The perception that LatAm as a region is less fundamentally exposed to the Brexit fiasco than other emerging markets is borne out by the data. Brazil and Colombia conduct a large amount of trade with the U.K. and the rest of Europe as a share of their total. A full 25% of Peruvian exports go to somewhere in Europe, with Brazil, Colombia, and Uruguay not far behind.
Just weeks ago, markets were in a tailspin amid the surprise Brexit vote, which consensus had gotten almost completely backwards. In the wake of the outcome, emerging market currencies did not escape the carnage, with J.P. Morgan’s EMCI index losing over 3% of its value in one day, the regional ETF (NYSEARCA:ILF) falling over 5% in a single trading session, and LatAm currencies were some of the hardest hit. The 7% decline of the MXN took the cake for the biggest decline, but the pain was felt by everyone in the region.
Yet, just a week later, risk has recovered virtually the entirety of those losses in all but the most directly affected markets. It, therefore, bears asking which LatAm markets, if any, will be adversely affected by the Brexit decision. One channel via which LatAm economies could be harmed is through diminished trade. Geopolitical uncertainty, higher tariffs, and reduced labor mobility all serve to lower potential GDP for the economies most affected by the decision, namely the UK primarily, as well as the Eurozone and European periphery secondarily. This, accompanied by loss of purchasing power thanks to weaker currencies, implies that demand from these economies for Latin American goods will take a hit.
There are two basic axes along which we can assess how exposed an economy is to an exogenous shock to trade. The first is to simply look at the magnitude of the share of total exports that is destined to the UK and Europe more broadly. There are several lessons to be gleaned from this. Firstly, the fact is that none of the major LatAm economies see a significant share of their exports go to the UK. On the other hand, once the rest of Europe is included, it is clear that the European market makes up a sizable chunk of the total for all but Mexico. Looking more closely at the data, we can see that a full 25% of Peruvian exports go to somewhere in Europe, with Brazil, Colombia, and Uruguay not far behind.
The second axis along which we need to examine this question is simply how important exports are to a given economy. Economies like Brazil and Argentina that have both larger domestic consumer markets, as well as higher trade barriers, rely less on their export markets to drive growth. Unsurprisingly, commodity exporters like Chile, Mexico, and Peru find themselves more exposed to changes in global demand.
By aggregating these two axes, we can start to understand just how significant the effect of the Brexit fallout will be on these respective economies. The results are interesting and not necessarily obvious. While countries like Brazil and Colombia conduct a large amount of trade with the UK and the rest of Europe as a share of their total, their relatively smaller reliance on trade makes them less vulnerable to trade shocks. Meanwhile, the smaller economy of Uruguay, and Chile and Peru’s reliance on commodity exports makes the three of them substantially more susceptible to weaker demand out of Europe than their peers.
LATAM PM’s Take: There are of course myriad other factors driving FX and FI markets in LatAm. The perception that LatAm as a region is less fundamentally exposed to the Brexit fiasco than other emerging markets is borne out by the data. Nonetheless, there is real differentiation here in terms of the potential drag from this event, something that should be factored into the outlook for these economies and their respective risk markets going forward.