Latin America Business: The Worst in 2014     

The worst news in Latin America business in 2014.

BY LATINVEX EDITORS

The worst events in Latin American business this year, according to Latinvex editors.

#1 The Fall of Petrobras

The spectacular free fall of Brazilian state oil producer Petrobras tops our list of the worst business events in Latin America this year.

While the company has been suffering from years of state meddling, the big meltdown happened this year when investigators stumbled upon a huge corruption scheme within Petrobras, Latin America’s largest company on the Latinvex 500.

Brazilian authorities in March started a probe – dubbed Operation Car Wash – into money laundering. That investigation led to the arrest of Paulo Roberto Costa, former director of refining and supply at Petrobras, who subsequently told investigators about the widespread corruption at the oil giant.  The scheme involved skimming some $3.9 billion from Petrobras contracts and sharing the proceeds with corrupt officials and legislators between 2006 and 2012. More than 36 people have been arrested so far, including Nestor Cervero, former international director of Petrobras.

While the Brazilian investigation continues, Petrobras now also has to deal with a US investigation into possible violations of the Foerign Corrupt Practices Act (FCPA). Perhaps even worse, Petrobras now faces a slew of class-action lawsuits in New York over the impact the corruption had on the company’s perfeormance. The latest lawsuit was filed by Morgan & Morgan PA on Monday on behalf of investors who purchased shares of the company between May 20, 2010 and Nov. 21, 2014, Reuters reported.

Last week, two other law firms filed class-action lawsuits against Petrobras. Wolf Popper LLP filed suit on December 8 on behalf of investors who bought U.S.-traded shares of the Brazilian company between May 20, 2010, and Nov. 21, 2014, Reuters reported.  The next day, Pomerantz Law Firm filed a class action lawsuit on behalf of clients who purchased who purchased Petrobras securities between May 20, 2010 and November 21, 2014, it announced.

In 2011, Moody’s Investors Service rated Petrobras three levels above its owner, Brazil’s government. Today, the bond rater says the oil producer would merit a junk grade without state support and is proving a drag on the nation’s own creditworthiness, Bloomberg reported recently.

Originally investors had expected that the third quarter earnings would be released on October 24. Then they were supposed to be released on November 14. But that day Petrobras announced that they would be released on December 12. However, they have been delayed further and won’t likely be released until next year, Bloomberg reported.

The bad news for investors is that there appears to be no serious effort at cleaning up the mess. President Dilma Rousseff has repeatedly said she wants to keep Petrobras CEO Maria das Gracas Foster. Rousseff herself was chairwoman of Petrobras during the worst corruption, but claims she knew nothing.

#2 Argentina’s Debt Default

Brazil has clearly been more successful at producing soap operas than its smaller beighbor, Argentina. But Argentina has clearly overtaken its bigger neighbor when it comes to producing real-life soaps.

During a 19-month period before it defaulted on debt on July 30 – its second default since 2001 – Argentina’s government did everything in its power to avoid reality.

Argentina in 2001 defaulted on its foreign debt and in 2005 reached an agreement with most of its creditors who accepted a cut on their payment. However, a group of holdouts sued for full payment of $1.33 billion plus interest. In November 2012, US Federal Judge Thomas Griesa ruled in their favor.

During the next 19 months, Argentina wasted time with various legal maneuvers instead of trying to reach a deal with the holdouts. (To see the details of the farce, see this Latinvex analysis).

“The government agreed instead on an adolescent vocal confrontation with American courts and then complained about a default that could have been easily avoided,” argues Claudio Loser, a former IMF official who now serves as President of the Centennial Group Latin America and a Senior Fellow at the Inter-American Dialogue. “Instead, they involved the UN, the G-20, and other fora to attack the holdouts, without ever seeking a practical solution.” 

Notably, Argentine journalist Martin Kanenguiser has called his new book on the subject, The dumbest default in Argentine history.

#3 Mexico Rail Auction & House Scandals

It was supposed to be another feather in President Enrique Peña Nieto’s hat, boosting ties with China and cementing Mexico as an investor-friendly country.  In the end, it worsened relations with China and weakened Pena Nieto’s credibility.

On November 3, a consortium led by China Railway Construction Corp. won a bid to build a $4.3 billion high-speed train line in central Mexico, marking the first large investment in transportation by a Chinese firm in the nation. However, four days later President Pena Nieto cancelled the contract.

Both decisions were attacked and left many observers dumbfounded. First, the China-led consortium in the end was the only qualified bidder despite the size of the contract, leading to accusations of influence peddling.

“The fact only one bid was made for the contract only served to underscore suspicions that the winner had been selected in advance,” the Globe and Mail reported. “Three of the four Mexican firms involved in the bid also had ties to the President, local media have reported. In addition, competing companies had failed in their efforts to persuade Mexico to extend an application window they said was far too brief.”

The news about the cancellation came just as Peña Nieto planned to visit china and his visit there – meant to forge closer ties between the two countries – was overshadowed by criticism by Chinese officials over the decision. Meanwhile, China Railways threatened legal action.

“Our company is extremely shocked [and] we will resort to legal means to protect the company’s legitimate interest when it’s necessary,” it said, according to Chinese news agency Xinhua.

In the end, Mexican authorities announced that they would pay China Railways $16 million in compensation for the cancellation. Meanwhile, China Railways plans to participate in a new bid when that takes place.

As if the bidding process wasn’t complicated enough, both First Lady Angelica Rivera and more recently Finance Minister Luis Videgaray were implicated in the issue, as they had houses that were built by Grupo Higa, a Mexican firm that formed part of the China-led consortium.

Rivera was in the process of buying her house and ended up announcing that she would sell the rights to acquire the house to avoid any conflict. Videgaray said he had acquired his house in October 2012, before he assumed public office in December 2012 and that it had nothing to do with the rail bid outcome.

“I acted honestly and in accordance with the law,” Videgaray wrote in a letter quoted by Bloomberg. “Those are the principles that guide me as secretary of finance and public credit, and nothing will distract me from the goal of contributing toward the transformation of Mexico to reach its true potential.”

No matter how the whole issue is analyzed, there is no doubt that it damaged Peña Nieto’s credibility.

#4 Panama Canal Dispute

It was supposed to be the pride of Panama, but instead the historic billion-dollar Panama Canal expansion has turned out to be a nasty business dispute just as the 48-mile (77 km) waterway linking the Atlantic and Pacific Oceans celebrated its 100^th anniversary.

The extent of the dispute came to light when GUPC (a consortium led by Spanish construction firm Sacyr) stopped work on the canal expansion for two weeks in February, causing shockwaves across the world.  

Already before then, it was clear that the dispute was serious. In an interview with Spanish newspaper El Pais in January, Canal Authority Administrator Jorge Quijano  lambasted the GUPC, partly alluding to their prejudice to Panamanians. “They really think that we still wear feathers on our heads; that they can twist our arms because they are big-time construction companies.”

GUPC won the July 2009 bid to build new canal locks after offering to do the work for $3.1 billion, lower than the $3.48 billion target price.  In addition to Sacyr, GUPC includes Italy-based Salini Impregilo, Belgium-based Jan de Nul Group and Panama's Constructora Urbana S.A.

A rival consortium led by US-based Bechtel had offered $4.2 billion for the expansion work, or $1.1 billion more than the GUPC. According to Wikileaks, it viewed the winning offer as uncredible and suspected Sacyr would attempt to renegotiate the contract up during implementation, which is in fact what ended up happening. 

After four intense months of negotiations – brokered by insurer Zurich – the Canal Authority (ACP) and GUPC in March reached an agreement that allowed work to restart. They also agreed to take the continued dispute to arbitration.

The agreement entailed that the ACP agreed to pay $37 million to cover December invoices, and both sides put in $100 million to get work restarted. The deal also entailed that the ACP extend a moratorium on the refund of advance payments until 2018.

Meanwhile, a $400 million surety bond from Zurich would be used as backing to obtain additional funding. The consortium had taken out the bond as a required insurance policy in case it did not finish the project.

Reaching the deal was no easy task, Jerry Brodsky, a partner and Director of the Latin American Practice Group at Peckar & Abramson, told Latinvex last week.

The expansion called for tailor-made designs and equipment that was state-of-the art. “It was engineered and designed by the contractor, who would now leave the job, which was about 65 to 70 percent finished,” he said. “You would have to bring someone else and that someone else would not give a warrant of work for the first contractor. You would have a state-of-the-art canal, with no warranty and that was death sentence. So, what made this deal possible, is that everybody was coming to the realization that the consequences of not paying this deal was much worse.”

Originally slated to be ready in time for its official Centennial celebrations in August this year, the expansion is now slated to be ready in December 2015, although some experts say it will likely be delayed further. The price tag has also gone up. The original cost was $5.2 billion, but it now stands at $6.7 billion and may reach $7 billion.

“The ground is certainly set for many legal battles that will go on for years,” Richard Wainio, a former planning director of the Panama Canal Commission who recently served as Port of Tampa CEO and follows canal development closely, told Latinvex earlier this year.  

#5 Chile’s Faded Star

For many years Chile has been a poster boy for business in Latin America. Not anymore.  This year, Colombia replaced Chile as the best place to do business, according to The World Bank’s Doing Business report.

Just as Chile’s economy was showing signs of a slowdown, President Michelle Bachelet decided to continue with her economic policies that were aimed at increasing regulations to the detriment of business.

“Uncertainties driven by the shift in political direction and her announced reform plans – on tax, labor, and education – have negatively affected the business environment and investor confidence,”  Claudia Wehbe, a Senior Economist for Latin America and the Caribbean at IHS Economics, wrote in an analysis recently.

Bachelet’s controversial tax reform, which will help pay for an increase in education spending, will entail that the corporate tax rate goes from 20 percent –Latin America’s second-lowest, according to a Latinvex analysis – to 25 percent in 2018 and up to 27 percent in 2019. Meanwhile, mining companies will see the royalty fee go from 5 percent to 14 percent (on top of corporate taxes).

Apart from the consequences of the rates, local and foreign investors were disappointed at the way they were pushed through despite business criticism.

“The lack of a smooth process in achieving a consensus over the reform and long discussions between the government and the opposition have created a less optimistic environment, which has had negative effects on consumer and investor confidence,” Wehbe says.

This week, the Bachelet government announced that it will submit a labor reform to Congress on December 29.

“Chile's proposed labor reform increases risk of workers' protests and stoppages in the mining and port sectors,” IHS analyst Carla Selman warns in an analysis.

The bill will require companies to engage with just one union, considered the "most representative", increasing its power, and will forbid companies from replacing striking workers. The Confederation for Production and Commerce (Confederación de la Producción y del Comercio: CPC) has claimed that the proposal will increase unemployment and further slow down economic growth.

While Bachelet is expected to consult more with the private sector this time than she did over the tax reform, unions are expected to stage a wave of protests and strikes to pressure her to implement core parts of the reform without concessions to the private sector, Selman warns.

Bachelet’s reforms are aimed at reducing inequality. Ironically, her predecessor Sebastian Pinera had reduced inequality to its lowest point in 40 years while maintaining market-friendly policies.  “Chileans within the highest decile earned 16 times more than those in the lowest 10 percent, compared to a difference of 21 during Bachelet's first administration,” Wehbe says.

GDP is expected to grow by a mere 1.7 percent this year, according to the latest forecasts from Chile’s Central Bank released on December 15, 2014. (The fifth downward revision this year). That’s the worst result since the 2009 crisis. Meanwhile, inflation will likely reach 4.8 percent, the highest level since 2008.

Bachelet also took the initiative to bring the hugely successful Pacific Alliance closer to the equally hugely unsuccessful Mercosur, pushing for Mercosur countries to join the alliance.

“While her first term was marked by pragmatism and a business-friendly environment, her second time in office is a showcase of socialism and arrogance,” Walter Molano, head of research at BCP Securities, argued in a recent column.

Bachelet’s reforms, he argues, “will roll back the dynamism that made Chile the most resilient economy of Latin America.”

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