Investment strategy
November 29, 2021

Why central bank independence is critical for Latin America

November 29, 2021
Jorge Amato
Head of Latin America Investment Strategy
SUMMARY

Many Latin American economies are finding themselves at crossroads where political change may result in important policy changes. There are fears that administrations at the extremes of the political spectrum may derail years of monetary stability and central bank independence.


  • For example, Mexico’s currency sold off recently on the back of Lopez Obrador’s move to pull former Finance Minister Arturo Herrera’s nomination for central bank governor. Back in June, the President has announced that Herrera would take over the central bank in 2022. That nomination was then withdrawn in August. A week ago Herrera was told his nomination would be reconsidered, but the latest headlines are that, again, the nomination has been pulled and that Victoria Rodriguez, finance undersecretary, will now be nominated. Current governor Alejandro Diaz de Leon will leave his post on December 31, 2021.
  • Why is this causing anxiety and why is it important for investors who the central bank head is? The purpose of this note is to address this broader issue and central bank independence rather than the specifics of the Mexican case. This is a topic we consider critical to understanding current fundamental underpinnings of emerging market (EM) economies and their possible vulnerabilities and could give us some insight to identify and quantify potential risks and opportunities.
  • Such fears are causing investors to demand high risk premiums from Latin American markets. What we believe is currently happening in the region is that social pressures resulting from years of lack of growth combined with increasing income and wealth gaps are generating sharp polarizations in voter preferences towards the far right and far left ends of the political spectrum.
  • This higher uncertainty has translated into equity market and currency weakness that would typically not occur given current favorable external conditions presented by high commodity prices, terms-of-trade, earnings recovery and level of economic activity.
  • In other words, we believe current Latam market weakness has a very high degree of political risk embedded and it is this political risk that is feared could translate into policy changes that could further weaken fiscal accounts which in turn might turn to be financed by CB monetary supply.
  • All in all, we consider the balance of risks of such a sequence of events as lower than what markets are currently pricing in. Having said that, election results, compositions in congress and policy rhetoric bear close scrutiny in the coming months.

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