By Don Quijones, Spain & Mexico, editor at WOLF STREET.
As Spain gears up for municipal elections this Sunday, the prospects for the governing People’s Party (PP) are looking increasingly bleak. Times have changed dramatically: four years ago the party rode a wave of popular anger with the “socialist” government’s disastrous handling of the financial crisis to win a landslide victory in the general elections.
Now, Rajoy’s government is mired in myriad corruption scandals and the PP will be lucky to hold on to half of its seats in the next general elections, to be held toward the end of this year. Just how bad things could get for the PP will depend largely on how the economy fares during the lead up to the elections. And that will depend on forces not only at home and in Europe, but also in Latin America, a region that in recent years has provided huge bonanzas for Spanish companies and investors. But now the good times are coming to an end.
A Rapid Slow Down
According to the IMF’s latest growth forecast, the region’s economy will grow by a meager 0.8% in 2015. Put simply, things are slowing, and fast. In 2010, Latin American growth clocked in at 6.1%; by 2011, it had fallen to 4.9%; in 2012, 3.1%; in 2013, 2.9%; and in 2014, 1.3%. You get the picture.
The reason this could be a serious problem for Spain is that Spain is by far the most exposed economy to the region! And when the economies of Latin America catch a cold, it doesn’t take long for the symptoms to begin appearing elsewhere. The last time Latin American economies began collapsing in unison, it hit the U.S. financial system (read: The Tequila Crisis: The Prelude to Europe’s Economic Storms).
Few Spanish executives are more worried than Cesar Alierta, the CEO of Spain’s telecoms giant Telefónica. Alierta has just paid Venzuela’s capital Caracas an impromptu visit. According to some reports, he was in town just to meet up with the company’s local executives; according to others, he was there also to speak with representatives of some of the country’s biggest political parties – excluding, one assumes, the governing socialist party.
The main reason for Alierta’s concerns is obvious: Venezuela’s basket case economy is fast unraveling, threatening the financial health of Telefónica’s Venezuelan division. As El Confidencial reports, in the last five years alone Telefónica has had to write off €7.5 billion in losses as a direct result of the government’s constant devaluations of the national currency, the Bolívar. The last time this happened, in the fourth quarter of 2014, the company lost €3 billion.
The problem for Telefónica and most other foreign multinationals operating in Venezuela (and Argentina for that matter) is that they cannot repatriate the profits they generate in the country. The money just sits in bank accounts losing value. What the Spanish government now fears is that after serial devaluations of the Bolivar, the Venezuelan government’s next move will be to nationalize the assets held in situ by companies like Telefónica.
Hence the escalating war of words and deeds between Madrid and Caracas, with Venezuelan President Maduro accusing Spain of sowing political instability and plotting with opposition leaders to unseat his government. For its part, Madrid accuses Maduro’s government of supporting the Basque terrorist organization ETA and financing Podemos, the populist left-wing party that many in the Spanish government and media often paint as carbon copies of Venezuela’s Bolivarian socialists.
A Continental Shift
If the risks Spanish companies faced in Latin America were limited to Caracas, the problems could be contained. But they extend far beyond the Venezuelan border. Spanish companies are particularly exposed to South America’s two largest economies – Brazil and Argentina. Just three years ago, with Chinese demand for their commodities seemingly insatiable and cheap credit flowing, both economies were growing at a fair click. Now, both the Chinese demand and cheap credit are drying up. As a result, Argentina is deep in recession while Brazil has spent the last year teetering on the edge.
Yet these are two of the markets upon which Spanish corporations – in particular its biggest banks, utilities, and construction companies – have staked their future. As Spain’s recently departed banking godfather Emilio Botin said just before his death last year, Santander Bank hardly makes money in Spain these days. Now under the supervision of his daughter, Ana Botin, the bank’s dependence on Latin America has grown. In the first quarter of 2015 the region provided 38% of the group’s total profits, with Brazil alone accounting for 21%.
As WOLF STREET recently reported, given its grim cocktail of fiscal, financial and economic conditions, Brazil is probably not the best place right now to be focusing your business operations! Since 2010, the county’s annual GDP growth has shrunk from 7.5% to 0% today. Yet Brazil remains a crucial market for Spanish companies like Telefónica (22% of revenues), Gas Natural (26% of EBITDA), and Abertis (17% of revenues).
The New Eldorado
For other Spanish companies, Mexico is the new Eldorado. Spain’s second biggest bank, BBVA, made over 40% of its global profits in Mexico last year, while Latin America as a whole accounted for over two-thirds of the group’s operating profits. Granted, at this precise juncture Mexico’s macro conditions are significantly more favorable than Brazil’s, in particular given Mexico’s exposure to the U.S. economy. But enormous risks still persist. The country is extremely vulnerable to low oil prices and the capital outflows associated with the rising dollar. It is also struggling with rampant corruption and fighting a losing war against the drugs trade and myriad other forms of organized crime.
That is not to say that countries like Brazil or Mexico are necessarily bad places to do business; quite the contrary, they present a bewildering array of opportunities for discerning international investors. But they are not where you want to be concentrating the lion’s share of your business risks at a time when emerging markets are grinding to a halt across the globe.
But this is precisely what many of Spain’s biggest publicly listed companies have done. In the aftermath of Spain’s real estate collapse, when opportunities at home were almost non-existent, Latin America’s fast-growing economies were a godsend. However, they could soon become a curse. Given the scale and scope of some companies’ exposure to the region, the contagion is likely to spread across the Atlantic, putting an abrubt end to Spain’s flimsy economic recovery — and by extension, Rajoy’s reelection chances. By Don Quijones, Raging Bull-Shit.
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