Brian Porter Speech - April 25, 2014
Not All Emerging Markets are Equal: Scotiabank’s Focus in Latin America
Address by Brian Porter
President and Chief Executive Officer, Scotiabank
National Club, Toronto
April 25, 2014
Thank you for inviting me to speak today.
A strong international orientation has long been part of Scotiabank’s strategy. Our footprint stretches across three regions around the globe: Latin America, the Caribbean and Central America, and Asia. Today, Scotiabank has almost twice as many branches outside of Canada as within Canada.
About half of our earnings are generated internationally. And most people don’t realize that 50,000 of our 83,000 employees are located outside Canada. So, we know a thing or two about operating in international markets!
That experience gives us good insight into emerging markets from Central America, to South America and to Asia, including Thailand.
But don’t worry; I’m not going to take time to do an in-depth analysis of each market we operate in today – unless you want to be here all afternoon!
We have learned from being one of the world’s most international banks that not all emerging markets are equal. At Scotiabank, we have learned how to differentiate among emerging markets – even those within a single region.
That insight has led us to focus our international business in the Latin America region, which for Scotiabank includes Mexico. We earned $1.2 billion dollars from the region in fiscal 2013.
In particular, we are focusing our efforts on the four major Latin American markets of Peru, Colombia, Mexico and Chile. I’ll explain our thinking here in a few moments.
As it happens, these four countries comprise a relatively new preferential trade and investment bloc known as the Pacific Alliance, which I’ll also elaborate on shortly.
These countries clearly illustrate my hypothesis today that not all emerging markets should be viewed in the same way.
To support my hypothesis, I will cover three things:
- Firstly, discuss how the development of -- and distinctions among -- emerging markets has reinforced the importance of choosing the right markets;
- Secondly, explain why both the current and the long-term opportunities within the Pacific Alliance are so attractive for Canadian enterprises -- including Scotiabank;
- And finally, share our investment thesis for our key operations in Latin America, and how we have managed risk.
EMERGING MARKETS OVERVIEW
Now, I will turn to my first point about the distinctions between emerging markets.
Despite the disciplines of investing, market sentiment can shift suddenly – sometimes causing investors to treat emerging markets as a single asset class or basket. When one country or region suffers a setback, the negative reaction can spread quite quickly.
Scotiabank is a prime example – our stock price was down eight per cent versus our peers in January -- largely because of our emerging markets exposure.
In the last few months, we have seen investors react to the prospect of reduced growth in many emerging markets and the return of stronger growth in the developed economies. These are among the factors which have led to a “sell off” in emerging markets and the return of capital to the more developed world.
The developed markets, such as the United States, the U.K. and Continental Europe are regaining some of their economic footing in the aftermath of the global financial crisis.
During and following the crisis, capital flowed away from the developed low interest rate world to higher growth and yield environments. Today, there are signs that this is reversing somewhat.
These capital flows affect different emerging markets in different ways. We see a wide range of economic prospects, monetary and fiscal policy, and social issues across the emerging markets.
Each country is also at a unique point in its level of economic development, political evolution and regulatory maturity.
At Scotiabank, as I mentioned earlier, our primary focus in Latin America is the four countries that comprise the Pacific Alliance: Peru, Colombia, Mexico and Chile. Individually, each of these countries has attractive economic fundamentals and growth prospects:
- Mexico has size, with GDP of $1.2 trillion, exports of $371 billion and a population of 112 million – four times the size of Canada’s.
- Peru has a strong fiscal position. It’s sovereign debt to GDP is 16 per cent and their foreign exchange reserves have grown to $66 billion.
- Peru and Colombia are also sizable markets with GDP of more than $200 billion and $360 billion respectively.
- And Chile – which for all intents and purposes is a developed nation – has a proven track record of economic growth and a $270 billion dollar economy.
Taken together, the Pacific Alliance bloc forms the world’s sixth largest economy – when measured by purchasing power parity – and is the seventh largest exporter.
Within Latin America, the Alliance has 208 million people, and accounts for almost 40 per cent of GDP of the region, and 50 per cent of trade.
Historically, some trade blocs and alliances in Latin America have taken a defensive and protectionist stance. By contrast, the strategic purpose of the Pacific Alliance is to fully leverage opportunities for increased global trade.
Members of the Pacific Alliance are committed to high levels of trade liberalization. They already have bilateral agreements with one another. And they each have trade agreements with major partners such as Canada, the U.S., the E.U. and a number of Asian countries.
Economic linkages between the four countries have been further reinforced by the integration their stock exchanges. MILA, as the integrated stock market is known, has listed companies with a combined market capitalization of $700 billion. This size makes it second only in Latin America to the Brazilian stock exchange.
The potential integration of the Mexican bourse later in 2014 would make MILA a significant market in global terms. Regardless, MILA has already further linked these countries by facilitating an easy flow of capital across borders.
Central banks in Pacific Alliance countries are also increasingly sophisticated and independent. For instance, they have established swap lines with other key central banks. In addition, these countries fiscal positions and current account balances (relative to GDP) are becoming healthier than ever.
And, the development of deeper capital markets and stronger central banks has resulted in a more efficient and effective economic system.
Critically, all of this is translating into greater investor confidence in the Pacific Alliance.
MEXICAN PESO CRISIS
For the Pacific Alliance countries – and others in Latin America more generally – an important catalyst for structural reform and modernization was the Mexican Peso Crisis 20 years ago.
That crisis exposed some systemic weaknesses in Mexico – and other markets in Latin America – at the time. It revealed large current account deficits relative to GDP, as well as the challenges of having currencies that were fixed to the U.S. dollar.
The situation was further compounded by large U.S. dollar borrowings and low foreign currency reserves. These factors caused a 50 per cent devaluation of the peso in the span of 10 short months in 1994. And, Mexican GDP declined by more than six per cent that year.
The outcome of the crisis was a $50-billion bailout to stabilize the country and its economy. Fortunately, however, that crisis led to transformational change.
REFORM AGENDA – PACIFIC ALLIANCE
In the two decades since then, Mexico and other members of the Pacific Alliance have undergone important structural and legal reforms. The impact of such reforms has been amplified by a number of other developments. These include:
- Accelerated globalization and the formation of the Eurozone, which has increased trade;
- Rapid economic growth in China;
- The emergence of a growing middle-class in select countries; and,
- Quantitative easing in many developed economies, which drew capital to emerging markets at attractive rates.
Because of the differences between emerging markets in Latin America, the Pacific Alliance countries have benefitted from these developments more than their immediate neighbours.
Mexico is a great example. Since the Peso Crisis, Mexico has reformed its financial markets, labour markets, political processes, and fiscal policies. And the reforms continue.
Government spending of $300-billion over the next four years will upgrade Mexico’s economic infrastructure including ports, highways and telecommunications.
This will improve Mexico’s ability to export to foreign markets. And its appeal as a destination for foreign capital will be enhanced.
Mexico recently announced that it will allow foreign direct investment in the upstream energy sector. This is the first time that this has been allowed since the state energy monopoly, Pemex, was created almost 80 years ago. This will take time and patience to unfold and will reward investors and enterprises with a longer-term view.
These reforms in Mexico are just one example of the general shift to a more open, free-market approach in the Pacific Alliance countries.
Other Canadian enterprises are seeing the opportunities in Mexico and other Pacific Alliance countries.
I was part of Prime Minister Harper’s delegation to the recent Trilateral Summit in Mexico. I was reminded, once again, that there are almost 3,000 Canadian enterprises – including 150 public companies – doing business in Mexico today.
These reforms have resulted in the Pacific Alliance becoming a very attractive place to do business.
As a financial institution we are interested in the solid economic growth prospects, the stability, and the related expansion of an increasingly educated, but “under-banked” middle class.
These strong economic fundamentals should be equally attractive to manufacturers, consumer goods companies, resource businesses, insurance companies and pension funds – among many others.
Let’s look at economic growth and stability for a minute. Alliance members have average GDP growth forecasts of 3.8 per cent in 2014 and roughly the same in 2015.
By contrast, GDP growth in Argentina, Brazil, Paraguay, Uruguay and Venezuela is expected to average just 1.5 per cent this year and next.
To put a sharper point on this difference, Pacific Alliance countries are growing twice as fast as their neighbours. And even the Brazilian economy is forecasted to grow relatively modestly this year and next.
As further evidence of this relative stability, Peru, Colombia, Mexico and Chile all have investment grade sovereign debt ratings. Brazil is the only other Latin American country with such a rating.
The improving economic performance of the Alliance countries is helping to raise income levels, create better political and social stability, and build the confidence required to sustain this growth.
Tangible evidence of these factors can be seen in the Alliance’s expanding middle class. In Peru, it doubled from 2005 to 2011, and now seven out of ten Peruvians belong to the middle class. And in Mexico, some estimates indicate that the middle class is approaching the 50 per cent mark.
The OECD forecasts that the middle class in Central and South America will grow from 180 million people today to 300 million by 2030. In that same period the purchasing power of this group will more than double to $3.2 trillion dollars.
And forming behind the traditional middle class is a large “pre-middle class”. This emerging group represents about 50 per cent of the population in the Pacific Alliance and about 30 per cent of the purchasing power.
The final element of our Pacific Alliance investment thesis is the relatively low rates of “bancarization”. In other words these countries are significantly “under banked.”
Domestic credit provided to the private sector by banks in Latin America averages 41 per cent of GDP. That compares to 80 per cent in Asia and 130 per cent here in Canada.
As these economies grow, so too do the potential benefits for financial institutions – including Scotiabank.
It is also an important development for other sectors too, because access to credit and other financial services creates the lifeblood that fuels business and trade.
From my comments today, you can tell that we are bullish on the mid and longer-term prospects for the Pacific Alliance countries.
However, investing in emerging markets is not without its risks – we learned that lesson the hard way through our experience in Argentina more than a decade ago. Any company doing business in an emerging economy should have a sound and comprehensive strategy for managing risk.
Here are some of the most important considerations from our playbook:
- Develop a deep understanding of – and respect for – cultural and historical nuances in each country;
- Seek out trusted partners with local expertise and engage with the full range of stakeholders;
- Put in place a strong risk management framework and develop an understanding of the local judicial system;
- Ensure strong leadership by putting your best talent in place;
- Enforce the highest standards of business ethics and conduct;
- Make sure your local control functions are effectively governed and mirror Canadian standards; and,
- Finally, don’t invest everything in one country – diversify your exposure.
The bottom line is companies must ensure they are being adequately compensated for the incremental risk that comes with emerging markets exposure.
At Scotiabank, our long history of operating internationally, together with our disciplined approach to risk management, has provided us with that comfort.
At the outset of my remarks today, I suggested that not all emerging markets are equal.
I then gave you several reasons why we believe this to be true – and I contrasted Latin America generally with the unique attributes of the four Pacific Alliance countries.
In Scotiabank’s case, this thinking is consistent with our strategy. We believe we have attractive growth opportunities across the Bank – many of which relate to the Pacific Alliance.
Since becoming CEO last fall, I have indicated that we will emphasize the Latin America region, relative to the other international regions that we operate in. And, more specifically, we have also indicated that we will continue to build upon our businesses in the Pacific Alliance countries.
From time to time, emerging markets get unfairly painted with the same brush. At Scotiabank, we know they are not all equal and we are deploying shareholder capital accordingly.