The turmoil in emerging markets seems all too familiar. In the late 1990s Russia and several Asian countries suffered a series of interlinked crises that stemmed from high fiscal deficits, large current-account deficits, and dollar-denominated debt. In 1994 Mexico got into trouble after it built up unsustainable dollar debts, and during the 1980s several Latin American countries were forced to default when rising US interest rates made it impossible to pay back their loans. No wonder, then, that when US interest rates rise and the dollar strengthens, investors are quick to ditch emerging-market assets. They are particularly wary about developing countries that combine high current-account and fiscal deficits – funded by dollar-denominated debt – with a dearth of defence mechanisms, such as a big pile of foreign-exchange reserves. That’s why Turkey and Argentina have been the principal victims of the sell-off.
But the rush for the exit has created interesting buying opportunities. Investors have tarred all the emerging markets with the same brush, yet their individual situations differ widely. In a moment of panic, all emerging markets move the same way, but over time capital will return to the solid, well-managed, growing economies. Prime examples are the four members of Latin America’s Pacific Alliance. This outward-looking trade bloc comprising Mexico, Colombia, Peru and Chile will reward long-term investors over the next few years.
A new Latin American trade bloc
The majority of the world’s wealth and economic growth in the 21st century will come from Asia, and the Pacific Alliance is a way for these mid-sized Latin American economies to benefit collectively from this structural shift. Over the coming years closer integration between Alliance members will help drive growth. Since 2011 a succession of infrastructure projects, visa agreements and tariff reductions have boosted the movement of people and goods within the bloc. The creation of a shared stockmarket and standardised financial-sector regulation should increase inter-Alliance capital flows.
They survived the perfect storm
During the commodity downturn the Pacific Alliance members’ floating currencies devalued in line with the prices of the key raw material of each. That boosted the competitiveness of non-commodity exports and made imports more expensive – thereby acting as an automatic control on current-account deficits. What’s more, the Pacific Alliance countries had accumulated healthy foreign-exchange reserves. These can be used to repay foreign debts and prop up the local currency, precluding a rout. In Peru, where dollarised debt was relatively high, the central bank managed to control the depreciation, slowly bringing down the value of the currency and giving banks time to adjust to the new reality.
Why the Pacific Alliance is resilient today