Tue May 27, 2003 03:16 PM ET
By Pedro Nicolaci da Costa
NEW YORK, May 27 (<a href=reuters.com>Reuters) - The specter of deflation in the United States has intensified Wall Street's latest obsession with Latin America as an investment destination, but a persistent global slump in prices would be no fiesta.
As financial experts scramble for alternate ways of making money while U.S. interest rates languish at rock bottom, demand for Latin America's debt has soared, with yields so much higher across the region than in the United States.
If the feared deflation monster rears its head in the United States -- still a remote possibility but a scenario increasingly on the radar screen -- Latin America's commodity-driven economies would suffer disproportionately.
While consumers in the region may be heartened by the prospect of prices tumbling at the local neighborhood store, the longer-term impact on growth would be severe, analysts warn.
Companies faced with a stubborn decline in prices are sure to pass the deflationary pain onto their workers -- either through job cuts, wage decreases or both. Large debt burdens make Latin American nations especially vulnerable.
"Deflation is particularly harmful to countries that have lots of debt, because falling prices will inflate the real debt burden," said Christian Stracke, emerging markets debt strategist at CreditSights.
Brazil, with the region's largest economy, is a classic example. With an estimated $250 billion debt load, the country's large interest payments on external debt would magnify its woes under a scenario of global deflation as export revenues fall but interest costs stay put.
Mexico's close ties to the U.S. economy, which brought tremendous benefits during the boom years of the late 1990s, would bring just as much pain in a prolonged deflationary bust. Mexico startled economists with a surprise 0.41 percent decline in consumer prices for the first two weeks of May.
Chile, Argentina and Uruguay, with their heavy reliance on commodity exports, would also suffer.
BACK ON THE ECONOMIC MAP
Deflation reclaimed its importance in the economics lexicon in April after the Federal Reserve suggested for the first time since the Great Depression that it was worried about the risk of a persistent downturn in prices.
While reaffirming that the threat of deflation is still minor, Fed Chairman Alan Greenspan expanded on the point last week, arguing that price gauges require "close scrutiny and -- maybe, maybe -- action on the part of the central bank."
At first glance, deflation might seem like a blessing to Latin America, where not long ago, several countries grappled with triple-digit hyperinflation.
"The deflationary fears that are spreading around the world, and the growing likelihood that the monetary authorities in the U.S. and Europe will be forced to cut interest rates, are increasing the demand for high-yield assets" such as emerging market debt, Walter Molano, head of research at BCP Securities, said in a report to clients.
Yet a deflationary spiral that prevents a long-sought pick-up in U.S. economic growth would have severe consequences for Latin American economies, whose success often depends on the performance of their northern counterparts.
"The principal problem in Latin America today is not inflation," said Gray Newman, chief economist for Latin America at Morgan Stanley. "Growth is what this region needs, and I'm afraid that the damage of deflation to growth prospects would outweigh the benefits."
THE VALUE OF LABOR
A bout of U.S. deflation would also put Latin American economies at a serious disadvantage in global trade.
Capital goods like heavy machinery and factory equipment, manufactured primarily in rich countries, require more labor and are thus accompanied by higher wage costs. Agricultural or lightly manufactured goods, produced mostly in the developing world, require a much smaller input from workers.
A drop in capital goods prices usually requires wage cuts, which workers are loathe to accept without a fight, so industrial costs tend to fall more slowly than commodities prices, to the detriment of emerging market exporters.
Such imbalances would be less of a problem for some of the region's oil producers, like Venezuela and Ecuador, who could ride OPEC's price-supportive supply restrictions.
But the rest of Latin America would be in a tight spot if governments had no choice but to fight economic forces largely beyond their control.
By Marc Dupee
Special to TheStreet.com
05/27/2003 03:03 PM EDT
Millions of motorists hit the road over the Memorial Day weekend, kicking off the summer driving season. Some might have been pleased that prices at the gas pump have finally started to fall since the spike that accompanied the invasion of Iraq. But before drivers -- or holders of short positions in unleaded gasoline futures -- become too convinced that prices will continue dropping, consider the smoldering situation in Venezuela, OPEC's third-largest producer.
Just last December, labor and opposition groups staged a nationwide strike in an attempt to remove Venezuelan President Hugo Chavez from office. Tanker captains joined strikers at state-owned oil monopoly Petroleos de Venezuela S.A., also known as PDVSA, and refused to move cargo.
Output from the oil-dependent country of 25 million inhabitants plunged to 200,000 barrels a day from a prestrike level of 3.2 million barrels a day. The reduction in supply from Venezuela spurred rallies in unleaded gasoline and crude oil that took prices more than 12% higher during the month.
Chavez survived December's strike and de facto coup, and Venezuelan output rebounded sharply. However, the political and economic situation in the hands of Chavez continues to devolve. The resulting uncertainty greatly increases the odds of another round of social upheaval and threatens to disrupt the supply of oil and refined products from Venezuela.
At the heart of the maelstrom is the government's disenfranchisement of the opposition. A law has been proposed to censor the media and potentially quiet opposing voices. The "gagging law" needs only to be passed by the Chavez-dominated national assembly. But more devastating to the economy has been the imposition of foreign currency exchange controls on the country.
Dollar Politics
Opposition forces say that exchange controls are just a Chavez ploy to undermine the private sector. Venezuela exports oil and imports just about everything else. Dollars are required to complete transactions. Exchange controls have denied importers -- made up primarily of the private sector -- access to dollars to pay for goods brought into the country. Everything from food to medicine is running in short supply. The private sector, those least likely to vote for Chavez, are suffering in what appears to be a deliberate government attempt to damage the opposition's base of support. Businesses are closing, and official unemployment has reached 20%.
The result? The economy contracted a record 29% in the first quarter of 2003, and inflation is running in excess of 30%.
As Chavez seems to undermine the private sector, he's shoring up his political base by usurping key businesses. His administration has opened more than 100 government stores in poor neighborhoods and stocked the shelves with reduced-cost staples such as rice, beans and cooking oil. Cuban food brokers are helping the Chavez government with the procurement and bypassing established importers.
Thousands of employees who dissented or participated in last year's strike have also been fired from PDVSA, the nation's biggest employer, exacerbating the economic spiral. In short, Chavez's attempt to grab more power has made the already-volatile country a political powder keg, a situation that threatens U.S. oil and gasoline imports.
U.S. Connection
Venezuela -- along with Saudi Arabia, Mexico and Canada -- is one of the top suppliers of oil and refined products such as unleaded gasoline to the U.S. Before December's strike, Venezuela provided up to 17% of U.S. imports. The worsening social situation in Venezuela and its potential for disruption to U.S. supplies come not only at a time of increasing seasonal demand in the U.S., but also amid tightening domestic supplies.
U.S. environmental law requires that almost all of the high-density population centers from Boston to San Diego burn the less-polluting reformulated grade (RFG) of gasoline from March through October. Refineries have had trouble meeting demand in the past few years since RFG was mandated. This summer looks no different. Last week, the Energy Department said RFG stocks dipped by 10% to 33.3 million barrels as production fell. This occurred as inventories of the regular-grade unleaded gasoline rose.
Not Making the Grade
The volatile situation in Venezuela creates a lot of uncertainty and risk about supplies from that country. It also is taking a toll on supplies of refined RFG destined for the U.S. Normally, the country ships more than 2 million barrels of RFG a month. That's 6% of the current U.S. stockpile.
But for the past few months, PDVSA has consistently failed to get gasoline cargos certified as RFG. To move the refined product, PDVSA has resorted to selling cargoes as regular-grade unleaded gasoline rather than the cleaner-burning RFG grade.
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Why? Thousands of PDVSA employees were fired and replaced by loyalists. Among the fired were employees skilled in production and quality control methods that helped ensure consistent product. Political loyalty does not guarantee high quality.
The unleaded gasoline contract traded at the New York Mercantile Exchange conforms to the specifications for RFG and should reflect the fundamental situation of tightening supplies. The June contract (HUM3:NYMEX) closed at a one-month high Friday and broke the bearish symmetry that had helped define its downtrend. Look for this contract to test resistance at 0.9350 and possibly 0.9750.
Marc Dupee is an independent trader and co-author of the book The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to Marc Dupee.
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New Argentine President Nestor Kirchner has met with several regional leaders, pledging to "work with everyone" to help his country overcome its severe financial crisis.
Mr. Kirchner made the promise Monday in Buenos Aires, where he spent his first full day in office meeting with the presidents of Bolivia, Cuba, Colombia, Peru, Uruguay and Venezuela.
The presidents were among several regional leaders who attended Mr. Kirchner's swearing-in ceremony on Sunday. Mr. Kirchner is Argentina's sixth president since political turmoil led to the resignation of Fernando de la Rua in late 2001.
In his inaugural address, the new Argentine leader said the country must be opened to the world. He pledged to work for conditions where Argentina can create what he called a credible and serious economy.
Mr. Kirchner also called on international markets to be patient as he works to help the economy recover from the crisis that triggered widespread unemployment and social unrest.
Argentina has defaulted on $141 billion in public debt. President Kirchner says his administration will renegotiate the debt, but warned the country cannot pay back what it owes lenders at the expense of those in need of houses, schools, and health care.
Mr. Kirchner also says the priority of his new foreign policy is building a politically stable and prosperous Latin America with democracy and social justice as its foundations.
LONDON (<a href=reuters.com>Reuters) - World oil prices fell back on Tuesday as traders took profits from recent gains but players said underlying sentiment remained bullish in an environment of low global energy stocks.
London benchmark Brent fell 44 cents to $25.80 a barrel, retreating from highs of $26.71 a barrel hit earlier in the day, when prices reacted to reports that Saudi Arabia was preparing to trim June supplies.
U.S. light crude fell 54 cents to $28.62 a barrel after a strong start and traders said more fresh news would be needed to propel the price any higher. Some of the weakness was due to profit-taking on gasoline.
But analysts said the market remained worried about lower OPEC supply at a time oil stocks in the U.S., the world's biggest oil consumer, are far below average for this time of the year.
"Markets will be wary of moving much lower seeing that stocks are so low," Middleton said.
The inventories have come into sharp focus as the Memorial day holiday last weekend marks the start of the U.S. driving season when Americans take to the roads on vacation.
U.S. gasoline consumption in the summer accounts for 12 percent of global energy demand during the period and gasoline inventories are some four percent under year-ago levels.
Analysts said expectations had not materialized of large crude shipments to the United States after the OPEC cartel hiked output in March to compensate for the loss of Iraqi barrels as well as some Nigerian outages.
"There were all these expectations of a wall of crude which was supposed to arrive and resolve all the stock problems but that didn't seem to happen," said John Waterlow, analyst with Wood Mackenzie in Edinburgh.
OPEC
Crude prices have rebounded by more than 10 percent since the start of May, as U.S. energy stocks have failed to return to normal after a harsh winter.
Now concern is mounting that OPEC is preparing to trim supplies. A Gulf source told Reuters on Monday that Saudi Arabia was preparing to cut June supplies to match the output quotas agreed on last month. It is expected to cut output to 8.25 million barrels per day (bpd) in June.
Consultancy Petrologistics said Saudi Arabia pumped 9.1 million bpd in May with overall OPEC output at 26.7 million bpd.
Adding to the worry is that Venezuela, a key gasoline source for the U.S., says it will further delay exports of reformulated clean burning gasoline that is mandatory in many U.S. states.
One bearish factor however is that Iraq is gearing up for its first oil exports since the war, aiming to first sell some eight million barrels lying in storage at Turkey's Ceyhan port.
The head of Iraq's state oil marketer SOMO, Mohammed al-Jibouri, told Reuters on Tuesday Baghdad aims to export the first post-war barrels of crude by mid-June. He said steady exports should follow as output from oilfields is rising fast.
Before the war, Iraq supplied four percent of globally traded oil and analysts say a resumption of Iraqi exports is likely to trigger a price slide in the third quarter of 2003.
LIMA, Peru, May 27 (Forbes.com-Reuters) - Just three years ago Peru's President Alejandro Toledo won fame when he led bloody street marches protesting a hard-line regime he pledged to tear down.
Now the one-time opposition leader faces the biggest challenge of his two years as president from those same kind of marches and strikes as unhappy Peruvians take to the street, demanding the government scrap its market-friendly economic plan and do more to help the poor.
But analysts point to impressive macroeconomic figures -- in 2002 Peru topped Latin America with 5.2 percent growth -- and say they are unfazed by unrest as long as they know Peru will not abandon the economic plan strikers want to see trashed.
"Foreign investors are not worried about politics or social pressure because they are totally convinced Peru is strongly tied to the (International Monetary Fund) IMF," Bear Stearns analyst Jose Cerritelli said from New York.
"For them, Peru ... is the least worrying country in Latin America," he said, adding that unrest in Peru seems mild in comparison to the rebel violence in Colombia, the leftist designs of President Hugo Chavez in Venezuela, or even Brazil's president, former metalworker Luiz Inacio Lula de Silva.
But with teachers, health workers, court workers, and some farmers striking, blocking highways and angrily shouting out demands in the streets, analysts say Peru has its hands tied.
"This government recognizes people's rights, but unfortunately the fiscal situation doesn't permit them to satisfy demands," said Peruvian commentator Ernest Velit.
Even officials admit that despite strong headline figures including low inflation, people have yet to feel it where it counts -- in their wallets.
"If we can't significantly reduce poverty, the turmoil in the streets, the banging of pots and pans will get louder," Toledo said in a speech in the government palace on Tuesday.
DIFFERENT STRIKERS COULD UNITE
Outside Congress this week, hundreds of teachers from across Peru banged on pots and waved banners in the third week of a strike seeking a hike of 210 soles ($60) to their average monthly wage of 700 soles ($200).
The government -- elected on pledges of not only jobs but fiscal discipline -- is offering them just 100 soles ($29), arguing it cannot stretch a tight budget any further.
"If the government doesn't change its policy of kneeling down before the IMF ... if it does not look the Peruvian people in the face and make its policies more sensitive, it's going to have to go," said Jorge Vargas, a high school teacher from the northern city of Chimbote.
Vargas said Toledo -- who grew up dirt-poor in a mountain village before he won a scholarship to study in the United States -- was out of touch with real Peruvians, proposing that the government fork over money retrieved from the corrupt regime of ex-President Alberto Fujimori to strapped teachers.
Officials have recovered some of the cash skimmed off state coffers under Fujimori, who fled in 2000 in a giant corruption scandal and who now lives sheltered by Tokyo.
"With that money, each teacher could get a 230-sol pay rise. Or they could stop debt payments for five days, and each teacher would get 240 soles more," Vargas said.
