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Emerging markets collectively remain “high beta coupled”, so to speak, with their developed brethren per Wednesday’s Lex column, the implication being that an eventual price-to-book convergence and ultimately out-performance (per their relative fiscal fundamentals alone) are in the cards for those investors steely enough to latch on. Yet while anticipating this homecoming of sorts, now may be the perfect time to finally take a more discerning eye towards EMs instead of lumping them all-together, given that our premise remains that the strong fiscal balance sheets and still largely dormant, demographic dividends upon which much of their stories rest can all-too-easily be undone by an uncouth central bank (not to mention shoddy governance). Moreover not every economy is equally poised at the same moment to prosper equally, even from the loosest of monetary policies. Martin Sandbu’s Monday FT piece on Chile and the “middle income trap” is case in point as it underscores the importance of total factor productivity (TFP)—i.e. how efficiently capital and labor are combined–in helping to ease a given population’s transition from developing to developed as its PPP adjusted, GDP/capita invariably rises (in fact, a World Bank report from 2008, “Unleashing Prosperity” demonstrates that TFP is the fundamental driver of real output among developing nations). With this in mind Sandu notes that “Chile’s record is disappointing”, a mild understatement given that until only recently the figure has been negative. Even a recent estimate of around 1% sits well beneath the average emerging market annual rate of 2.4% from 2005-2008 (compared to 0.2% in advanced economies for that same period), a number which has admittedly declined per The Conference Board “as transitional productivity effects appear to [be abating] in some of the major emerging economies.” Thus, as the BCCH (Chile’s central bank) soon embarks on what the consensus now expects to be a 100bp easing cycle delivered in four consecutive 25bp cuts to help combat what analysts expect are downside risks to the 3.9% q/q saar GDP forecast for Q3 11, realize that while the monetary catalyst may be coming, the results could be underwhelming.
In central bank parlance the battle between “macro-precautionary” or “macroprudential” measures (such as capital controls and higher bank reserve-requirements) and more traditional interest rate tools may yet favor the old school. Barclays noted this week that at least “some EM policymakers appear to be waving the white flag in the currency wars” and as the FT’s beyondbrics noted today there’s no better example of such capitulation than Chile. There the peso just set a new high, since April 2008, versus the dollar, while inflation is expected to stay above the central bank’s 3 percent target “for some time”. The quandary of course is that rate hikes not only carry an economic cost but also attract “footloose foreign capital”–one primary reason why Brazil has attempted alternative measures. The Economist noted that one solution however may be to “welcome the inflows, let [currencies] rise where [they] will and . . . eliminate expansionary fiscal deficits”–both of which would theoretically ease price pressures and permit monetary easing–in kind tempering inflows. In Chile analysts expect another 50 point rise in May followed by consecutive 25 point hikes in June and July–leaving the key interest rate at 5.5 percent. At the same time, however, aggressive primary spending as a % of GDP is not helping the cause: while high copper prices turned a structural deficit into a 0.4% surplus last year, for instance, the number appreciably lagged the pre-crisis 8.8% level. In truth, this kind of stimulus should be saved until copper prices eventually do correct. For now, and likely through 2012 the state of the copper market is such that further peso appreciation beyond 450 may be inevitable as current account surpluses get fat–regardless of whether that means intervention selling or capital controls come back in vogue. Specifically analysts highlight that “miners are facing extreme challenges to growing output, including lower ore head grades, skilled labour shortages, equipment failures and long waiting times for new parts, all of which mean that mine supply will struggle to grow this year and is even in danger of contracting.” When this supply dynamic reverses, however, is when Chile’s central bank will really be put to the test.
The lower effective cost of imports has hitherto helped to tame inflation in Chile, although further dollar appreciation can be expected (two, three and five year swap rates all climbed to relatively new highs after the decision) as the $164bn economy expanded 7 percent in the third quarter year over year, its fastest pace since 2Q2005. Despite the fact that core CPI numbers came in below consensus (down 0.1 percent in October after rising 0.4 percent in September), and the country’s trade surplus hit a 22-month low, falling 88 percent to $214.9 million in October from $1.785 billion the month before, the central bank raised benchmark rates by a quarter-point (to 3 percent) for the sixth straight month this past week. Interestingly, though the peso has been the region’s strongest performer–up 14 percent since late June against the dollar–Chile has no plans to implement capital controls (such as Brazil’s 2 percent tax on inflows) to curb gains, per Finance Minister Felipe Larrain. “Capital is very smart,” he said. “You can say this short-term capital I don’t want, so they disguise it as long-term capital and they are really playing with the interest rate differential.” As an investment, the Chilean ETF (ECH) remains strongly correlated with the price of copper, which in turn follows the lead of the Shanghai index (China is the top consumer), argues trader Moise Levi. Using technical indicators (inverse head and shoulders; see graph left), he cites a close above 3150 on the Shanghai as a strong buy indicator on the metal.
Shares in Chilean glass products maker Cristalerias de Chile–which has a market capitalization of roughly $700 million and produces glass bottles and containers mainly for the food and beverage industry–rose 15% on Friday after the firm announced an agreement to sell its 20% stake in cable television operator VTR–the nation’s largest cable-television and broadband provider–to Celfin Capital for $303 million (roughly 7x EBITDA, per one analyst). A week earlier the company placed two series of five-and 20-year inflation-linked bonds worth a total 41.46 billion Chilean pesos ($75.3 million). One condition of the VTR sale is its possible future listing on the local stock market. VTR is currently in the process of bidding on a 3G wireless license which would allow it to enter the mobile telecoms market starting in 2010.
Cristalerias shares are still undervalued and thus make a sensible addition (following an expected short-term pullback) to our mock frontier portfolio; the case for the firm is strengthened as it represents a proxy on domestic demand growth against a backdrop of a stable nation with sound fiscal practices–its latest current account surplus was $1.13 billion in the second quarter, or 2.9% of GDP.
Per The Wall Street Journal this past week, Chile’s AES Gener issued $183 million of bonds in the local market. It has placed 10-year bonds denominated in dollars with an internal rate of return of 8.5%, compared with the 8.65% originally offered. The company will use the proceeds to fund its investment and growth plans. Gener is the second-largest power generator in Chile.
As for the country in general, Chile’s central bank cut its benchmark interest rate for a fourth time this year in an effort to pull the economy out of its worst slump in a decade. According to Bloomberg, economists expect the economy to shrink 0.5% in 2009, according to the median of 34 forecasts. And industrial output fell 11.5% year-on-year in February, according to the National Statistics Institute–the biggest decline since 1990.
While most finance wonks opine that dominant indices will need to double bottom (at the very least) before a secular, bull rally can take form, many also agree that the first-mover advantage in such a global rally will start in both commodities and emerging markets.
One such firm could be Sociedad Quimica y Minera de Chile (NYSE:SQM), a Chilean chemical manufacturer that deals in specialty fertilizers (its principal revenue source), iodine and iodine derivatives (used to produce polarizing film for LCD screens and contrast media), lithium and lithium derivatives (vital to the production of rechargeable batteries powering modern electronics and hybrid cars worldwide), potassium nitrate (to make glass or enamel coatings for refrigerators and bathtubs), and industrial chemicals.
SQM thus taps into two growing industries–agriculture and “green” technology. A report issued last month noted that:
Chile is the leading lithium producer in the world with SQM being the word leader with a 30% market share. The company has nine plants in the Salar de Atacama, which is considered the driest place on earth and holds the highest lithium concentrations currently recorded. Bolivia is estimated to have about half the world’s proven lithium reserves. Bolivia, however, lacks the expertise and infrastructure to compete with Chile and Argentina, which together account for more than half the world’s 27,400 tons of annual lithium production.
In February SQM announced 4Q08 net income increase of 170% year-on-year to US$120mn, while revenues climbed 29.9% year-over-year in the recent period to US$398mn. That said, the firm admitted that it expects 2009 to be a tougher year for the company. Yet at the same time, it also predicted that the recent decline in sales volume for fertilizer was “not sustainable given that specialty crop producers must fertilize to maximize yields and continue to provide export-quality products in order to maintain margins.”
The Chilean peso has gained 8.6% this year, the biggest increase among the six most-traded currencies in Latin America. During Wednesday trading, however, that number fell, with the peso reaching 595.80 per dollar from 587.85 a day earlier.
That said, pending dollar sales by the Finance Ministry, announced on Feb. 23 as part of an economic stimulus plan, will extend the dollar’s slide during the coming weeks, according to Celfin Capital in Santiago. “We could reach 550-570 [per dollar],” noted the firm’s head economist, Cristian Gardeweg.
Bloomberg reports that new accounting rules will allow Banco de Chile, the country’s second-largest lender, to boost dividend payments. The International Financial Reporting Standards that have applied to Chilean banks since Jan. 1 eliminate monetary adjustment charges among other changes, according to a report by Celfin Capital. These changes, which will be partly countered by lower loan growth and inflation estimates for 2009, should result in the bank paying out higher amounts of dividends in forthcoming years,” per analysts.
The synchronized global recession continues to hammer the banking sector as a whole; however, certain Latin American banks, and Chilean-based ones in particular, are bucking the trend thus far in 2009. Of the five best performing foreign banks, YTD, South Korea’s Woori Finance is up 16.75%, followed by Argentina’s Banco Macro at 13.77%. Rounding out the list are Chile’s Corpbanca (5%), Banco de Chile (4.92%) and Banco Santander Chile (1%). On the flip side, the five worst performers are all UK and Irish based.
While Chile may be sitting on a nice surplus thanks to its saving of copper revenues, allowing it to pursue more aggressive fiscal measures in the current downtown, that’s not to suggest that the economy as a whole is in the clear. On the contrary, Chile’s National Statistics Institute (INE) reported late last week that industrial production fell a bigger-than-expected 3.7% in December from a year earlier, after a 5.7% fall in November, sending the peso down 1.16% soon after the data was released in late-week trading, touching 619.00/619.50 per dollar before paring losses somewhat. Copper mining also fell more than expected. Chile’s mining sector alone, which produces more than a third of the world’s copper, was down 8.9% in December and 4.2% in all of 2008. Concurrently, exports of molybdenum, a metal used to harden steel and another of Chile’s top exports, decreased as well.
Per Reuters:
The INE said the result was due to a lower pace of economic activity and of both domestic and external demand that hit output of base metals, wood products and non-metallic minerals. “The economic data shows a downward trend which affects sectors from mining to business. This is because the dependence on the external sector makes them vulnerable to variations seen on international markets,” INE added.
Analysts predict that the data will likely put pressure on the central bank to again cut interest rates aggressively at a policy meeting in February.
JGW
Frontier Markets 