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Latin American Businesses Overall Continue to Face Challenges

The future continues to look challenging for many Latin American countries. Corporates will close out 2016 facing sluggish growth, depressed commodity prices and political risk, according to a new Fitch Ratings report. Latin American economies have weak fiscal positions and less ability to respond to the recessionary climate, according to International Monetary Fund (IMF) and World Bank economists who spoke at the 20th annual conference of the Development Bank of Latin America earlier this month.

Argentina’s short-term growth prospects for corporates remain weak due to higher utility tariffs, a weaker exchange rate and reduced policy stimulus, said Fitch in its Latin America Corporate Compendium 2016 report. Brazilian corporates’ cash flow crisis will linger, and heightened political uncertainty, low commodity prices and tight financing conditions will continue to depress economic conditions and credit quality, the agency said. And the Chilean economy is undergoing its third year of sluggish activity in part because of lower copper prices, low investments as a result of unclear government-promoted structural reforms and persistent weakness in consumer economic perception.

"The only bright spots are Mexico and Peru,” said Director Jay Djemal. “Both countries are expected to enjoy positive GDP growth that should support the corporate sector.”

The IMF’s most recent report on the region, Western Hemisphere: Managing Transitions and Risks, finds that a rapid increase in Latin American corporate debt has contributed to more corporate risk. “Total debt of nonfinancial firms in Latin America increased from US$170 billion in 2010 to US$383 billion in 2015,” the IMF said. “With potential growth across countries in the region slowing, in line with the end of the commodity supercycle, it will now be more difficult for firms to operate under increased debt burdens and reduced safety margins.”

A panel of experts from a variety of industries and areas of expertise will delve into current and future risks of trading in key Latin American countries at FCIB’s International Credit and Risk Management Summit in Amsterdam. The summit will take place Nov. 13-15 and includes a range of topics to support credit professionals who work for companies with international accounts.

How Should Europe Handle the Brexit?

Chris Kuehl, Ph.D.

It has been some weeks now, and theoretically emotions have cooled. The U.K. has a new and supposedly more pragmatic leader. There has also been time to start to digest the reality of the withdrawal, although at this point nothing has changed and the negotiations for the pullout have not even started. There are still two definite camps in Europe and two in the U.K. as well. Right now, the important contest is between the two sides in the EU as they prepare for the first summit to take place since the U.K. elected to withdraw.

On one side you have the position that Britain should be made to pay dearly for this decision. The Germans have been adamant that Britain should not be able to keep the “good stuff” and walk away from the parts it doesn’t like. In their estimation, this would encourage other states to pull out. There is likely some truth to this concern, but the other side of the argument holds that many current members want out already. If they continue to be frustrated by EU intransigence, they may well go the way of the U.K. The current challenge is coming from the “Visegrad Four” (Hungary, Slovakia, the Czech Republic and Poland) as they chafe against the EU’s refugee policy and the economic issues that they assert have not been sufficiently addressed. There have been plenty of other rumblings from Greece, Spain and even Italy.

One of the suggestions that has reappeared is the creation of a two-tiered EU—one tier of states that really want to further explore and pursue integration and even political unity and a second tier that wants a more distant relationship in which they engage with the common market and offer cooperation, as far as security and foreign policy is concerned. This would seemingly offer all the current members states what they want.

The first tier would likely include the current dominant powers and those countries most closely tied to them. It would be Germany, France, Italy, Spain, Belgium, Austria and perhaps Portugal. The states that have been most resistant to the dreams of federalism would be in the second tier. These would likely include Sweden, Denmark, Ireland, Netherlands, Poland, Czech Republic, Slovakia, Hungary and the Baltic states. It would be likely that Britain would reattach as part of that second tier. There is a good chance that some states that are not current members would opt for that second-tier alternative. This might include Norway, Iceland, Switzerland, Turkey and even Ukraine.

Nothing about this division would be easy. There is currently a slim chance it will even get a hearing. Right now, the dominant states are in a defensive posture trying to protect that federalist future, but if there are more defections, it will be clear that major reform will be needed to keep the whole edifice from collapsing.

A Look at Italy

Hans Belcsák

While much of the world’s attention was focused on the earthquake that devastated the towns of Amatrice, Arquata del Tronto and Accumoli, a political quake rocked the resurgent Five Star Movement. This may have given Prime Minister Matteo Renzi a better chance to win his critical constitutional referendum. Economic improvements may follow. But this is the best-case scenario. In the worst case, the government will fall; economic reforms will remain a pipe dream; and talk of a possible departure of Italy from the Eurozone will gain momentum.

Only a few months ago, the populist Five Star Movement of the comedian Beppe Grillo was riding high, having just emerged as Italy’s leading political party. Four public opinion polls had given it the edge over the ruling Democratic Party, or PD, of Matteo Renzi and had set alarm bells ringing about a fall referendum on which the Prime Minister has staked his career. Grillo’s party had already won victories in important municipal elections in Rome and Turin. Rumors had begun circulating about a possible government collapse, while the parliamentary leader of the Five Star Movement, Luigi Di Maio, demanded that Brussels allow public money to be pumped into the country’s ailing banks without any hit to private investors. The Movement was calling for a plebiscite to be held on ditching the euro and re-establishing a national currency.

But then along came a scandal revolving around Rome’s administrator for refuse, Paola Muraro, who was appointed by Mayor Virginia Raggi of the Five Star Movement only a short while ago to get the city cleaned up. The problem grew out of links she is said to have had with “eco-mafia” crime rings that feed off lucrative waste disposal contracts. The revelation quickly grew into a political threat not only to Ms. Raggi but to the whole Five Star party, especially as it followed hard on the heels of the exit of five technocrats in Rome, including the city’s respected finance chief, complaining about the “incompetence” of Rome’s newly installed administration.

If the Five Star Movement’s fortunes decline, this strengthens the odds of Renzi winning the crucial referendum on far-reaching constitutional reforms that he plans to hold in November and on which he has staked his political future. The reforms aim to make Italy more governable by such actions as stripping the Senate of much of its legislative powers and reducing the number of lawmakers, and also to boost the ailing economy. His government is weighing the merits and costs of increases in pensions for low-income retirees, directing some 500 million euros supposedly created by the constitutional reform to the “fight against poverty,” and bringing forward to next year an income tax cut originally planned for 2018. The trouble is, he has very little fiscal leeway and will, in fact, have to find spending cuts or extra revenues to offset the automatic VAT rises that are scheduled to hit next year.

He also wants to rescue the ailing banking sector, which is beset by multiple ills including exposure to peripheral government debt, mountains of bad loans, weak profitability and a fragmented structure. The country has 600 separate banks with a vast number of branches. As much as 17% of the loan volume is said to be sour, which is 10 times the level in the US. Currently, most at risk is Monte dei Paschi di Siena, the world’s oldest bank and Italy’s third-largest by assets, but it is far from being the only one with headaches. It is estimated that UniCredit, for instance, which is Italy’s only globally important bank, needs to be recapitalized with up to 10 billion euros while smaller, local banks such as Rimini, Vicenza and Veneto Bank need hundreds of millions.

It is doubtful that they will be able to raise those funds. Collateral offered up by borrowers is often questionable for various reasons such as the use of a bankruptcy law dating back to Mussolini’s times where it can take as long as 15 years to foreclose on a defaulted mortgage. Also, according to point 44 of the 2013 rules on state aid being provided to banks, European Union regulations require first that “subordinated debt must be converted into equity.” In Italy, retail investors own about 60 billion euros of such bonds and conversion would only cause a political upheaval. Such a “bail-in,” wiping out the holdings of investors, could also threaten confidence in the banks that sold the paper.

To go ahead with a multi-billion euro injection of state money, Renzi needs a waiver from European Commission state aid rules and a legal path through the bail-in regulations of the EU’s Bank Resolution and Recovery Directive. Italy has tried and failed to secure this in the past, and a renewed failure on this score could doom the prime minister’s chances to win the constitutional referendum. Defeat on this score would indeed do grave damage to his career and risk pushing Italy into prolonged political and economic instability. If the voters reject his reforms, Renzi has said he would resign. In such an event, he would likely be replaced by a caretaker prime minister before national elections that would lead to another weak administration.

The background to all this is formed by a very soft economy, which stalled in the second quarter with zero growth and a real GDP just 0.7% ahead of a year earlier. The Finance Ministry was quick to blame the setback on external factors including the Brexit vote, the European migration crisis and terrorism. But, clearly, domestic weaknesses bear much of the responsibility. This includes the fact that the country has too many small, unproductive businesses that are not growing. Banks have contributed to the difficulties with cozy links to selected borrowers. Faster economic growth would alleviate many problems afflicting the country, from the nonperforming loans that weigh down banks to a public debt that stands at 135% of GDP. Without it, Italy will stay in a rut and the voices calling for it to leave the Eurozone will get louder.

Italy is today arguably worse off than it was when it joined the monetary union. Its real gross domestic product last year was almost 4% lower than in 1998, while that of Germany has grown by 17%. Unemployment has declined in the past year, but only to 11.6% from 12.2%, while the Eurozone average is 10.1%. Youth unemployment in Italy, at 36.5%, is far above the Eurozone rate of 20.8%. Inflation is higher and productivity growth lower than in Germany. Capital is leaving the country. So long as these ills prevail, the view will grow among the people that Italy is getting little or no benefit from the supposed pooling of risks across the Eurozone, while it is being punished by the many fiscal, monetary and regulatory constraints membership implies and by the inability to devalue its currency. It is hard to see how this dilemma can be resolved and it would not come as a great surprise if Italians lost confidence in the euro. The question then will be whether they can be persuaded to worry more about the staggering costs of leaving the zone than about the difficulties of staying in it.

Global Roundup

Are negative rates in the eurozone “worth it?” What effect has the deposit rate of the European Central Bank (ECB), which has been in negative territory since June 2014, had on the eurozone financial system and economy? On the one hand, the costs of the negative deposit rate do not appear to be unduly burdensome, at least not at this time. On the other hand, however, there do not appear to be overwhelming benefits resulting from the negative deposit rate. (Wells Fargo)

Canada expects EU trade deal ratification in 2017. Canada is working toward signing a new trade agreement with the European Union in October with ratification slated for early 2017, Canadian Trade Minister Chrystia Freeland said on Sept. 12. Supporters of the deal say it would increase trade between the EU and Canada on a range of products, boosting the EU economy by $13.5 billion. (EurActiv)

South Africa: lost in stagnation. South Africa is struggling to deal with the impact of several lingering shocks, already being challenged by home-grown structural weaknesses. The introduction of credible and effective fiscal reforms will be crucial for rebuilding confidence and unfolding the giant’s potential. Yet, in case of political apathy or another major shock, the country’s solvency might deteriorate faster than currently anticipated. (Credendo)

Mexican economy unlikely to regain momentum before 2017. Mexico's economy has lost steam in 2016. The outlook has become cloudier with the upcoming U.S. elections stoking uncertainty about future economic relations between the two nations. The Mexican economy expanded at a solid rate of +0.5% (revised) in Q1 2016 on the previous quarter, but was unable to maintain the momentum into Q2, when the economy contracted -0.2%. (EconoTimes)

U.S. dollar debt grows in Argentina. Argentinean companies involved in international trade are increasingly turning to commercial loans in U.S. dollars to avoid the high interest rates implemented to combat inflation in the country. (Global Trade Review)

Singapore shipping trust seeks debt restructuring. A Singapore-based shipping trust that operates container ships is asking creditors for leniency on about $253 million of debt, in the latest sign of debt woes in the industry and in the city-state. Rickmers Maritime won’t be able to repay $179.7 million of senior debt due in March 2017 and the interest and principal on S$100 million ($73.3 million) of notes due in May 2017, it said in an investor presentation filed to the Singapore Exchange on Thursday. (Times of Oman)

Six events that will shape Europe in the next nine months. Europe faces a string of political and financial events that may lead to further instability in a region already battered by the effects of multiple crises. Last week, Global Risk Insights examined the events that could chart Europe’s future, from terrorism to several critical elections. (Global Risk Insights)

Deutsche Bank to fight $14 billion demand from U.S. authorities. The bank said it would fight a $14 billion demand from the U.S. Department of Justice to settle claims it mis-sold mortgage-backed securities, a shock bill that raises questions about the future of Germany's largest lender. (Reuters)


Week in Review Editorial Team:
Nicholas Stern, Editorial Associate and Diana Mota, Associate Editor