Election of Ivan Duque Could Represent a Pivot Point in Post-Conflict Colombia

How effectively the Duque administration handles the ongoing implementation of the 2016 peace agreement with the FARC may presage the ultimate success or failure of his presidency.

Colombians are particularly passionate about two things: J Balvin, the popular reggaetonsinger from Medellin and football. Some 60,000 Colombian soccer fans descended on Russia to watch their team play in the 2018 World Cup. Perhaps nothing unites that country more than watching James Rodriguez run up and down the pitch for 90 minutes. President-elect Ivan Duque, the youthful protege of former president and current Senator Alvaro Uribe, surely would have loved to see his country bring home the gold trophy. Although Duque emerged victorious in a runoff election held in June, the race was marked by divisiveness: Duque, a right-wing champion of free market orthodoxy, pitted against a former leftist guerilla, Gustavo Petro. Unfortunately, Duque won’t be receiving any help from his country’s soccer squad (Colombia lost to England in a penalty shoot-out on 3 July).

Colombia swings right

Colombia has benefitted from a period of relative political stability for the last two decades. Importantly, the country has managed to steer clear of the economic populism which has visited its Latin American neighbors (the most obvious example being Venezuela). Colombia’s political establishment coalesced around the Partido Social de Unidad (Unity), which the outgoing president Juan Manuel Santos and Uribe co-founded in 2005. However, owing to certain differences of opinion over negotiations with the Revolutionary Armed Forces of Colombia (FARC), Uribe split off from Santos to found the Centro Democratico (CD), the party from which the incoming president Duque also hails.

A dominant theme from Duque’s 2018 campaign was the supposed inadequacies of the peace accord reached in 2016 between the Santos administration and leaders of the FARC. Duque, a political disciple of the Uribe school, has voiced concern over what he views as the leniency afforded to former members of a rogue militant group that cost some 200,000 lives and forced 7 million (~15% of the population) Colombians from their homes. The Uribe wing is especially repulsed by the FARC’s permission to hold political office in Congress. Despite receiving less than 2% of the popular vote in March, the FARC now holds 10 seats in Colombia’s legislature.

While still early to draw conclusions, perhaps there are parallels to be drawn from Uribe’s presidency from 2002-10. During his administration, Uribe championed law and order, furiously strived to present himself as being “tough on security” while embracing extradition of narco-traffickers to the United States as an effective anti-crime measure. Some analysts have suggested that Duque may serve as a sort of puppet president for Uribe. Yet however strong Duque’s personal opinions may be of the 2016 settlement, he will not be able to reverse the terms of the agreement by himself (nor are his political views on the matter especially black and white). Many elements of the peace agreement are enshrined in the constitution and will require more than a simple majority vote. Political observers anticipate that Duque will seek to build a coalition consisting of the right-wing Partido Conservador and the more centrist Partido Liberal.

Campesinos (de cocaina) Colombianos

Despite Colombia’s political drama, the country is in the middle of a tourism boon. In part popularized by the Netflix television series Narcos, Colombia’s Medellin of Antioquia has seen an uptick in visitors from around the world. Young people also flock to Cartagena, the Spanish colonial port on the coast, to spice up their Instagram profiles. Even allowing for this “Narco-tourism”, armed gangs tied to drug trafficking known as “bacrims” continue to roam the countryside. Colombia’s political (and economic) future thus rests heavily on the fate of campesinos Colombianos, or its small-holder farmers. While many farmers grow perfectly legal crops like coffee – itself a tourist attraction – more farmers are increasingly turning to coca production, the primary ingredient for cocaine which in turn fuels the drug trade. Worth watching of the incoming Duque administration will be its handling of the implementation of certain rural development programs started under the Santos administration and codified by the peace agreement.

As part of an an effort to bring the FARC to the negotiating table, the Santos government halted its aerial fumigation of coca crops. On the campaign trail, Duque suggested that he would restart the program immediately. It came as something of a surprise then on 26 June when the Colombian government announced the authorization of herbicide-spraying drones aimed at coca crop eradication. In just the past year, coca production in Colombia has soared. The US remains the primary market for Colombian cocaine and despite outsized media attention on the opiate scourge, cocaine use has trended up in recent years. This helps explain the Trump administration’s public rebuke of Colombia’s handling of the drug trade. As Duque seeks to deliver on his campaign promise of ramping up his country’s exports to the US, he may use coca eradication as a bargaining chip in future trade negotiations.

Many analysts wrongly conflated the outcome of the peace settlement to a corresponding drop in coca production as FARC was heavily invested in the cocaine trade. A sort of feudalistic system operated in the Colombian countryside where the FARC either threatened noncooperative farmers with violence or engaged in outright extortion. However, since the peace settlement, instead of farmers moving to substitute their coca for alternative crops, the opposite has happened in a classic case of perverse incentives. As currently constructed, the peace agreement incentivizes farmers to grow coca. This is because farmers only qualify for monetary compensation if they were growing coca in the first place. Most farmers are thus reluctant to try their luck with alternative crops if it means throwing government subsidies away.

No farms, no future

In soccer, it pays to demonstrate patience especially in the early going. A team’s ball possession is a direct byproduct of accurate passing. So goes the peace process in Colombia. However, many Colombians feel like it’s nearing halftime and their country still hasn’t scored any goals. Take one example: Ley de Victimas y Restitucion de Tierras(LVRT), a victims and land restitution law first passed in 2011. The law was formed with the expectation that the government would compensate an estimated 4-6 million victims of both right-wing paramilitaries and left-wing guerillas during the 50-year civil conflict as well as return an estimated 5-8 million hectares of land seized by illegal armed groups. However, by mid-may 2018, the LVRT had restored ownership of just 300,000 hectares of land to its original owners, merely 4-8% of the original goal. Given the law preceded the peace deal by 5 years, many Colombians are understandably frustrated by such lackluster implementation.

If Duque is serious about unifying the country, he must not forget the campesinos. Many areas of the country, especially the rural hinterlands, remain in a state of lawlessness. Despite FARC agreeing to demobilize, other armed groups including the Ejército de Liberación Nacional (ELN), a Marxist militia, and Clan del Golfo, a neo-paramilitary group, have exploited the FARC’s vacancy. In simple terms, the drug trade remains far too lucrative for Colombian criminals to abandon wholesale. It does not help matters that Colombia’s next-door neighbor, Venezuela, is heading for economic ruin. Several sources in the intelligence community have indicated the presence of robust industrial-style drug operations operating in the Venezuela borderlands. It would not be a surprise if Colombia’s outgoing president was complicit in nudging this activity across the border.

Where Santos failed to expedite certain reforms aimed at narrowing the urban-rural divide, Duque has an opportunity to start fresh. However, the political establishment is fearful that Senator Uribe is operating in the shadows and perhaps even calling the shots. Some fear a return to hard-liner policies which will only serve to further alienate the rural population and empower criminal opportunists. Failure to implement rural development programs might mean a return of violence which could lend itself to even more extremist candidates in the next presidential election. Thus, the ultimate success or failure of the historic peace agreement signed in 2016 may hinge on whether Duque lasts more than 4 years.

Steven works as a Senior Analyst for EY and holds a B.A. in economics from the University of Maryland.

Rebels Go Mainstream: How FARC’s Political Party Can Influence Colombia’s 2018 Elections

In 2016, Colombia’s government reached an historic, but highly controversial peace agreement with the Revolutionary Armed Forces of Colombia (FARC) paramilitary group, after more than 50 years of violent conflict.

In April of this year, in a highly controversial official part of the peace plan, Colombia’s Congress approved FARC as a political party, granting them 10 seats in Congress.

This component of the deal has sparked outrage amongst many seeking greater punishment for FARC’s crimes. Many Colombians fear the prospect of a former militant group known for kidnappings and other illicit activities attaining legitimate political power, all at a peaceful, but fragile time for Colombia.

Despite Colombia’s history o violence and corruption, the country has succeeded with peaceful democratic transitions of power. It also has stewarded a healthy economy, with GDP growth averaging 4% annually from 2000 to 2015 and healthy inflation at around 3%.

However, the country currently runs a fiscal deficit and the peace plan calls for ambitious workforce reintegration and rural development programs for former FARC soldiers. The cost of these efforts over the next decade is estimated at a daunting $45 billion.  Consequently, Colombia faces conflicting priorities and agendas.

FARC faces a major learning curve as a political party accustomed to violent resistance, now expected to contribute to peaceful governing. It also faces an upward battle for approval since many voters remain angered at its past crimes and skeptical of its intentions.

However, the peace agreement grants the opportunity for FARC to gain more seats in Congress in 2018 and 2022. Colombia will elect a new president in May 2018.

A strong anti-establishment attitude toward the current centrist president, Juan Manuel Santos, means a number of outcomes may result, which could a) inadvertently strengthen FARC’s influence, b) threaten a return to militancy, or c) allow FARC to create gridlock. None of these scenarios appear ideal for a country trying to move forward.

2018 Presidential election scenarios

President Santos won the Nobel Peace Prize for his efforts, but only around half of Colombians support the peace agreement and about a quarter of Colombians approve of his performance. He is ineligible for a third term and his center-right party, the Social Party of National Unity, which built a strong moderate coalition in Congress, has frayed.

These circumstances indicate a desire for change and inclination by voters for a more populist platform. Consequently, a wide-open presidential race with 53 candidates has been created. A win by either side could strengthen or antagonize FARC and its far-left platform.

Left-Wing victory

The presidential race currently has three major progressive contenders: Humberto de la Calle, Juan Manuel Galan, and Gustavo Petro. Each has stated his commitment to the peace agreement.

Under this scenario, FARC as a political party should stay relatively quiet, considering that a left-wing administration will most likely follow through with heavy spending on rural development and workforce reintegration programs. However, a leftist administration may not implement the critical fiscal reforms many outside observers deem necessary to maintain Colombia’s credit rating and foreign direct investment.

Meaning in the longer-term, Colombia could fail to sustain rural economic development, ultimately threatening FARC’s faith in the government and willingness to compromise.

Right-Wing victory

Former President Alvaro Uribe vehemently opposed the peace deal and led a public campaign to resist its implementation. The right-wing presidential candidate, Ivan Duque, of the Centro Democratico party, is widely seen as Uribe’s chosen candidate.

Duque would unlikely terminate the peace deal, but politicians on the right have stated their intent to alter components of the deal such as amnesty for FARC soldiers involved in drug trafficking. These actions, combined with the likelihood that a right-wing administration will prioritize fiscal reforms, may antagonize FARC and play into their socioeconomic grievances, giving them a bigger microphone.

Threats from slow-moving reintegration

Under either scenario, many Colombians will continue to aggressively oppose FARC’s new rights as many feel that more ex-FARC soldiers should be prosecuted for their crimes. If ex-FARC soldiers are systematically murdered or attacked this could create renewed violent conflict, but also could give FARC a platform to blame this on government incompetence or claim collusion.

Additionally, under any administration, reintegration programs could continue to move slowly, leaving many ex-FARC unemployed. Lucrative black market activities remain in the rural areas they have now vacated. If programs appear insufficient or disorganized, FARC soldiers could return to activities familiar to them.

Regional dynamics

Colombia is one of seven countries in Latin America that will elect a new president during the next 12 months. At a time where much of the region has shifted to a center-right government, widespread frustration with corruption and slow economic growth has sparked a re emergence of populism. Neighboring Venezuela will remain socialist for the foreseeable future. If major powers such as Colombia, Mexico, and Brazil also shift left this could make FARC’s agenda slightly less radical.

Even if Latin America does not shift left, the massive turnover of leadership creates the potential for political polarization. Additionally, the average voter turnout rates vary greatly.

South American countries had an average turnout in the mid-70s, but Colombia now averages only 43%. Considering the crossroads at which Colombia finds itself, this number should be concerning.

If FARC leaders succeed at generating even 5-10% more support than anticipated, this could create just enough influence by FARC in Colombia’s congress to stall the progress of critical policies.

Domestic and international stakeholders seeking guidance on how FARC’s arrival as a political party will affect Colombia as a market and political allies should watch closely for voter turnout levels, the margin of victory for the next president, and his success in building a governing coalition to stave off gridlock.

The wave of elections in Latin America in 2018 could shift regional alliances, including trade deals. How the Colombian Congress balances granting legitimacy to FARC, while also containing its ability to create chaos, will be an important factor in Colombia’s growth or stagnation.

 

Samuel Schofield is a Contributing Analyst at Global Risk Insights. As originally appears at: https://globalriskinsights.com/2017/12/farc-official-party-in-colombia/

 

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

Colombia: Why Violence Is On The Rise Again One Year After FARC Peace Treaty

Colombia completed ratification of a landmark peace treaty with the FARC on 24 November 2016. A year later, the initial excitement has transformed into serious doubts about the deal’s success.

Rising violence

The historical absence of state institutions in Colombia’s rural areas has undermined the legitimacy of the peace process. Over the past decades, the guerrillas had managed to uphold a rebelocracy – a state within a state – and the forced and sudden change of regime was bound to encounter difficulties.

In the past year, the number of community leaders assassinated has increased dramatically. These figures include government officials, but also activists and civil society leaders who have no known ties with the guerrillas or organized crime groups. Indeed, some have been vocal critics of illegal activity.

This suggests that the disarmament process and transition of former revolutionaries into civil society have left power vacuums in areas of the country that were already experiencing a weak or non-existent presence of the state. Post-treaty, conditions have worsened for many impoverished rural communities.

In April 2017 in Tumaco, an area previously controlled by the guerrillas, coca farmers rallied to demand payment under the Substitution Plan – a policy designed to incentivize the transition from illicit into licit crops by means of cash payments. The police response was to shoot to kill.

Government officials justify such orders by claiming that renegades and drug cartels are using the peasants as human shields by paying them to assist rallies against the state. Reports suggest that two weeks prior to the protest, one police officer was shot dead and 17 more were kidnapped in the area. The task force responsible for the investigation alleges that it had reason to believe that organized crime groups were paying up to $35 to anyone willing to attend the protests.

A flawed process

By March 2017, a month prior to the protests in Tumaco, the guerrilleros were expected to start surrendering their arms and moving to safe spaces designed to guarantee a proper transition into a civilian life. This was to be supported by a number of bills passed to accelerate the process of amnesty as well as guaranteeing that individuals who were willing to give up the armed insurgency would be protected.

The United Nations has sent observers to verify that arms were being handed in and destroyed. But this does not account for those fighters who do not take part in the process. Hence, even assuming that it will get harder to smuggle arms into the country, the process leaves gaps whereby not all the weapons will be handed in.

Furthermore, provisions for the safe transition to legitimate livelihoods are jeopardized by the aforementioned fact that the presence of the state within and around the areas formerly controlled by the guerrillas is weak at best. Therefore, non-state armed groups are very likely to prevail.

Looking ahead

Far from ending violence, the Peace Treaty has increased competition for the control of territory. Before the agreement, two major guerrilla groups controlled the market for drugs and violence in Colombia; after their dissolution, entry barriers have been torn down, hence new players will enter as long as it is profitable – similarly to what happened in Mexico after the fall of the Gulf Cartel.

The planting of illegal crops – mostly coca – will continue. Despite government incentives, in the long-run it still remains more profitable for farmers to produce illicit commodities. The restart of fumigation techniques that were banned in 2015 reflects this trend, which has seen a doubling in illegal crop production over the past four years.

 

Marc Hernando Santacana is an Analyst at Global Risk Insights. As originally appears at: http://globalriskinsights.com/2017/10/col/

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

Will Colombia’s FARC Peace Deal End In Economic Boom Or Destabilization?

Colombia is at a critical crossroads: the next six months will determine whether it is destined for an economic boom, or destabilization. How Colombia balances the competing priorities of security, budget deficit, and economic growth in the lead-up to the 2018 presidential election, will determine risks for the coming decade.

Hard-earned upsides at risk

Colombia has come a long way in the past decade. Last year, the government reached a peace agreement with the Revolutionary Armed Forces of Colombia (FARC) paramilitary group, after more than 50 years of violent conflict. In June, the FARC completed a months-long process of handing in all of its weapons, a major milestone.

The country’s leaders have also stewarded a healthy economy, with GDP growth averaging 4% annually from 2000 to 2015 and inflation in line with developed economies at around 3%. Colombia has diversified its economy away from dependence on fossil fuel exports, meaning less exposure to dipping commodity prices.

Moreover, Colombia’s membership in the Pacific Alliance (PA) with Mexico, Chile, and Peru, has expanded its access to export markets and improved its growth prospects. From 2010 to 2015, the GDP of PA countries grew by 1.5% more, and had 3.6% less inflation, than the Latin American average. At the recent Pacific Alliance Summit, the four member-states committed to implementing mutually favorable trade conditions, creating a common infrastructure fund, and agreeing a common pension fund investment tax rate.

But all of these impressive positive developments are at risk if Colombia fails to follow through with austerity measures on a budget deficit partly created by decreasing commodity prices. Fitch has signaled a possible credit downgrade if GDP growth and revenues do not improve. Colombia’s GDP only grew 1.1% in the first quarter of 2017, and a 2.0% expansion is expected in 2017.

Colombia is also walking a fine line in continuing to reduce its interest rate to spur consumer spending, risking the acceleration of an already high rate of inflation, and the weakening of the currency. But perhaps the greatest threat to growth and stability comes from the potential for the benefits of the peace deal to be lost following the 2018 presidential elections.

Opportunities in agriculture and tourism…

The peace agreement with the FARC includes ambitious rural development goals, in which Colombia banked on the demilitarization of violence-plagued regions to allow for further reduction in defense spending. This would free up funds to balance the budget and attract much-needed longer term foreign direct investment. Colombia aspires to capitalize on its diverse climate, natural resources, and urban centers to diversify and make its economy more competitive.

The FARC largely resided in rural and tropical regions of Colombia, where there are now opportunities for investment in infrastructure modernization, and expansion of the agriculture and tourism industries. Currently, Colombia only uses 16% of its arable land for farming, leaving considerable room for growth in agricultural employment and production. According to a GRI source at ProColombia, the country’s export bureau, avocado and pineapple production are priorities in this regard.

…threatened by unfinished business

Yet these ambitions could still be derailed. Colombia faces the tall order of reintegrating thousands of rural militants back into the formal economy, displacing illegal sources of revenue such as cocaine production. If the process takes too long, disillusioned militants may simply return to illegal activities.

This is made more likely by the fact that the demilitarization of the FARC created a power vacuum in their previously held territories. Smaller gangs and militias have taken the opportunity to use the lands for cocaine production, which soared 52% between 2015 and 2016.

Meanwhile, the socioeconomic crisis in neighboring Venezuela has resulted in a wave of refugees flowing into Colombia, creating potential security risks. Colombia has indicated its social programs are unable to absorb any additional immigrants, which is likely to force some immigrants to turn to petty crime, increasing risks in urban centres.

…and political divisions

The FARC peace agreement, despite its benefits, has divided the country. President Santos spent significant political capital pushing through the deal, and has a 24%approval rating, barely higher than that of the FARC itself.

Former President Alvaro Uribe consistently voiced opposition to the peace deal, and has vowed to overturn it if his party wins the presidency in 2018. In June, Uribe’s party, the Democratic Center, and presidential candidate Andres Pastrana’s Conservative Party, announced a coalition. This increases the chances that the deal could be torn up after the next elections.

While a more right-leaning government would maintain austerity and pro-trade policies, which would be largely positive for the economy, the cancellation of the FARC peace deal could result in a backlash by militants, as the deal promised them political representation in Colombia’s congress and economic incentives. FARC militants returning to arms would force the government to expand military spending, reducing the available funds for infrastructure and economic development plans.

Speed is of the essence

The government’s ability to buttress growth and avoid Colombia falling into the ‘middle-income trap‘ will depend on whether it can rapidly generate FDI, infrastructure modernization, and development of new industries. This in turn requires swift implementation of the FARC peace plan, laying a solid foundation that would not easily be undone by a change of ruling party next year.

 

Samuel Schofield is a Contributing Analyst at Global Risk Insights. As originally appears at: http://globalriskinsights.com/2017/10/colombias-competing-stakeholder-obligations-boost-stall-growth/

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

 

The Three South American Nations with the Most Challenging Tax Systems In The Region

24 countries from the Americas were chosen for TMF Group’s Financial Complexity Index for 2017.

We’ll look in depth at the top three systems from the region in this article and have added another dimension to the analysis by looking at the overall and parameter specific performance in the World Bank’s Doing Business report of these countries.

Brazil

We’ve already seen some challenges on the tax and accounting front that the country imposes on entities operating within their framework in the second article of this series. These mostly relate to the multi-level and multi-rate tax system making it difficult for even well-intentioned companies to ensure full compliance.

Brazil is not an easy place to do business either. The country ranks a low 123 among 190 nations evaluated for the Doing Business survey. And supporting the TMF Group’s assessment on a complex tax structure is the country’s rank of the ‘paying taxes’ parameter in the Doing Business survey, where it ranks 181 – placing it among the bottom 10.

As far as future developments in its tax system are concerned, the Complexity Index report observes that it could become even more complex in the short-term referring to the move to a more controlled automatic tax reporting system. But it remains positive about the longer-term implications of some initiatives like eSocial.

Colombia

A major reason which makes Colombia’s tax system difficult is the wording of its tax rules, which allows for different interpretations, according to the 2017 Financial Complexity Index report. The report also noted that though Colombia transitioned to IFRS in 2016, some differences between accounting and tax books remain.

Further, requirement of adherence to strict rules like keeping commercial documents for 20 years and tax ones for five years add to the complexity of the system.

Among the three countries from the Americas in the top 10 most complex global tax and accounting systems, Colombia is the best place to do business, ranking 53 among 190 nations. In fact, the country is the second best in the world on the ‘getting credit’ parameter. However, ‘enforcing contracts’ and ‘paying taxes’ remain challenging areas for the country and both are detrimental to conducting business.

The Complexity Index report outlines that the country is continuing to undertake tax reforms. Starting this year, the number of declarations required to be submitted have been reduced. Further improvements will make the country stand out, especially in Latin America.

Argentina

Double-taxation issues plague Argentina due to tax collection being spread across multiple jurisdictions of the national, provincial, and municipal governments.

The Complexity Index report highlighted that even though several firms have moved to the IFRS regime, companies which are regulated by entities other than the National Value Commission (CNV), like financial institutions and insurance companies, are not permitted to apply the standards.

Meanwhile, according to the Doing Business report, ‘paying taxes’ is the parameter that the country has fared quite poorly in, ranking 178th among 190 countries.

The Complexity Index report anticipates reforms to the tax system, specifically regarding possible reductions in taxes on salaries and banking.

Last To the Party: Colombia Could Turn A Corner After Its Slowest Quarter Since 2009

Though Late, Colombian Stocks Have Joined the Emerging Markets Rally

Up until very recently, Colombian stocks told an underwhelming story of late. As recently as May 4, the MSCI Colombia Index had risen just 3.6% for the year, garnering limited attention at a time when the Emerging Markets Latin America Index was up 10.7%, and the broader Emerging Markets Index had gained 13.7%.

However, since then, things have changed quite a bit. So much so, that the Colombia Index was up 11.25% as the month of May drew to a close. The country has now bettered the Emerging Markets Latin America Index, which was up 9.6% in the same period.

ETF performance

The recent rise in Colombian equities merits a closer look at the following ETFs:

  • iShares MSCI Colombia Capped ETF (ICOL)
  • Global X MSCI Colombia ETF (GXG)

Financials, utilities, and materials, in that order, have helped these two funds post their double digit gains this year.

While the regular and preferred shares of Bancolombia S.A. (CIB) have helped ICOL, the sponsored ADR has powered the GXG.

The utilities sector across both funds has been led by Interconexión Eléctrica S.A. E.S.P. (IESFY). The company’s stock had reached an intraday high of 13,900 pesos on May 26 – a level not seen since January 2011 – due to reduced regulatory risk.

View on Colombian stocks

Colombian ETFs have not yet attracted significant investor interest from the US. Though the Colombia-listed iShares COLCAP Fund, the first and largest local equity ETF available in Colombia to all investors, has attracted inflows worth $150 million in YTD 2017, the two US-listed ETFs have only attracted a combined $1.5 million with GXG attracting $822,500 YTD according to Bloomberg data.

The ICOL is only slightly more expensive than the iShares MSCI Brazil Capped ETF (EWZ) but much cheaper than the iShares MSCI Mexico Capped ETF (EWW). While Brazil is undergoing a political crisis, Colombia has been making progress on its peace deal with rebel group FARC.

Macro economically, the country’s economy rose just 1.1% in Q1 2017 – the slowest pace since 2009 – mostly due to the fact that mining production shrank by 9%. However, many are considering this to be a bottom for the country as construction activity is expected to pick up. If oil prices remain firm, they will also help the economy.

Meanwhile, there are mixed views from analysts regarding Colombia stocks. According to reports by Bloomberg, HSBC analysts have added CIB to their model Latin American portfolio. On the other hand, Citigroup has kept Colombia at ‘underweight’ citing that it is “too hard to find conviction ideas at reasonable prices.”

For investors taking the ETF route, the broad-based ETF basket would help mitigate risks that come along with investing in individual stocks.

The Three Stocks MSCI Is Inducting Into Its Emerging Markets Index

Stocks added to MSCI Emerging Market Index

At its semi-annual review for May, MSCI made three major additions to its emerging market index. Effective 1st June, MSCI will add Indian Oil Corp Ltd of India (IOC), Novolipetsk Steel  (NLMK) of Russia, and Bancolombia SA of Colombia (CIB).

Stocks that get included in the MSCI indices usually attract sizable fund flows. There are passive funds that track these inclusions to keep tabs on the overall market sentiment. Index weighting and composition is an important metrics for investors as fund managers and foreign investors try to mimic the index when allocating their funds and building their portfolios. Stocks that are included in the MSCI Index generally see higher allocation from foreign investors. The addition of stocks to major indices also increase their overall trading volumes and thereby their returns. Deletions, however, lead to declines in the stock’s returns.

Shares of Indian Oil Corporation advanced 2.8% over the past one month and have gained a whopping 34% YTD. Novolipetsk Steel has gained 6.2% over the past one month but has generated negative returns of 6.4% during the year so far. Meanwhile, Bancolombia’s ADR is up 20.7% YTD and 12.8% in the past one month.

Trading volumes of these stocks will likely surge once they are included in the index from June 1 onwards as hedge funds will buy into them to mimic the MSCI Emerging Market Index (EEM).

Why Peru and Colombia Have a Higher Spread of Profitability than Emerging Markets Globally

Higher profitability + idiosyncratic opportunities

Felipe Asenjo, regional head of equities at SURA Asset Management sees valuable investment opportunities in the Pacific Alliance countries of Mexico (EWW), Chile (ECH), Columbia (ICOL) and Peru (EPU). Asenjo expects companies in these regions to grow at 17% CAGR over the next 3 years. “The Pacific alliance has always had a higher spread of profitability than global emerging markets… the second region in the world in the last 15 years with the highest delivery of earnings growth,” said Asenjo.

Meanwhile, Diana Kiluta Amoa, senior portfolio manager on the local-currency team at JP Morgan (JPM) Asset Management sees idiosyncratic investment opportunities in Peru and Colombia.

[stockdio-historical-chart stockExchange=”NYSENasdaq” width=”100%” symbol=”EPU” displayPrices=”Lines” performance=”false” from=”2017-01-01″ to=”2017-05-16″ allowPeriodChange=”true” height=”350px” culture=”English-US”]

Peru

Private investment in Peru (EPU) is expected to bounce back and grow 0.5% in 2017 and gradually reach 6.5% growth by 2021, according to the Economy and Finance Ministry. The Ministry expects greater infrastructure investment due to the resumption of projects linked to Brazilian enterprises, to be the primary driver of such growth. The agency also expects increased mining activity to boost private investment. The Finance Ministry also forecasts public investment to rise by 15% in 2017 and in 2018.

The Peruvian economy has already shown its resilience towards the El Niño phenomenon (causing heavy rains and flooding), by slowing less than expected. Prudent actions taken by the central bank such as cutting interest rates should “boost activity” and put Peru on track towards an expected 3% overall economic growth, claims Prime Minister Fernando Zavala.

[stockdio-historical-chart stockExchange=”NYSENasdaq” width=”100%” symbol=”ICOL” displayPrices=”Lines” performance=”false” from=”2017-01-01″ to=”2017-05-16″ allowPeriodChange=”true” height=”350px” culture=”English-US”]

Colombia

According to Santiago Angel, head of the Colombian Mining Association, enormous potential lies on offer in the mining industry (XME) in Colombia (ICOL), which serves as a major growth engine for the economy. Angel sees the industry bringing in a whopping $1.5 billion in 2017 and $1.7 billion in 2018, with a five-year investment of $7.5 billion; provided the government guarantees legal certainty to businesses. Coal (KOL), gold (GLD), and copper (COPX) remain the three main mining sectors in Colombia.

AngloGold (AU) and Eco Oro Minerals (GYSLF) are the larger players in Colombia’s gold sector. The biggest coal companies are Drummond, Glencore (GLNCY) (GLNCF), Murray Energy, Colombia Natural Resources, and Cerrejon, which is jointly owned by BHP Billiton (BHP), Anglo American Plc (AAUKF) and Glencore.

The Best And Worst ETFs For Investing in Latin America

Investing in Latin American equities

Directly investing in Latin American markets can be risky for foreign investors as most of the countries are frontier markets. ETFs investing in Latin America stock markets are largely concentrated in two major markets – Brazil and Mexico. While some countries have opened up their stock markets to foreign investors, these economies remain difficult to access due to illiquidity and poor trading exchanges.

Investors betting on the revival of Latin American economies have two options. They can either consider investing in ETFs providing exposure to the entire Latin American region or place their bets in the continent’s largest markets through country-focused ETFs.

Regional ETFs

The iShares Latin America 40 ETF (ILF) provides exposure to the overall Latin American region but 80% of its holdings are concentrated in Brazil and Mexico, followed by Chile, Peru and Colombia. It invests in a portfolio of the 40 largest companies in the region, which are more than 50% dedicated to the financial and consumer defensive sectors. YTD, this ETF has climbed up 14%.

Another popular Latin American ETF is the SPDR S&P Emerging Latin America ETF (GML). This ETF invests in a basket of 245 stocks, thereby providing larger exposure to various stocks in the region. YTD this ETF has gained 15.1%.

Country ETFs

Investors seeking concentrated exposure in specific countries can consider investing in the following country ETFs:

  • iShares MSCI Brazil Capped ETF (EWZ)
  • iShares MSCI Mexico Capped ETF (EWW)
  • iShares MSCI Chile Capped ETF (ECH)
  • Global X MSCI Argentina ETF (ARGT)
  • iShares MSCI All Peru Capped ETF (EPU)
  • iShares MSCI Colombia Capped ETF (ICOL)

ETFs investing in Brazil have outperformed in the last two years as the country continues to recover from a recession. YTD the iShares MSCI Brazil Capped ETF has gained 13.4% as investors are pinning their hopes on reforms in a recession-struck country.

It’s All Blue Skies, Not Bumpy Roads for Latin America

Blue skies ahead

Arthur Rubin, Head of Latin America Debt Capital Markets, SMBC Nikko Securities America, Inc., who was recently interviewed by Bonds & Loans, sees all blue skies ahead for Latin America, no bumpy roads. Over the past 18 months, whenever we’ve seen some event causing credit spreads to widen, it has usually been very short-lived, said Rubin. He sees two major tailwinds boosting Latin America to blue skies.

Economic Tailwinds

The rally in copper and base metals is already having a positive spill-over effect on Latin America (ILF). And the markets expect the rally to go on. So, if there is a re-pricing or correction, it may have serious ramifications for economies like Peru (EPU) & Chile (ECH), believes Rubin.

Moreover, governments in both Colombia and Peru are focused on infrastructure. In Peru, Rubin sees a lot of things going on in the power sector, more infrastructural development in the energy refining and power generation space. In Colombia, policy direction is going the right way, and the government is making strides in bringing inflation back down to levels near its target.

The risk that remains for Latin America currently is of Chinese (FXI) (YINN) growth underperforming. At the end of the day, the rally in commodities owes a lot to the perception that China is back on a more stable growth path. If the pace of growth in China falls short of expectations, it would affect the recovery in commodity prices, and consequently commodity dependent Latin America economies.

Political Tailwinds

Left-wing leadership, often associated with ‘populism’ as opposed to ‘conservatism’, seems to be taking a back seat in Latin America.

  • Argentina is doing better under the aegis of its new right-wing president, Mauricio Macri
  • Mexico is being led by its right-wing president Enrique Pena Nieto since December 2012.
  • Conservative Michel Temer holds the office of the President of Brazil since August 2016.

In Chile, billionaire Sebastián Piñera of the conservative Chile Vamos coalition is seeking to return to presidency in November this year, as the left-leaning governing coalition is already in disorder.

The Greatest Risk Facing Latin American Economies Is the One We Cannot See

The risk we cannot see

Latin American equity has been a strong performer thus far this year. The iShares Latin America 40 ETF (ILF) has returned 12.7% so far this year (as of March 23), an outsized driver of emerging market (EEM) (VWO) performance. The rally, driven by the commodity price rebound has been instrumental in driving up the stock market. The market upswing and the continued preference for emerging market debt seems to indicate that investors in the Latin American economies are shrugging off the near-term risks posed by the Trump administration.

[stockdio-historical-chart stockExchange=”NYSENasdaq” width=”100%” symbol=”ILF” compare=”EEM” displayPrices=”Lines” performance=”true” from=”2017-01-01″ to=”2017-03-23″ allowPeriodChange=”true” height=”350px” culture=”English-US”]

Pockets of uncertainty

However, the greatest risk facing the Latin American economies is the one we cannot see, said Arthur Rubin, Head of Latin America Debt Capital Markets, SMBC Nikko Securities America, Inc., during a March 23 interview with Bonds & Loans. There remain pockets of uncertainty, says Rubin. “The new norm under the Trump administration maybe pockets of uncertainty, driven by unpredictable and unforeseen policy initiatives that don’t really last that long.” The markets are already pricing in the rate hikes expected in the U.S. However, in the event of a policy occurrence beyond the expected, emerging markets such as those placed in Latin America, stand more exposed to risk of possible repercussions.

Local-debt winning investor favor

While Rubin does agree that the volume of international debt issued globally is on the rise, he doesn’t see Latin American economies such as Colombia (GXG) (ICOL), Peru (EPU), and Chile (ECH), taking the plunge, just yet. Credit spreads, which are beginning to tighten for many economies, are still wide enough for certain LatAm economies.

Local currency emerging market debt is already flying high amid U.S. policy reshuffle. The current and expected U.S. policy reshuffle including monetary policy tightening, along with protectionist curbs are expected to strengthen the U.S. dollar (UUP), which works against holders of emerging market (EEM) (VWO) dollar-denominated debt which gets expensive with a rising dollar. This is when local-currency debt takes center stage as the instrument that is immune to such policy risk.

What Could Make Dollar-Funding an Attractive Option in Colombia?

Peso funding continues to be attractive in Colombia

There’s a perception that credit conditions tightening in Colombia (GXG) (ICOL) will cause borrowers to begin to look towards dollar funding. However, SMBC Nikko Securities America sees peso funding continuing to be attractive and sufficient, at least for now. If growth in Colombia starts moving up to around 3 or 4%, such that demand for credit becomes more robust, then we could see the constraint showing up, said Arthur Rubin, Head of Latin America (ILF) Debt Capital Markets at SMBC.

What could make dollar-funding at attractive option?

  1. The need for international funding should arise only when we see sustained high levels of economic growth in the region, which is when we would also witness a rise in local funding cost, and credit spreads between local and international funding, tightening.
  2. Moreover, with the markets already pricing in the two 25 basis point increases by the Fed this year, it would only take an unexpected occurrence, to make dollar-funding attractive for countries like Colombia (ICOL), Peru (EPU) and Chile (ECH).

For now, dollar-funding isn’t as compelling an option

For now, credit growth in the corporate sector in Colombia has been declining, keeping any stress on bank liquidity at bay. We are still seeing a number of Colombian peso bonds being floated. Large borrowers such as utilities and consumer firms are able to secure peso funding domestically. Moreover, local-currency funding continues to prove more attractive in cost terms as compared to dollar-funding.

“The need to diversify funding sources in both Peru and Colombia, hasn’t really been there,” said Rubin. “With domestic capital markets and local-currency funding being able to suffice the funding needs arising in Colombia and Peru as of now, going abroad for dollar-funding isn’t as compelling an option.”