Most parents have heard those barely credible ‘I won’t do it anymore’ promises from a misbehaving child.

In Argentina, the public dared to believe the misbehaving government. ‘When the new CPI index is introduced, it will start to reflect what is really going on with prices in the economy’, they hoped.

But, while the government reports monthly inflation at 0.6%, private estimates are more than double the official rate. What’s going on? Are private analysts grossly mistaken?

That’s what Commerce Secretary Guillermo Moreno thinks. “The true indexes are the official ones. Anything else is just speculation.”

Let’s take a look at a topical example. As daily headlines inform us all, food prices around the world are soaring. But in Argentina, which is suffering from shortages of some goods due to a major agricultural strike, they are rising at just 0.7% a month. Interesting…

The ‘food & drink’ category of inflation is critical for poverty indicators. So there is a clear motivation for the state to try and keep official figures from reflecting the recent surge in prices. And so, in Argentina, while poverty indexes are in decline, the view from the streets paints a very different picture. And it’s not some visual illusion, as the government claims. You just have to step outside to see what’s really going on throughout the country.

Poverty isn’t the only indicator ‘benefiting’ from under-reported inflation data. Real GDP growth also gets a boost. Why? Because price indexes are used to ‘deflate’ economic activity. Put simply, any part of nominal growth that is not put down to price increases must be due to higher output.

Of course, the list of negatives associated with the deliberate manipulation of inflation data is much longer than this. Some of the notable others are: fewer new investment projects in the economy, capital flight away from national public debt, limited (or no) access to international financial markets, and distortions in relative prices. Worst of all, it makes it impossible to tackle the actual inflation problem.

This situation hits every investor with a stake in the Argentine economy, whether it is in the real economy or financial markets.

In the real economy, the unpredictable price dynamics (that is, not the official ones), make it impossible to forecast future returns from investment. Even short-term projects become difficult to evaluate in the current environment. For example, two months ago you might have invested in Argentina’s export sector, following consensus forecasts for further peso weakening. You’d be pretty annoyed that the Central Bank unexpectedly changed position, and has prompted the peso to appreciate from AR$3.21 to AR$3.04 during that period.

In capital markets, things aren’t much better. On top of an undeveloped and inefficient local market, Argentine paper is becoming more and more volatile as instability in the economy increases.

Perhaps the biggest deception in the price indexes is creating the illusion that things are going in the right direction. They are not. The government wants you to believe that inflation is stable, when it is rising in all other corners of the world. That poverty levels are falling. That growth rates comparable to China are positive (even as this seems impossible given current conditions). And all the while, actual inflation will continue to harm the economy, until we reach a point of no return. By then, it will be too late.

Until tomorrow,
Horacio Pozzo

The US presidential elections are approaching. Latin America has a keen interest in the outcome, though maybe not as much as before. Not only has the region grown stronger in recent years, but the US has lost some of its global influence to the Eurozone and emerging Asian giants.

The Bush administration forgot Latin America. This is a grave mistake — and one that the incoming president needs to remedy.

For now, the candidates are doing whatever they can to attract Latino support within the US. With an estimated 10 million eligible voters, this community could be decisive in determining who wins the White House. A Gallup opinion poll says 62% prefer the democratic candidate, Barack Obama. There’s a long way to go yet though.
“Obama brings a perception that the country is changing; that it recognises its errors and is prepared to amend them,” says Ted Piccone, Vice President of foreign policy at the Brooking’s Institute. “Meanwhile, [Republican nominee] John McCain projects an image of continuity.”

Obama promises to a radical change in relations with Latin America. It’s time to “lend a helping hand” he says. Too bad no-one thought of that earlier, when the region needed US support the most…

But according to Otto Reich, former assistant Secretary of State for the Western Hemisphere, McCain has the upper hand over his rival.

“McCain has visited nearly every Latin American country, while Barack Obama has never even set foot in Latin America,” says Reich.

This could work in McCain’s favour. If people think he has a better understanding of the region, they will view his policies as more credible. The Republican candidate is hammering this point across.“I know the [Latin American] leaders, I know their problems, and I understand the importance of our relations with them,” he says.

Meanwhile, Latin America awaits. My colleague Germán Sanchez referred to comments by Hugo Chávez in this recent article.

The Venezuelan president declared  “I would like to get ready so that, whoever becomes the next US president, we will work together to fight global hunger and save the world from food, energy and environmental crises.”

In Mexico, the choice of president does matter. It is by far the most exposed Latin American country to decisions made in Washington DC.

One of these concerns the future of the North American Free Trade Agreement (NAFTA). On this front, Mexico would prefer a McCain victory. His support for NAFTA has become a central feature of his campaign. In contrast, Obama wants to renegotiate the agreement. He has even suggested he would abandon it altogether if necessary.

McCain also supports a Free Trade Agreement (FTA) with Colombia. Quoted in Argentina’s La Nacion daily, he says “one of the main goals of my government will be to promote free trade [in Latin America]. It is key to improving economic conditions in the region and will benefit the US economy.”

Obama, on the other hand, is less than convinced. “If John McCain believes that 80% of Americans think the country is heading in the wrong direction because we haven’t approved free trade with Colombia, he doesn’t understand the American people” says the Democrat.

McCain is also considering the elimination of agricultural subsidies, which would be hugely beneficial for some Latin American states. Without doubt, countries like Argentina and Brazil would earn billions of dollars from increased agricultural exports to the US.
Latin Americans (and especially Mexicans) are also interested in US migration policy. Obama has promised “reform within the first year of my presidency”. McCain also says he is committed to change. “We will tackle migratory reform,” he says in an article on CNN Expansion, “the day after my inauguration, I will send the matter to Congress.”

Energy is another topical point in the coming election. “I want to work with countries like Brazil to find cleaner ways of producing energy…” says Obama.

Another major concern for both candidates is drug trafficking. Both recognise the efforts of Mexico and Colombia in the fight against drugs, and have promised to continue supporting them. This issue is clearly of great importance to both Latin American states, not least in their efforts to promote sustainable growth.

I’m not certain that either candidate will follow through on all of his promises regarding future relations between the US and Latin America. But at least the US is clear that it can no longer neglect the region.

But Washington shouldn’t only seek to improve relations as a way of curbing the influence of socialist leaders like Chávez and Bolivia’s Evo Morales. It should forge closer business ties for growth and development of the entire region.

Buenos Aires, Argentina June 27, 2008

My friend Alfredo is so lucky! Thanks to his profession he is traveling across the continent. Alfredo is a geologist, and with the price of a barrel of crude oil soaring in the clouds, he has plenty of work to keep him busy.

This is so because the main oil companies are roaming the entire region in search of areas to explore. And the countries that guarantee institutional stability and exhibit respect for the law are the ones that are benefiting the most at this time. For example, Peru has managed to successfully attract several bids in the field of hydrocarbon exploration and has already received its first positive results. My friend Alfredo is preparing himself for a new trip as his company has already been working in Peruvian territory …

Now it is probable that Alfredo will also travel to Colombia, since this country has just announced that it will auction oil blocks for hydrocarbon exploration. The pending bidding has been nicknamed “Mini Round 2008”.

As reflected in the economic website “América Economía” (and confirmed by Alfredo), in this “Mini Round 2008”, companies will bid on a set of distributed blocks of small and medium sized river basins totaling 5.1 million hectares: Valle Medio del Magdalena-Catatumbo, Valle Superior del Magdalena, Llanos Orientales, Putumayo and Cordillera Oriental, most of them having the same basic characteristics: most of them come with geologic information and are located in areas with rich hydrocarbon potential.

This represents without a doubt a great opportunity for the oil companies if we consider the potential wealth of hydrocarbon that is yet to be discovered in Colombia (it seems there are around 20,000 million petroleum barrels in reserves yet to be discovered), and about which I have already spoken in previous articles.
Colombia, like the rest of the countries in the region, wants to take advantage of the good moment for the price of oil. However, it tries to prevent being too exposed to oil price fluctuations since the strong increase in the value of the barrel has been hitting internal prices hard and this is one of the main explanations for the inflationary pressures that its economy is undergoing.

Attached to the subject of inflation is the increase of the internal supply of energy. Colombia not only wants to increase the production of oil, but also has bid on the expansion of its energy capacity, which is not a unique strategy that the government of Alberto Uribe is taking to control prices. They are now also looking to attenuate inflationary pressures by decelerating internal costs.

I believe that last week’s change regarding price agreements was a good decision. Companies’ commitment to wanting to maintain prices without variation is not a bad thing. However, this becomes problematic when this policy fails to lead to measures resolving the underlying cause of price increases and when the system becomes greatly abused leading to temporary extensions of price agreements. These policies have been shown to consistently fail, as they are already being demonstrating again in Venezuela and Argentina.

The announced fiscal measures taken in the last few hours to minimize inflationary pressures consist of the reduction of public expenditure by $ 1.5 billion pesos (representing something like a US$ 858 million savings). Through this cut, the Colombian government took care to not affect the social policy of public costs and this is a good political decision as well, from the perspective of Colombia’s well being.

Although I say that these measures, taken to reduce public expenditures, are positive, I have to ask myself: are there any negative effects created by these cost cutting measures? It depends on how you look at them; one could say that since they will affect internal demand, it could lead to smaller growth in domestic consumption. Perhaps it is possible to think that they could have a negative impact on economic activity in the short term, although not one of significant magnitude.

Something positive that I see regarding these policies that are being carried out in Colombia is that they are consistent with long-term economic growth. What do I mean by this? Colombia is not seeking a solution to problems that arise such as inflation, which amounts to the application of a “Band-Aid”, a measure that only provides momentary relief and one that generates negative consequences in the medium to long-term. The government of Colombia is prepared to endure the costs, which in the short-term imply adverse shocks such as the increase of energy and food prices to ensure sustained growth.

It is for this reason that Colombia appears to be an attractive country in which to risk medium and long-term investments, one of them is related to the oil sector.

We will meet again tomorrow,

Horacio Pozzo

In October 2007, I took a trip to Montevideo in Uruguay and was surprised by the boom in the real estate market there. It’s full of new construction.

The real estate market in Uruguayan cities has been performing well lately. The conflict between Argentine farmers and their government is having a positive impact on the Uruguayan real estate industry.

However, Uruguay is experiencing more than just a real estate boom. From the air I could see large expansions of crop fields… ones I later discovered were primarily soy fields.

The expected annual growth rate for Uruguay is 6.89%. Its economy is growing due to internal factors as well as external ones. But it is the external factors that are creating both opportunities and threats for Uruguay.

The strong price increases for agricultural commodities, coupled with the Argentine government’s recently implemented higher tax rate on farm exports, has created a strong expansion in Uruguay’s grain sector. The soy boom is not limited to only Argentina and Brazil…

As we pointed out last Monday, Uruguay recently shipped its largest consignment of soy ever, sending 38,000 tons of the grain to China. This opens up the possibility of accessing new markets and continuing its expansion.

Argentine newspaper Clarín reports: “Lately, soy has become part of the Uruguayan agenda. In 2003 there were 4,000 cultivated hectares. Today they surpass 400,000. According to the Ministry of Agriculture, Livestock and Fisheries, soy has expanded throughout the country, replacing fields that were once allocated to livestock, dairies and other crops.”

Many Argentines have seen very good investment opportunities in Uruguayan farmland and the number of Argentine-owned fields there has increased.

Although this large wave of Argentine investment has generated benefits for the Uruguayan farmers, such as contributing to the modernization of technology and creating fresh capital for the sector, its “locust like” behavior represents a threat to the future of Uruguayan farmlands.

The main cause for alarm is soy farming methods: leases are short-term and companies want to extract the greatest yield from the land in the shortest amount of time. This practice, in turn, depletes the soil.

For this reason the Uruguayan Ministry of Agriculture, Livestock and Fisheries has said it will force farmers to explain their methodology and to rotate crops. It says this is the “best way to conserve the soil.”

The Uruguayan government’s concern over soy farming has risen with the influx of Argentine farmers who, escaping the taxes imposed at home, have moved to Uruguay to plant soy.

Andrés Berterreche from the Ministry of Agriculture, Livestock and Fisheries said to local newspaper El Espectador: “The State is the guarantor of natural resources, and even when they are in use, they belong to the State, even if the land has a registered owner”.

It is probable that greater control by the Uruguayan government will put pressure on the soy boom there, or it will reduce the obtainable yields (since it will closely monitor planting methods). But the government hopes that soy production will keep on growing it tries to limit the negative effect this boom could have on farmland.

Uruguay is not only trying to take advantage of international food prices regarding soy. It is also growing strong in the meat sector. Uruguayan newspaper El Observador de Montevideo reports that, so far in 2008, meat exports increased 58%.

It is important to note, however, that this strong growth of exports is linked, to a large extent, to the rise in meat prices (an increase of 60% from January to May). During this same period the volume of exports increased by only 4%.

Even though the increase in the amount of meat exported might be low, the outlook for this sector is more than favorable thanks to the rise in prices.

I have tasted Uruguayan meat. It’s top quality. And I have no doubt that its growth potential is huge.

The Uruguayan government is extensively promoting beef. It’s doing so now at Expo Zaragoza 2008 (a three-month exposition in Zaragoza, Spain) — the goal being better penetration in the European market.

Uruguay also wants to continue growing in the lamb market. During his trip to Mexico, Uruguayan president Tabaré Vazquez opened the Mexican market to lamb meat. Uruguayan’s Ambassador in Mexico José Korzeniak said to ADNMundo: “Mexico is a market that imports 40% of its bovine meat and 56% of its ovine meat. That’s the reason why we believe that it is a market interested in our ovine meat”.

One final thing. If investments in the food sector don’t interest you, on Tuesday there was a natural-gas-field discovery in the Uruguayan continental shelf, and the government has said it is very probable that there is an oil field in the territorial waters facing the city of Punta del Este, 100 km from the coast line.

Raul Sendic, the president of Ancap, the Uruguayan company that discovered the fields, said: “There is evidence that in various areas of the shelf natural gas reserves exist, but we cannot yet determine if there is oil there, which is what really interests us.”

The magnitude of this discovery cannot yet be precisely determined. But Uruguayan authorities are hoping it will help them reduce their energy dependence.

Additionally, Sendic announced the Uruguayan government is contacting international companies to sell that information. It is calling interested parties regarding exploration in the area by the middle of next year.

We will meet again tomorrow,

Horacio Pozzo

Buenos Aires, Argentina June 23, 2008

What is the relationship between Scotiabank (SCOTIAC1) and the British fund Aureos Capital to the increase in local currency loans in Peru? You will find the answer in the following lines…

The first thing I want to point out is that Scotiabank has reached an agreement to manage pension funds in Peru after acquiring a 50% share of Profuturo AFP (PROFUTC1), according to the Peruvian newspaper El Comercio. The deal will cost Scotiabank $35 million.

AFP Profuturo was founded in 1993, when pension funds were starting in Peru, and manages the country’s fourth private pension fund (there are four pension funds in Peru). It serves 21% of the total pension fund clients and accounts for 17% of the total market share.

The Peruvian pension fund is a multi-fund system which means affiliates can choose, according to their risk aversion, between three different types of funds. This shows the development of the Peruvian’s pension fund system. Argentina has been debating the possibility of multi-fund systems, but until now it has been impossible to achieve this goal (and it is still a long way from becoming a reality).

El Comercio also noted that during the month of May the dollarization of loans granted by the financial system had decreased in all its segments, totaling 75.24% on mortgage loans, 72.1% on commercial loans, 20.03% on micro-company loans and 19.75% on consumer credit. There are also more people repaying their loans. Levels on delinquent accounts are 0.83% on commercial loans, 3.16% on micro-company loans, 2.55% on consumer loans and 0.81% on mortgage loans.

This dollar loan reduction and the current low delinquency levels are clear signs of a good stable macroeconomic and growth context which makes additional local currency financing possible.

And regarding the private capital fund Aureos Capital (a fund that invests in medium sized companies), the Peruvian press agency Andina interviewed Erik Peterson, the regional manager of the company, last week. He noted the following regarding investment prospects in Peru: “We see a lot of potential in the Peruvian market which is rapidly growing; its economy has one of the highest growth rates in the region; and we feel that this growth is sustainable.”

For Peterson, Peru is transforming itself into a country that interests foreign investors: “We feel that over the long term there is going to be more interest in the capital market sector and among strategists that want to invest in Peru”.

I cannot affirm that those issues mark a definite trend, but they are clear signs of the progress the Peruvian economy has been experiencing.

Moreover those signs also indicate a very good outlook for the development of Peru’s financial system. According to Andina, the pension funds in Peru are growing at a 20% year-on-year rate, a higher level than its regional peers (averaging about 15%) and one obtained by more people entering the labor system… This increased flow of resources to pension funds has to look profitable to investors and we will surely find them in the Peruvian economy and its capital markets (will they invest in Petroperu when this company goes public?)

On the other hand, the increased financing using local currency will encourage a higher loan demand for consumers, investments and mortgages (the latter at a slower pace).

Finally, the economic stability of Peru and its growth potential will probably encourage the development of venture capital and private equity, which in turn will grant access to financing and external support to many companies that rely on investment to grow.

It will be necessary to closely watch the evolution of the financial system in Peru so that good opportunities do not pass us by.

We will meet again tomorrow,

Horacio Pozzo