LATAM MACRO ANALYSIS Q1 2016

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1 Prepared by: Fernando Honorato Barbosa Chief Economist and Head of Research OVERVIEW OF THE REGION In another volatile first quarter, the market shifted from depression to euphoria, benefiting emerging assets. Concerns about a hard landing of the Chinese economy, weaker economic data on the global economy and discussion of a possible new banking crisis in Europe were elements that guided the poor performance of assets until mid-february. The dissipation of some of these fears with the adoption of stimuli in Europe and China and especially a more cautious tone from the Fed contributed to a relaxing of skepticism, resulting in a renewed flow of capital to emerging markets. Given this context, stabilizing oil prices and a rally in some commodities (without any fundamental explanation) placed Latin America in a prominent situation. Since February, the Brazilian, Colombian and Chilean stock markets have risen 24%, 12% and 6%, respectively, in local currency. The FX trend was no different during this period: 10% appreciation of the Real, 6% for the Colombian peso and 4% for the Chilean peso against dollar. The question that remains, however, is whether this trend will continue. In our understanding, even though the economic fundamentals of the region have not changed, the external environment should favor this renewed appetite for risk. In China, the transition to a flexible exchange rate should be less turbulent in the coming months. Moreover, the possibility of additional stimuli cannot be ruled out. The scenario that prevails in the United States is of a Fed more lenient about the normalization of interest rates. Aspects inherent to the Latin American economy should bolster this process of greater appetite for assets in the region. In this sense, the real adjustments of currencies over the past few years have facilitated a series of investments in Latin America. Added to that is the adjustment of the labor markets, making regional labor more competitive in dollars. The progress of adjustments in Argentina and new mining operations in Peru make these countries the most attractive in Latin America for the short term. Despite some problems, the positive highlight is the Mexican government s commitment to its fiscal targets. In Brazil, the possibility of implementing a reform agenda also shifts the outlook to a positive scenario. The bullish behavior of copper and end of the monetary tightening cycle are factors that also support Chilean assets. Despite the apparent relief in the short term, the need to advance reforms remains the dominant challenge in terms of structural positioning in the region. 1

2 Sep-14 Mar-1 Sep-1 Nov-1 Mar-16 Sep-14 Sep-14 Mar-1 Sep-1 Nov-1 Mar-16 Apr-16 MARKET INDICATORS Change (%) between 4Q1 and 1Q16 (eop) LATAM Currencies* Stocks Market** CDS Y USD 10Y Govt. Bond Argentina 13,71 11, Brazil -9,31 1,47-26,10-1,41 Chile -,77 6,99-26,16-4,90 Colombia -,43 1,82-11,08 -,28 Mexico 0,42 6,76-4,7 -,24 Peru -2,96 37,79-13,37-4,92, BRAM, * (+) means devaluation versus USD ** Local currency; Merval, Ibovespa, Colcap, Mexbol, Lima *** eop: end of period Commodities (%) LATAM Live Cattle -1,90 Coffee -1,28 Soybean 4,41 Wheat -0,99 Crude Oil, Brent 1,9 Crude Oil, WTI -9,49 Copper 2,06 Iron Ore 3, LATAM Exchange Rate (Base Sep/2014 = 100) LATAM Stocks (Base Sep/2014 = 100) Brazil Chile Mexico Peru Colombia Argentina Brazil Chile Mexico Peru Colombia Argentina CDS Year and Rating 400 BRA 30 SOA 300 CRO TUR 20 POR COL 200 INO PER PAN 10 MXN HUN IND MAL CHI ROM SLO ABU 100 THA PHI POL AUS AST 0 IRE NTH 0 CZE FRA 0 B BB 1 BB+ 2 BBB- 3 BBB 4 BBB+ 6A- 7A 8AA- AA 9 AA+ 10 AAA 11 Source: S&P, BRAM Next: Argentina: Rising inflation and a further retraction of activity are part of the adjustment; Brazil: The need for reforms and adjustments; Chile: The growth is expected to moderate in 1Q16; Colombia: Need for adjustment becomes more apparent; Mexico: Consumption in the country is likely to continue as one of the main growth drivers; Peru: The entry into production of new plants will increase exports and accelerate growth. 2

3 jan-08 jul-08 jan-09 jul-09 jan-10 jul-10 jan-11 jul-11 jan-12 jul-12 jan-13 jul-13 jan-14 jul-14 jan-1 jul-1 jan-16 May-12 Nov-12 Feb-13 May-13 Nov-13 May-14 Nov-1 Apr-12 Oct-12 Apr-13 Apr-14 Argentina: Rising inflation and a further retraction of activity are part of the adjustment Country signs an agreement with most of the holdouts and moves towards re-accessing the global financial markets. The two most resistant funds to an accord, NML and Aurelius Capital, reached an agreement with the Argentine government to pay US$ 4.63 billion. In all, also counting the smaller holdouts, Argentina should shell out a total of US$ 9 billion to no longer be considered in default. To make these payments, however, the government is dependent on Congress to repeal a law prohibiting differential treatment for creditors who suffered from the default in Most creditors agreed to renegotiate their debt in 200 and 2010 under different conditions from those accepted by the latest creditors. After obtaining support from the Lower House to continue payments under the established conditions, we believe the Upper House will also support the change in legislation. Rising inflation and a further retraction of activity are part of the adjustment process for the Argentine economy. According to OJF consulting, activity shrank 1.6% MoM in February, while inflation accelerated from 29.6% in January to 32.9% in February. The effects of the unification of the exchange rate and monetary push made by the past administration have had an impact on price dynamics in the country. To contain escalating prices, the interest rate controlled by the Central Bank remained close to 30% throughout the third quarter. Given this adjustment process, consumer confidence has been on a downward spiral since the end of last year. The Argentine economy should continue to lose strength, which will make wage negotiations ( paritarias ) with the big unions more difficult. It is vital that the government obtain modest nominal increases in these negotiations to continue the process of bringing inflation down Argentina: Activity Index % 40% 3% 30% 2% 20% 1% 10% % 0% 26.2% Argentina - Inflation (Consumer Price Index - CPI) 40.9% 31.4% 33.9% Source: OJF, BRAM OJF Index Source: Argentine National Congress Argentina - Interest Rate: BADLAR (%) , BRAM 3

4 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jul-16 Jan-0 Aug-0 Mar-06 Oct-06 May-07 Dec-07 Jul-08 Feb-09 Sep-09 Apr-10 Nov-10 Jun-11 Mar-13 May-14 Mar-94 Mar-9 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-0 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-1 Mar-16 Brazil: The need for reforms and adjustments The need for reforms and adjustments in the Brazilian economy have been governing confidence in the country. Both investor and consumer confidence are at levels close to the 2008 crisis. This has been reflected in the industry and broad retail, with retractions of -11.8% and -10.1% in the first two months, respectively. The deterioration of activity has impacted the level of revenue (real decline of -8.7% in Jan-Feb), which, added to the difficulty in cutting spending (+.% over the same period), create a scenario where it is impossible to stabilize gross public debt (we expect the debt/gdp ratio to climb to 76% of GDP by the end of 2016). Faced with an economy suffering from significant idle capacity, with a real FX gain of more than 27% over the last year and real wages falling 2.1%, the signaling of a credible adjustment to the public finances could contribute to a faster-thanexpected exit from the recessionary state. We project a 4% contraction of GDP in 2016, from -3.8% in Brazil: Industry and Retail Sales Brazil: Real Exchange Rate (Basket of 20 currencies) (mar/16): 3.70 Industry Retail Source: IBGE Source: BCB, BRAM Avg. (jan/99 - dec/09) In terms of monetary policy, the Central Bank (BCB) degraded its evaluation of the global outlook and kept the Selic rate at 14.2%. Frustrating market expectations of a 0pb hike, the BCB argued that the context of lower global growth (more deflationary) should contribute to the convergence of inflation in the coming months. Consumer prices increased 9.4% in the last reading (March), remaining well above the target range (4.%-6.%). We understand that inflation should decelerate more sharply in the 2 nd half due to the effects of the widening negative output gap and comparison base. Moreover, inflation expectations for the coming years should also retreat on the back of the more appreciated exchange rate. Given this scenario, we are currently working with an interest rate cut as of September, involving three 0bp cuts this year. 11.% 10.% 9.% 8.% 7.% 6.%.% 4.% 3.% 2.%.9%.3% 4.2% Source: IBGE, BRAM Brazil - IPCA 12 months (%) (Selic Rate - base scenario) 7.3% 6.7%.8%.9% 10.7% 6.4% 9.3% 7.9% 6.% forecasts 4

5 Jun-13 Dec-13 Apr-14 Jun-14 Apr-12 Oct-12 Apr-13 Apr-14 Jan-11 Jul-11 Chile: The growth is expected to moderate in 1Q16 Economic activity should moderate further in the second quarter. After advancing 1.3% in the fourth quarter of 201 in annual terms, the growth of the Chilean economy is expected to moderate in 1Q16, expanding less than 1% over the period. This trend should continue throughout the second quarter, driven by a smaller contribution from the external sector. Household consumption should continue to rise in 2Q16, still driven by real wage gains. However the weakening of the labor market should contribute to lower wage gains and a moderation of household consumption in the coming quarters. Investments and government spending are expected to contribute positively to growth in the second quarter and along We expect the Chilean economy to expand 1.8% in 2016, after growing 2.1% in Chile - Nominal Wage Chile: Retail Sales (%YoY) 3., BRAM YoY 3 month avg. Moderation of inflation should lead the Central Bank to maintain interest rates unchanged in the 2 nd quarter. Although inflation expectations are close to 4%, above the target (2.%), the FX appreciation and weakening labor market should lead the Central Bank of Chile (BCCh) to keep interest rates unchanged at 3.0%, at least in the short term. However, throughout the year, with the resumption of the tightening cycle by the Fed and expected depreciation of the Chilean peso, the BCCh should make some adjustments to interest rates in order to avoid FX pass-through to inflation. The weakening of activity and high interest rates should contribute to a reduction of inflation in Chile: Inflation Source: INE % YoY % Core Target (3%)

6 Feb-13 Apr-13 Jun-13 Dec-13 Apr-14 Jun-14 Jan-06 January February March April May June July August September Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 October November December Colombia: Need for adjustment becomes more apparent Despite the recent recovery of oil prices, the growth of the Colombian economy is expected to cool in the second quarter. The weakening of activity should be driven by household consumption, government spending and investments. A loss of revenue due to lower oil prices led the government to implement spending cuts totaling 0.7% of GDP in order to meet its deficit target for 2016 (3.6% of GDP). The deterioration of the public accounts in recent years should accelerate the debate on tax reform to reduce the government s dependence on oil revenue, in an attempt to avoid the risk of a downgrade by S&P. The slump in confidence and recent deterioration of the labor market should lead household consumption to decline in the current quarter. In terms of the external sector, weaker domestic demand should result in lower imports and a slight improvement in the current account, from 6.9% in 201 to.0% of GDP in Given this environment and after the Colombian economy expanded 3.1% in 201, we expect % growth in Colombia - Central govt Balance (Ytd, thousand mi USD) Colombia Trade Balance 12 Months - US$ Billions Faced with the acceleration of inflation and un-anchoring of expectations, the Central Bank (Banrep) should promote further adjustments to interest rates. We expect inflation to increase 6.% in 2016 after rising 6.8% in 201. With inflation forecasts over the oscillation interval (3.0% +/- 1%) in 2016 and inflation expectations close to the target ceiling in 2017, the Colombian central bank (Banrep) should continue to adjust interest rates. We believe Banrep will apply two more 2bp interest rate hikes, bringing the benchmark rate to 7.0% per annum at the end of the second quarter. Moreover, the monetary authority acknowledged that the recent appreciation of the exchange rate should be temporary, which will require greater caution in the next actions to fight inflation. For this reason, we believe Banrep will use instruments other than interest rates to control inflation in Colombia - Inflation Total Target Tradable (ex food) Food, BRAM 6

7 Nov-11 Feb-12 May-12 Nov-12 Feb-13 May-13 Nov-13 May-14 Nov-1 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Feb-13 Feb-07 Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Feb-13 Mexico: Consumption in the country is likely to continue as one of the main growth drivers. Scenario for the Mexican economy includes activity growing at a moderate pace. On the positive side, consumption in the country is likely to continue as one of the main growth drivers in the coming months. According to ANTAD, retail sales grew an average 9.1% during the first two months of the year. Even though a deceleration is expected, the good performance of remittances and greater purchasing power due to low inflation should lead retail commerce in the country to grow around 6% this year. Low oil prices are still the main risk to the economy. If the oil industry and investments in the construction sector are to suffer from the effect of this environment in the short term, the concern over the long term is the Mexican fiscal consolidation process, given the government s high dependence on revenue related to oil (approximately 20%). In this regard, Moody s kept the country s rating at A3, but changed the outlook to negative from stable, expressing concerns about PEMEX s debt trajectory Source: ANTAD Mexico - Retail Sales ,000 47,000 42,000 37,000 32,000 27,000 Mexico: Remmitances (in Mexican peso) (12 months accumulated) 37, ,06 368,11 469,702 The behavior of the exchange rate has become the main point of concern for the Mexican Central Bank (Banxico). Although inflation remains accommodated (2.8% in the March reading), incipient signs of an intensification of FX pass-throughs have begun to worry Banxico, such as the 3.2% variation in the ex-food core indicator (above the 3% target). In an attempt to keep inflationary expectations anchored, Banxico raised interest rates 0bp at an extraordinary meeting in February. Even though the current scenario requires greater restraint in government spending throughout the year to avoid a possible downgrade, and with the Fed signaling a gradual tightening of interest rates, we believe the prudence shown until now by the Mexican authorities will continue, implying two more 2bp interest rate hikes by Banxico in the 2 nd half Mexico - Inflation Total Core Central target Upper limit 7

8 Sep-12 Nov-12 Mar-13 May-13 Sep-13 Nov-13 Mar-14 May-14 Sep-14 Mar-1 Sep-1 Nov-1 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Mar-02 Dec-02 Sep-03 Jun-04 Mar-0 Dec-0 Sep-06 Jun-07 Mar-08 Dec-08 Sep-09 Jun-10 Mar-11 Dec-11 Sep-12 Jun-13 Mar-14 Sep-1 Peru: The entry into production of new plants will increase exports and accelerate growth Completion of the second round of the presidential election should be the main event of the second quarter. The new election will take place on June, between Keiko Fujimori and Pedro Pablo Kuczynski (PPK), who received 39% and 24% of the vote, respectively, in the first round. The latest polls point to a fairly balanced scenario in the second round. Both candidates have a center-right agenda and are seen as friendly to the private sector. So regardless of who wins the election, both should maintain a commitment to macroeconomic stability and the strengthening of Peruvian institutions. The mining sector should again support GDP growth in the second quarter. The entry into production of new plants will increase exports and accelerate growth in 2016, a trend that should be clear in the second quarter. After expanding 3.3% in 201, we forecast 3.% in The external sector is expected to make a positive contribution during the year, the opposite to what we expect from investment. The government transition should naturally lead to a reduction in public investments at first. As for private investment, we do not expect the low level of confidence to stimulate new projects, at least in the short term. Household consumption should expand moderately this year. On the inflation side, although the end of El Niño will bring some relief to food prices and therefore inflation, we expect the Central Bank to make some adjustments to the exchange rate during the second quarter. Since Peru s real exchange rate is the most appreciated among countries in Latin America, the country s central bank (BCRP) will probably allow it to depreciate over the year in an attempt to stimulate the competitiveness of local companies Peru: Monthly GDP by sector (12 months, ytd %) Peru: Business Confidence Historical Avg Source: CEIC, BRAM GDP Mining Manufacturing Commerce Source: BCRP, BRAM Peru - Inflation (%YoY) Consumer Price Index (CPI) Source: CEIC % YoY Central Target Upper limit Core 8

9 FORECASTS Argentina GDP (%) Inflation (%) Interest Rate (eop* %)** Exchange Rate (eop) Brazil GDP (%) Inflation (%) Interest Rate (eop %) Exchange Rate (eop) Chile GDP (%) Inflation (%) Interest Rate (eop %) Exchange Rate (eop) Colombia GDP (%) Inflation (%) Interest Rate (eop %) Exchange Rate (eop) Mexico GDP (%) Inflation (%) Interest Rate (eop %) Exchange Rate (eop) Peru GDP (%) Inflation (%) Interest Rate (eop %) Exchange Rate (eop) * End of period. **30 Day CD rate Contact Information BRAM US LLC Bradesco Asset Management US New York Office São Paulo Office contact@bram-us.com Disclaimer Past results are not indicative of future investment results. Investments are not guaranteed and you may lose money. This publication is for informational purposes only and reflects the current opinions of the author as of the date of original publication. Statements attributed to the author do not necessarily reflect the opinions of BRAM US LLC or its affiliates. Information contained herein, including figures provided by third parties, is believed to be accurate, but cannot be guaranteed. Any forecast, projection or target is there to provide you with an indication only and is not guaranteed in any way. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. Potential investors in emerging markets should be aware that investment in these markets can involve a higher degree of risk. 9