantly boosted borrowing in domestic currencies, particularly over the past decade, with many launching programmes or incentives to attract foreign investors to their instruments.
“It is healthier for governments to borrow in their own currency because this allows them to more easily control their current account deficit and their balance sheets,” explained Joaquin de La Guardia, Managing Director of Geneva Asset Management.
“But the reality is that not every country in the region is going to be attractive to foreign investors, and some credits are easier to move in and out of than others; they need to have a consistent record of responsible fiscal policies, an independent Central Bank and a tight grip on inflation.”
Clearing and Settlement
One of the most seemingly trivial but significant steps the region’s countries have taken as part of efforts to attract foreign capital into their local markets is to partner with large clearing and settlement houses like Clearstream and Euroclear, which align countries with international trading standards and facilitates access for foreign investors.
Chile became the fourth country in the region to join Euroclear in February this year, after Mexico, Brazil, and Argentina, while Peru and Panama are soon to follow.
Ricardo Gómez, Head of Fixed Income in Latin America at Larrain Vial, a Chilean brokerage, said primary driver for governments and for real money managers to implement this kind of scheme is to increase the weight that countries have in benchmark indexes. The higher a country’s weight in the indexes, the more liquid their local markets become, thus the more appealing to foreign investors.
After Chile joined Euroclear, its peso-denominated sovereign 2021s were incorporated into the JP Morgan GBI-EM, increasing the country’s weight in the broadly based emerging market government bond index from 0.1% to 0.32%. It is a minuscule percentage if you consider that Chile has one of the most developed bond markets in the region, but just 5% of the country’s peso-denominated debt is owned by foreign players.
“We estimate more bonds are soon to follow which will increase the weight of Chile in the index, the same way Colombia did,” Gómez explained.
Some observers argue there is a discrepancy between the attractiveness of Latin American local currency credits and the level of liquidity available in these markets. Santiago Fernandez, director of SFC Investment, a brokerage house based in Panama, is very optimistic about the impact big brand clearing and settlement houses could have on the region in terms of attracting more foreign players into the local bond markets.
“Most of the time the yield of local bonds surpass the country´s inflation rate, which makes local bond markets very attractive to foreign investors, the only exception in the region being Venezuela,” he explained.
The data seems to reflect that optimism. Coupled with anticipation of a stronger US dollar on the horizon, capital inflows into emerging market local currency credit reached a 19-week high in February at US$2.5bn, according to data from the IIF. Latin American markets along saw nearly half of those inflows as just over $US900mn poured into the region’s local currency credit – including Chile. So far this year, Latin American local markets received US$3.2bn from foreign investors.
Panama to Join the Club
Following in the footsteps of Chile, Panama is set to become the latest Latin American country to join Euroclear.
The country is distinct from other countries in the region because its currency is directly pegged to the US dollar, also one of its official currencies, and it has limited control over its monetary policy. The local capital markets, much like Panama’s economy, is heavily dollarized.
“Notwithstanding, to attract institutional investors the market must meet international standards of clearing and settlement as well as known and proven price discovery processes,” said Roberto Brenes, the former head of the Panama Stock Exchange (PSE).
“The Panama Stock Exchange and the local clearing house, LatinClear, have forged alliances to that effect,” Brenes explained.
Investors have warmed to the impending Euroclear deal, with the country’s local paper often yielding very high returns with almost no exchange rate risk.
“With the Euroclear deal, investors will be able to receive the higher returns from the local Panamanian bonds”.