Economic Analysis - Private Sector Debt: Political Risks Undermining Debt Appetite - JAN 2018

BMI View : Private sector debt levels will rise across Latin America in 2018 on the back of low interest rates and an improving growth outlook. However, political uncertainty will remain a major headwind, potentially undermining investment.

Private sector debt will likely rise modestly across Latin America in 2018. Following a period of de-leveraging, strengthening economic activity growth and low interest rates will encourage the regions' corporates to take on new debt in order to finance investment in expanding capacity. Data through Q117, the latest available, shows that in the region's major markets, households and corporates continued to deleverage into 2017, which is in line with our view ( see 'Private Sector Debt: Investor Appetite Will Support Growth', May 18). Economic activity broadly disappointed in H117, largely due to elevated political risk and weaker-than-expected commodity prices. While growth has picked up in H217, in line with our view, political uncertainty remains a weight on investment in most markets ( see 'GDP Roundup: Political Risk Will Subdue H2 Recovery', August 24). As a result, debt levels in the region are unlikely to rise significantly in 2017.

Moving forward, we expect this trend will gradually reverse , particularly within the corporate sector. Corporates in the region are underleveraged relative to their emerging market peers. The combination of an improving growth outlook and low nominal interest rates should bolster corporates' willingness to take on, and ability to secure, debt. In most markets, we expect private sector investment into upgrading and expanding productive capacity will underpin activity growth over the coming quarters. While idiosyncratic factors will weigh on some sectors, such as Brazilian construction, we are broadly positive on the materials, energy and consumer sectors.

Household debt will see more restrained growth. Although lower interest rates and stabilising labour markets could offer some upside, debt servicing remains a burden on households in markets like Brazil and Colombia, where consumer debt levels are relatively elevated.

Debt Levels Stable As Deleveraging Continues
Private Non-Financial Sector Debt, % of GDP
Source: BIS, BMI

We see limited systemic risk from an increase in debt over the coming quarters. Sector level data suggests that debt is largely concentrated in exporting industries, principally materials, and non-cyclical industries, such as utilities. Higher average commodity prices will support stronger corporate balance sheets for materials firms, while relatively stable exchange rates will ease external debt service burdens for non-exporting firms.

Political uncertainty remains a prominent risk to our outlook for private sector debt and economic activity growth more broadly. Elections in Brazil, Chile, Colombia and Mexico will have significant impacts on policy direction over the coming years ( see '2017-2018 Elections: Policy Direction Hangs In The Balance', April 27), with outsider and populist candidates likely to run competitive campaigns that could undermine firms' willingness to make long-term investments.

Political risks hang heavily over Brazil. While business sentiment has been buoyant over recent months, an unfinished set of economic reforms, rock-bottom public approval of the political establishment and voters' early preference for anti-reform candidates suggests that the coming months will produce volatile swings in business sentiment that will pause investment decisions. Data from Q117 shows Brazilian corporates and households continuing to deleverage, and with the election scheduled for October 2018 we believe this process could continue well into Q318.

In addition to an upcoming election, Mexico also faces additional risks stemming from NAFTA renegotiations, adding a further complication to business sentiment. Although we expect the agreement's core tenents to remain in place ( see 'NAFTA Update: Deadlock To Result In Few Treaty Changes', September 29), uncertainty will persist over the near term. This will likely weigh on firms' decisions to secure capital for medium and long-term investments.

Argentina is most likely to see strong increases in debt levels over the coming quarters, although this will be concentrated in the corporate sector. A lack of access to external capital markets has long hindered firms' ability to borrow and invest, while a lack of trust in the domestic financial system has kept households from taking on debt. With confidence in the economy's recovery steadily rising, particularly following a strong showing for President Mauricio Macri's Cambiemos coalition in October's legislative elections ( see 'Cambiemos' Electoral Gains Will Support Reforms', October 23), we expect that firms will increasingly feel comfortable making long-term bets on the economy. Corporate debt remains low, at 12.1% of GDP in Q117, which is 26.7% below Q108, but strong external investor interest in the country will ensure capital is available at relatively favourable terms for Argentine firms.

In contrast, household debt will take multiple years to tick up. Given a history of elevated inflation and economic crises, Argentine households have long preferred to hold assets abroad or in cash, and have avoided seeking credit. In Q117, household debt equalled just 6.1% of GDP, far out of line with Argentina's per capita income and below regional peers such as Chile. This suggests substantial upside for consumer debt over the coming years, but we expect that the shift in consumer preferences toward credit will be slow to unfold. Still, there are already early signs of a shift. Anecdotal reports from Argentina's small mortgage market suggests that interest in mortgages has begun to pick up over the last year.

Latin America Private Sector Debt, % of GDP
Households Q117 Corporates Q117 Private Sector Q117 Private Sector Q108 Change, %
Source: BIS, BMI
Argentina 6.1 12.1 18.2 21.2 -14.2
Brazil 22.1 42.4 64.5 51.3 25.7
Chile 43.2 100.5 143.7 92.6 55.2
Colombia 25.0 40.5 65.5 42.6 53.8
Mexico 16.5 26.2 42.7 28.7 48.8