The 2018 elections in Mexico and Brazil turned on its head the investment norm driving Latin America’s two largest economies. After three decades of corporatist politics, some impressive institution building and admirable fiscal and monetary discipline, Mexicans elected a left-wing maverick to los Pinos and gave AMLO’s Morena party and its coalition a majority in both chambers of congress. Meanwhile, Brazil, the country that has failed to realize its enormous potential for decades now finds itself led by a man willing to tear down the coddled trappings of the political class, simplify Brazil’s byzantine tax code and untether the business sector from over-regulation.
Both AMLO and Bolsonaro ran populist campaigns, promising to upend the political status quo after a period of unprecedented corruption revelations and intolerable crime levels. Both leaders tapped into an angry sentiment that helped them stand apart from the mediocre leadership of established parties, the PT in Brazil and the PRI and PAN in Mexico. But there end the similarities between these two populists.
The Good: Brazil
Judging by capital flows, the Latin monied classes endorse Brazil’s Bolsonaro and worry about Mexico’s AMLO. Bolsonaro has a plan and should have the political support to pass pension reform, long considered the third rail of Brazilian politics. In Davos, Bolsonaro reiterated his commitment to simplify Brazil’s tax codes and drastically cut the time it takes to start a business. Paulo Guedes, the former investment banker who now leads the Ministry of Finance, went a step further, promising to lower the nation’s tax burden from 36% of GDP to 20%. Brazil plans to shrink its bloated central government by as much as 25% with the closure and consolidation of several ministries. Brazil will privatize the controlling interest of Eletrobrás as well as up to 20 airports, led by Curitiba’s. New concessions will be issued to build rail lines and ports to facilitate Brazil’s natural resource exports. The national content laws that stymie investor interest in Brazil’s offshore oil resources will also be reformed to help entice more investment.
In short, the Bolsonaro government plans to undertake in the next 24 months the very reforms that political economists have prescribed for the last thirty years and everyone assumed were simply impossible given the dysfunctionality of Brasilia. Together, these reform announcements have attracted waves of new capital to Brazil, driving the Bovespa to new records and strengthening the Real— improving the acquisition power of every Brazilian. Not surprisingly, an IBOPE poll conducted at the time of his inauguration in early January 2019 found that 75% of Brazilians approve of Bolsonaro and 65% believe that he can revive Brazil’s economy in a matter of months.
Paulo Guedes is steering the economic policy ship of Brazil, for now. His priorities are: i) pension reform; ii) tax & labour reform; iii) de-regulation; and then, finally, free trade. He knows that foreign institutional capital will not stick around unless pension reform is prioritized. He also knows that the economic nationalists in cabinet and congress are not ready to lift protectionist walls until the government lowers the custo Brasil through tax reform and de-regulation. Brazil has pending two possible trade agreements, based one on a long-standing negotiation with the EU-Mercosur and the other on a recently started negotiation of a Canada-Mercosur agreement. EU industrial and consumer goods exporters are a far greater threat to Brazil’s inefficient and overtaxed manufacturing base versus Canada’s natural resource exporters. As such, pundits expect the Canadian agreement to pass first, but neither will likely be put to vote before 2021. To convince the protectionist voices inside government that Brazil should sign these free trade agreements, Guedes must first ease the tax and regulation burden on Brazilian business with internal reforms.
The Bad: Mexico
AMLO’s first major policy decision as President was to cancel the USD13 billion airport construction project in Texcoco, east of the overcrowded Benito Juárez Airport. At first glance, this appeared to be a concession to his voter base, which includes students, farmers and green-minded urban voters. But a closer look reveals a more worrisome tendency. Structured as a transparent referendum, the quickly assembled and questionably counted plebiscite included less than 2% of eligible Mexican voters. Santa Lucía, a military base, is favoured by AMLO and lobbied heavily by construction firm Grupo Riobó, which curiously was contracted to produce an analytically dubious feasibility study that favours the base as the best option for airport capacity expansion. The Montreal-based International Air Transport Association has publicly declared that Santa Lucía and Benito Juárez airports cannot technically co-exist because they are too close to one another, contradicting the findings of the Riobó study and questioning the safety of AMLO’s new pet project.
So many bold pronouncements have Brazilian financial markets in a giddy mood. A quick read of Brazil’s new congressional makeup shows that legislators are more open today to reform than in recent memory. But the devil is in the details when passing laws, and Brazilian congressional politics is notoriously laden with pork, with little to no party discipline on votes. Bolsonaro and Guedes are to be applauded for laying out an aggressive but much-needed reform agenda. After Carnival ends and congress begins debating pension reform, we will see how persuasive Bolsonaro can be with his former congressional brethren.
As for placating his electoral base, which includes a large contingent of evangelicals, Bolsonaro regularly emits strong language against political correctness, gays and indigenous land rights. Those remarks are offensive and regressive and tend to alarm the educated classes and the media, but spoon feeding Bolsonaro’s voter base has few economic consequences for Brazil. The exact opposite can be said of AMLO.
In another surprise move, AMLO forced a 60% wage cut on the Central Bank, including its five governors. That prompted one governor to resign ahead of schedule on top of the regularly scheduled rotation of another governor. Later, the Mexican courts overruled the dramatic pay cut at Banixo but the damage was done, the 2nd governor had resigned. In an article that AMI Perspectiva published in May 2018 called Who’s afraid of AMLO?, I identified the Central Bank as of one of the few institutional pillars that would help curtail the populist instincts of AMLO. Such pillars are vital given the Morena party (AMLO’s party) control of the executive and legislative branches in a country with a notoriously weak judiciary. But in two years from now, one third of the way through his mandate, AMLO will replace the third of five governors and thereby take control of Mexico’s most important independent economic institution. The battle lines are already drawn with the Central Bank, whose acting Governor, Alejandro Díaz de León-Carillo, declared: “Loose fiscal policy will have to be met with tighter monetary policy.”
AMLO’s efforts to “drain the swamp” by forcing massive wage cuts promises to drive Mexico’s very capable technocrats into the arms of the private sector. Who might step into their shoes is what has insiders truly worried. If government cannot retain the brightest minds to run its institutions, then it will be run by a motley combination of untested amateurs, rash ideologues and corrupt dinosaurs.
Mexicans have placed their faith in AMLO to fight corruption based upon the singular belief that he is a man of integrity and he will lead by example. That is a noble thought but a society’s ability to combat corruption requires more than leading by example from the top. It also requires a robust and efficient judiciary system and publicly trusted whistle-blowing institutions that act upon citizen-provided evidence.
AMLO, who cut his political teeth in the 1970s at the zenith of the PRI’s political power and Mexican oil wealth, anchors his economic policy on the rebuilding of PEMEX and wants to commit billions of dollars to build downstream refineries. Mexico’s higher cost of capital means that it can never financially compete with amortized refineries in Texas where most Mexican transport fuels are refined. Betting on hydrocarbons today seems like a fool’s errand for any investor, let alone for a government. Even Saudi Arabia is desperately trying to wean itself off oil.
The rational voices of advice that guided AMLO through his campaign are increasingly sidelined by the man who controls the presidency, the Senate and the House. Mexico’s billionaires—who underwrote so much of Mexico’s industrial expansion over the last two decades—are quietly but quickly moving swaths of their Mexican-based assets offshore. Affluent home pricing in Mexico City has dropped an estimated 20% since October 2018. A sense of gloom is taking hold among the elite in Mexico, even while AMLO’s approval ratings continue to climb.
Divergent Foreign Policies
When it comes to foreign policy, AMLO and Bolsonaro again contrast one another. It has always struck me as hypocritical how Latin American governments can appear so pious when it comes to upholding the international rule of law and human rights abroad while flouting their own laws at home. But for Mexico to abstain from signing the Lima Group convention letter denouncing Maduro’s farcical re-election and sit on the sideline as the world finally stands up to the ever-hardening dictatorship in Venezuela places AMLO on the wrong side of history. Bolsonaro, on the other hand, was quick to question Maduro’s legitimacy after fraudulent May 2018 elections re-elected him to office. Shifting Brazil from a Venezuela ally to its loudest critic proved crucial in attracting support from the US, Canada, Israel and Western Europe to the idea of making Guaidó, the Venezuelan congressional leader, the country’s de facto interim president.
The Ugly: Venezuela
Twenty years after Hugo Chávez was first elected as President, Latin America’s once shining star of a nation has been plundered by a military-led cabal whose own manipulative interpretation of Venezuela’s revered constitution categorizes the chavistas as dictators operating under a fig leaf of democracy. The political showmanship of Chávez and oil prices above USD120 per barrel permitted the plundering to continue, with only a few critics at home and abroad, generally dismissed by Chávez as spoiled Venezuelan elites slumming it in Miami. But when Chávez died in 2013 and oil prices collapsed in late 2014, the wheels came off one of the most expensive political joy rides the world has ever known.
- PDVSA oil production has dropped 2.5M to an estimated 1.2M barrels per day, less than North Dakota. When Chávez first took office, Venezuela produced 3.5M/day.
- Non-gold foreign reserves dropped 65% from USD23bn to USD8bn.
- Gold reserves dropped 76% from USD21bn to an estimated USD5bn.
- Venezuela dramatically reduced its once highly effective Petrocaribe program which had helped buy diplomatic support from 17-member countries.
- 49% of the U.S.-based Citgo was mortgaged to Russia’s Rosneft.
- Homicide rates leapt to 60 per 100,000 people, triple the level of Mexico and 10 times the level of homicide rates in the U.S.
- An additional two million, mostly middle class, fled Venezuela, including many of the nation’s most capable entrepreneurs, scientists, academics, engineers and doctors.
Some estimate that over USD100 billion was stolen from government coffers over the last two decades. Since 2014, Venezuela’s GDP has plummeted 63%, more than double the collapse of the U.S. economy during the Great Depression (-29%). Venezuela today is a skeleton of its former self.
But recent events have injected a sense of hope into the hearts of Venezuelans. The blatantly manipulated elections that re-elected Maduro with 67% of the vote in 2018 finally pushed the opposition into action under the bold leadership of Juan Guaidó and inspired protesters to fill the streets. Except for the most vicious units of the military, soldiers have refrained from exercising physical force on peaceful protestors. Guaidó has proven himself a masterful tactician, employing social media to bring out throngs of protesters, sneaking across the border with Colombia to visit President Duque, and from there flying to Brasilia and Washington to garner support and gaining unprecedented international press coverage of the Venezuelan crisis. Citing the same constitution that the Chavistas so effectively employed, Guaidó, leader of a majority opposition in congress, has knighted himself interim President of Venezuela. To the delight and surprise of many governments in Latin America, Donald Trump has thrown considerable State and Treasury department resources behind Guaidó as a catalyst of change in Venezuela.
The world hopes for a bloodless transfer of power in Venezuela. However, there are plenty of reasons to assume that i) the transition of power may prove more difficult than hoped and ii) rebuilding governance across Venezuela may take years. To begin with, the military brass will not be lulled into submission by the promise of legal impunity, which has been offered by Guaidó. Abandoning Maduro and the sitting Chavista government means walking away from highly lucrative illicit and corrupt business operations that have turned military leaders into millionaires many times over. Today, this group manages PDVSA and its purse strings as well as many of the service companies that transport fuel, import high grade additive fuels, operate the PDVSA maritime vessels, manage Venezuela’s ports that export oil and import staples. The sanctions placed on Venezuelan oil exports by the U.S. directly impact exports to the U.S. (40% of total) but Donald Trump cannot prevent Venezuela from selling its oil to non-compliant countries like China and Russia who may choose to ignore U.S. sanctions.
Beyond the dozens of companies owned and operated by military leaders in Venezuela that rely on the PDVSA teat, there are other businesses that operate in an illicit parallel economy that no amount of international pressure can do much to change. Cocaine production in Colombia today is back to record levels. Most of it is channelled to global markets via Venezuela where, purportedly, gangs who report to the Venezuelan military traffic the product. The gangs and the Venezuelan army live in an uneasy peace after dozens of battles that have reportedly left hundreds dead over the last several years. In the massive state of Bolívar in eastern Venezuela (one-fourth of the nation’s landmass), the world’s greatest gold deposit is exploited today by informal miners, controlled by gangs who then report to factions of the military. The gold that they mine is smuggled into Brazil and sold for dollars that are brought back into Venezuela to buy bolívares at the inflated black-market rate. Both the gold and the cocaine trafficking are multi-billion-dollar criminal enterprises. The next government will have to wage battles across Venezuela to quell these businesses which, at the ground level, are run by well-armed gangs who for the last five years or more have been stockpiling high-calibre weapons that they purchased from underpaid soldiers and officers of Venezuela’s once-proud military.
Once physical security is re-established in Venezuela, the key to reviving Venezuela’s economy will be the reconstruction of PDVSA and the energy sector in general. That is no easy task. Venezuela still has the world’s largest oil reserves (the Orinoco belt contains more oil than the rest of the world has pumped out of the ground in the last 100 years). However, the impressive engineering and managerial talent that once ran PDVSA is now spread across the globe helping run dozens of energy companies on five continents. In a desperate bid to stay afloat, the chavistas auctioned off massive oil fields and concessions to over two dozen countries including: Russia, China, Cuba, Norway, Brazil, Iran, India, France, Spain, Argentina, Ecuador, Uruguay, Chile, Italy, Portugal, Belarus, Vietnam, Malaysia, South Africa and ALBA energy (Bolivia, Cuba, Nicaragua, Ecuador, Dominica, St. Vincent & the Grenadines). The next Venezuelan government may choose not to recognize the legality of some of these concessions or find it challenging to prompt the concessionaires into developing their fields, given the low price of oil. With its own finances in tatters, PDVSA will find it challenging to boost production using equipment and infrastructure left to rot for two decades and the control of its own reserves possibly entering a legal quagmire.
Lording over such potential oil wealth has enabled the Maduro administration to rack up an estimated at USD157 billion of foreign debt, or about 150% of GDP, more than double what a resource-driven emerging market can normally sustain. Of total debt, probably USD13.5 billion is owed to the Chinese and another USD4 billion to Russia. Neither lender nation is likely to forgive those debts unless they extract lucrative future oil concessions. The problem is that more than half of Orinoco is spoken for by other concessionaires. The chavistas did not only rob Venezuela of its existing wealth and assets, they also mortgaged a good chunk of the country’s resource future. But for now, the hope of a change in Venezuelan leadership has its country and much of the world gripped with excitement and anticipation. Planning for the future can wait.