While on a recent research trip to Brazil, Colombia, and Peru, we emerged with the sense that fiscal policy uncertainty weighs more heavily in Brazil and Colombia than in Peru. Overall, we came away less concerned about Peru than Brazil and Colombia despite Peru’s recent political and social upheaval. As counterintuitive as it seems, Peru’s fundamentals are in relatively solid shape despite recent protests and a lack of clarity about how long the current president will remain in office. In Brazil and Colombia, on the other hand, there is little doubt about who will be president for the next several years. Yet in both countries the fiscal policy trajectory beyond 2023 is concerning.
Among these three countries, the tension between fiscal and monetary authorities is without doubt the highest in Brazil. The current administration adopted a fiscally impulsive stance even prior to taking office and, while the Ministry of Finance with Haddad at the helm, appears to be pushing for a pragmatic stance, it remains unclear that Lula and his PT (Workers’ Party) are in alignment with Haddad. Our sense is that the overarching focus of the Lula administration is economic growth. The central bank remains hawkish and is keeping a close eye on fiscal policy. In the absence of a credible fiscal framework, it will be difficult for that hawkishness to dissipate which, in turn, makes it more likely that the government will look to bolster growth via fiscal policy and state-owned enterprises (e.g., Petrobras, the state-owned oil company and BNDES, the state-owned development bank).
In Colombia, where we continue to believe that there are reasons to be constructive on 2023 fundamentals (both fiscal and external), we came back from this trip more concerned about the fiscal outlook for 2024. We still believe that the Petro administration’s ambitious reform agenda will not sail through without being watered down (reforms in Colombia never succeed without being diluted), but this time around the government is proposing far more reforms at once and some will be approved. Our main concern is that pension reform, which is in fact greatly needed in Colombia, will be passed in a form that keeps the local rates market on edge. Given that fiscal revenue will fall beyond 2023 and social expenditure will be higher, continued fiscal consolidation relies on gradual elimination of the fuel subsidy and lower borrowing costs. We have higher conviction on the former than the latter. And in the meantime, it appears increasingly likely that market-friendly Minister of Finance Ocampo will leave his post in 2024.
Meanwhile in Peru, the clearest impact of protests and political uncertainty on fundamentals has been via growth, which was impacted negatively in January, but leading indicators for February and March are already improving. Downward revisions to 2023 growth estimates have already taken place, with the central bank estimating 2.6% (vs. 3% previously), but this will still be a higher growth rate than we are likely to see in any other major Latin American country this year. And both fiscal and external accounts remain in solid shape. Political uncertainty and social tension will remain a constant in Peru, but protests have dissipated throughout most of the country and institutions such as the Ministry of Finance and central bank continue to function well, and face relatively lower turnover compared to the presidency.
Overall, after our trip, we believe it is fair to say that, beyond 2023, fiscal dynamics will deteriorate in Brazil and Colombia, but not Peru. Political risk premium will likely remain in Peruvian spreads, but we do not anticipate a meaningful impact on fiscal fundamentals or further spread widening versus. peers over the next 12 months. And while we believe the fiscal trajectory going into 2024 is negative for both Colombia and Brazil, we are relatively more constructive on the former than the latter given more of this negativity is priced into Colombian bonds.