Guest blog: Is Latin America facing unusually high risks? An economic analysis and its consequences

By Samuel Aguirre, Senior Managing Director and Leonardo Florencio, Senior Managing Director at FTI Consulting.

Macroeconomic risks are potentially significant

As interest rate hikes and recession loom in the developed world, the economic outlook for emerging markets is also one of concern, especially in Latin America, which is plagued by high inequality, inflation, subpar economic growth, and political instability. The COVID-19 pandemic has hit the region particularly hard, and governments have by and large sharply increased government spending to protect the most vulnerable populations and contain social unrest.  

Macroeconomic risks should not be underestimated. If rampant monetary tightening continues to beset the U.S. and Europe, Latin American countries may experience significant capital outflows and currency devaluation. This is especially worrisome due to some countries’ need to finance external accounts and the public sector with foreign capital inflows.

Capital scarcity may further stifle growth, since governments might fail to replace depressed private investment with public investment owing to already high budget deficits and public debt. This situation can potentially be made worse if a number of downside risks materialise, such as if there is further escalation of war in Europe or if the Chinese economy struggles to grow. 

Recent elections bring increased risk

With high food and energy prices, combined with rising inequality, most governments were unsuccessful in sustaining approval ratings. Social discontent in the region has ushered in a new pink tide, with the recent election of anti-establishment left-wing candidates following a wave of protests and social unrest in the region.

After the pre-pandemic election of Andrés Manuel López Obrador in Mexico (2018) and Alberto Fernández in Argentina (2019), social discontent has led to the election of Luis Arce in Bolivia (2020), a former finance minister of Evo Morales; Pedro Castillo in Peru (2021), a former union-leader; Gabriel Boric in Chile (2021), a former student union leader; and Gustavo Petro, a former guerrilla member and the first ever left-wing candidate to win a presidential election in Colombia (2022).

One of the primary risks associated with the new rise of anti-establishment governments in Latin America concerns contracts in natural resource sectors such as oil & gas, mining and energy.  

In Colombia, for example, President Gustavo Petro has shown a strong environmentalist view and anti-carbon stance. The government is also entertaining a freeze in some existing mining licenses that are deemed to have been granted without proper environmental scrutiny. Although many such measures would be difficult to implement in a national congress permeated by political fragmentation, potential contract breaches could lead to increasing arbitration proceedings in the region.  

Mexico’s president Andrés Manuel López Obrador has pushed to annul the 2013 energy reform introduced by his predecessor that emphasized foreign investment in the solar and wind energy sector. López Obrador has sought to reposition Mexico’s energy sector to prioritize state-owned fossil fuel generation companies, damaging the solar and wind energy sector.

Similar risks exist in other Latin American countries with recently elected left-wing leaders. In Argentina, a few months after his election, President Fernández attempted to expropriate crop trader Vicentin SAIC, raising investor concerns. In Brazil, presidential candidate Lula has expressed wishesto undo past privatizations, a measure that would certainly be challenged in courts, leading to prolonged litigation. 

Recently elected governments will need to navigate troubled waters to capture the upside of the current economic scenario (e.g., increase in commodities prices) while avoiding its negative aspects. Judging by the sharp decline in approval ratings of elected presidents and significant setbacks for these leaders, voters have shown little patience with politicians who fail to live up to their expectations.

Investors’ risk assessment should include increased litigation risk

The re-emergence of the Latin American left in a scenario of high public debt may incentivise nationalisation trends, especially in energy and natural resources. As a consequence, investor-state and post-M&A disputes tend to increase.

Companies that already own or intend to invest in businesses in Latin America must be aware of the risks and pay close attention to details – especially in concession grants in strongly regulated industries such as energy, utilities and oil & gas –  since loopholes or vague language in these contracts may allow for arbitrary government interference.

It is also important to consider past court rulings regarding contract violations of private concessions, as well as the stability of political institutions. Systems with a strong and independent judiciary are less likely to be disrupted by a populist leader than more fragile ones. The Latin American market is a fertile place to invest but legal risks must be assessed with diligence to make informed decisions.

*Disclaimer: The content of this article does not reflect the official views of the International Chamber of Commerce. The opinions expressed are solely those of the authors and other contributors.