Russia's troubles could spur dollar inflows to Latin America

COSTA DO SAUIPE, Brazil, March 31 Mon Mar 31, 2014 10:35am EDT

COSTA DO SAUIPE, Brazil, March 31 (Reuters) - Leading Latin American economies such as Mexico and Brazil are poised to receive short-term capital flows from investors fleeing Russia due to fear of geopolitical instability and an economic recession there, analysts said.

Such inflows are not expected to be strong enough to have a lasting impact on the countries' exchange rates but have already caused market buzz and became a topic of discussion during this weekend's annual meeting of the Inter-American Development Bank in a resort near the Brazilian city of Salvador.

"There are indications based on what we have heard from our European analysts that some of that money that is flowing out of Russia may be coming to the region," Mauro Leos, Moody's senior analyst for Latin America, told Reuters on the sidelines of the IADB meeting.

Leos' comments echoed remarks made by local analysts in Brazil, who had attributed part of the real's recent gains to dollar inflows coming from Russia.

He noted, however, this is likely to be a "short-term and not very significant phenomenon" that is not going to make a "big difference in terms of capital inflows and appreciation of local currencies."

Many investors have been pulling out of Russia as Western powers' sanctions over Moscow's annexation of Crimea risk tipping the Russian economy into a recession. Goldman Sachs recently predicted capital outflows from the country could reach $130 billion this year, or double the level recorded in 2013.

In Latin America, Brazil and Mexico are the two main destinations for such inflows but for very distinct reasons, analysts said.

While both countries offer deep financial markets with diverse investment options, Mexico is a favorite for its economic stability and a government push for structural reforms that has led Moody's to lift its credit ratings to grade A.

Brazil, on the other hand, lures investors with its high and still-rising yields. As the central bank continues to battle inflation, Brazil's benchmark interest rates are expected to climb to 11 percent on Wednesday.

INSTABILITY NOT GOOD FOR ANYONE

Despite a possible short-term boost, the geopolitical instability and economic weakness resulting from the Russia-Ukraine crisis could hurt emerging markets in the long run, officials with the Mexican government, the International Monetary Fund and the IADB warned.

"Geopolitical risk isn't good for anyone," Manuel Sanchez, a board member of the Mexican central bank, told Reuters during the IADB meeting.

"This is not a favorable element at a moment when financial markets are digesting a new trajectory for the U.S. monetary policy," he added, referring to market concern that the U.S. Federal Reserve may start raising interest rates earlier than expected.

Fears about the timing of withdrawal of U.S. monetary stimulus have hurt emerging markets by increasing investors' aversion to risk across the board.

Alejandro Werner, the IMF's director of the Western Hemisphere Department, made a similar warning during a speech to investors at Costa do Sauipe.

"Maybe there will be some small effect in terms of the mandates on some money that has to go somewhere and that generates flows to Latin America, but I think that significantly increasing the geopolitical risk and hampering the recovery in Europe is not a good thing for the global economy and Latin America," he said.

Moreover, short-term capital flows are not the kind of investment that Latin American countries are in need of, said the IADB chief economist Jose Juan Ruiz.

"What is crucial to Latin American is to grow and keep its economic predictability. That is the right way to attract capital flows and, besides that, the money we want is that coming from foreign direct investment," he said.

Flows of short-term capital leaving Russia could exit Latin America as quickly as they entered, Moody's Leos said. "So this is more like the flavor of the hour, not even of the day. The region is not going to look any different because of Russia." (Reporting by Walter Brandimarte; Editing by Meredith Mazzilli)