Nomura | Region Views

3 May 2012

Region Views

Emerging Markets Research | LatAm

Latin America: A changing of the guard

Over the past decade, Brazil has undoubtedly been the shiniest macro story in Latin America, offering investors ample opportunities. Looking forward, however, stars appear to be increasingly aligned for an economic outperformance of Mexico. A changing of the guard is slowly but surely taking place, and we believe this is well worth investors attention.

3 MAY 2012

Fixed Income Research

Contributing Strategists

Tony Volpon

+1 212 667 2182 [Link]@[Link]

Brazil: A golden decade, an uncertain future

Looking at the past ten years or so, one would not be exaggerating in saying that this was Brazils decade. This is made abundantly clear if we look at the relative performance of Brazil in relation to the other large economy of the region, Mexico. But it is perhaps most evident by looking at the likely pessimistic prospects that seemed in store for Brazil back then. Ten years ago Brazils economy looked extremely weak, with high current account deficits and years of low growth. The election of a leftwing labor leader to the presidency seemed to threaten undoing the policy and institutional advancements made since the 1994 Plano Real inflation stabilization program. Capital flight due to the election generated a fall of almost 80% in BRL, pushing inflation above 16% per year. That this was the beginning of the best decade in the countrys recent history was something markets did not see forthcoming. The game changer for Brazil was the ascent of China. Though not well understood at the time, the entry of China in the WTO in 2001 began a process by which commodity demand, from what soon became the most dynamic economy in the world, massively improved the fortunes of countries like Brazil. Over time, as the decade progressed, both the price and the quantity demanded for key commodity exports steadily rose. At first, and still under the influence of the 2002-2003 devaluation of BRL, the Brazilian economy saw a vast improvement in its external accounts and for a brief period even ran a current account surplus. But the very improvement of the countrys external situation, especially the buying back of most FX-denominated government debt and steady accumulation of foreign reserves, lowered the perception of risk in the economy and led to the beginning of a lending and consumption boom. Brazil adopted what we have called the Lula model of growth (see The end of the Lula model?, 24 April, 2012), whereby credit and wage policies are used to multiply and distribute the wealth effects generated by the China-led commodity boom. This consumption-led growth strategy worked very well, despite generating constant inflationary pressures. Growth over the last five years to 2010 averaged 4.5%, much above the 2.5% levels seen in the 1990s, and many observers came to believe that such levels were sustainable for Brazil going forward. Many believed a new era of prosperity had arrived. This optimism has been much diminished by the disappointing growth of 2.7% seen in 2011, which made Brazil one of the worst performing countries in the region. Though there were many well recognized cyclical factors that led to lower growth, we see this result as a confirmation of worries we first

Benito Berber

+1 212 667 9503 [Link]@[Link]

George Lei

+1 212 667 9947 [Link]@[Link]

Tanuja Gupta

+1 212 667 1072 [Link]@[Link] This report can be accessed electronically via: [Link]/research or on Bloomberg (NOMR)

Nomura Securities International Inc.

See Disclosure Appendix A-1 for the Analyst Certification and Other Important Disclosures

Nomura | Region Views expressed last year about the exhaustion of the credit deepening process ( see Does Brazil have a credit bubble?, 06 July, 2011) and the negative effects that ever tighter labor markets were having in the economy (see Looking for a bubble in Brazil? You will find it in the labor market, 13 July, 2011). Though the Brazilian government has taken measures to address issues in both industry and credit markets, we believe that without undertaking more serious reforms to address falling productivity and inadequate investment levels, Brazil will not soon see growth levels close to those seen from 2006 to 2010. The era of picking the low hanging fruit generated by the commodity boom is over, and difficult challenges lie ahead.

3 May 2012

Mexico: The dawn of a new era

Despite the opening of the economy with the signing of free trade agreements since 1994, privatizing many sectors and the consolidation of democracy in 2000, the Mexican economy failed to embark on a highgrowth trajectory in the past decade. The potential GDP growth rate in Mexico was one of the lowest in the region at 3.0% y-o-y. In addition, rising violence threatened the investment climate besides hurting the society. However, the outlook is improving rapidly (see Mexico: Getting bullish, 29 March, 2012) To understand why we have a positive outlook, it might be useful to describe the status quo of the economy: Rigidities in the labor market, a sizable informal market, high dependency of fiscal accounts on oil revenues, existing monopolistic and oligopolistic structures, lack of investment in the state-dominated energy sector, are among the problems that have slowed down growth in Mexico in the past. The medicine, in the form of the so called structural reforms, has proven to be elusive. Congress, which since 1997 is not dominated by any particular party, has had difficulties in reaching consensus with respect to economic policy. Being linked to the US was a detriment when the epicentre of the 2008-09 global crisis in turn was the US financial sector. However, now that the worst episode in the US appears to be over, while the worst in the eurozone seems still ahead of us, strong US links now prove very advantageous. After all, one-third of total GDP is directly linked to economic activity north of the Rio Grande. Mexico is becoming an increasingly attractive choice for US-destined, labor-intensive manufacturers due to increasing labor costs in China. When China entered the WTO, there were several warnings about the possible repercussions to Mexico. Sure enough, Mexico lost market share to China particularly in the US. However, over the past 10 years, unit labor cost in China has grown much faster than in Mexico. Although productivity rises quickly in China, even quicker rise in wages keeps pushing up unit labor cost, especially after 2003. The faster rate of wage increases in China than in Mexico implies that the cost advantage China once enjoyed is dissipating rapidly. Chinese labor rates were 33% of Mexicos in 1996, yet now they are fairly close or even higher than that in Mexico. In addition to external factors behind our positive outlook such as being tied to the only G3 country with a positive growth outlook and regained competitiveness against China, there are domestic ones: domestic consumption, which used to be dormant for many years, is now expanding at a tune of 25% annually. The expansion of credit is taking place amidst a sound banking system where 85% is foreign owned and from a low level of indebtedness. Also, Presidential and congressional elections, which used to bring about bouts of volatility, will likely this time confirm a macroeconomic framework characterized by low inflation, prudent fiscal and pro-market policies.

Nomura | Region Views On July 1, Mexicans will elect a new president, and both chambers of congress. Indeed, every six years, elections bring about the possibility of change and also volatility in the markets. However, we believe this time it will be different. The presidential candidates of the PRI and PAN, which are the two parties most likely to win the election, guarantee the continuation of sound market friendly policies within a stable macro economic framework. Furthermore, recent polls suggest the centre PRI party is poised to win the presidency and most importantly majority in Congress. The PRI presidential candidate Enrique Pea Nieto, who leads polls by more than 25ppts, has repeatedly talked about opening the energy sector to private investment and reforming the tax system to reduce the dependency on oil revenues (see Mexico: Election 101, 10 April, 2012). Therefore, it is very like that a number of the structural reforms will get passed. Finally, the openness of the capital account, the FX convertibility and easy access to the financial markets gives Mexico an edge over other EM economies (see Mexico Flows Monitor, 20 April, 2012). While the growth outlook in the rest of the world, including emerging economies, seems to be moderating, Mexico is poised to see a rise in its potential growth rate.

3 May 2012

Mexico versus Brazil: A shifting macro picture

In the past 10 years, Brazil has overtaken Mexico in terms of both GDP and GDP per capita, measured by nominal US dollars, due to a combination of factors: a very positive terms of trade shock, declining country risk premium and the subsequent boost to potential growth, BRL appreciation vs. MXN depreciation, robust domestic demand, etc. Nonetheless, many of these favourable factors have gradually exhausted themselves, and the macro picture is gradually tilting in Mexicos favour.
Fig. 1: Nominal GDP: Brazil vs Mexico
500 450 400 350 300 250 200 150 100 50 2001 2003 2005 2007 2009 2011 Index (2001 = 100) Brazil Mexico

Fig. 2: Nominal GDP per capita: Brazil vs Mexico

14000 12000 10000 8000 6000 4000 2000 0 2001 2003 2005 2007 2009 2011 US$ Brazil Mexico

Note: GDP are nominal figures in current USD terms. Source: Nomura, Haver Analytics.

Source: Nomura, Haver Analytics.

Terms of trade and the commodities boom

Over the past decade, Brazil has successfully ridden the commodity boom and transformed itself into a major supplier for Asia/China, principally providing iron ore, soy beans and crude oil (Fig 3). Commodities now account for over 70% of Brazils total export basket, with China overtaking the US as Brazils biggest trading partner in 2009, while Chinas share in Brazilian total exports rose more than fourfold since 2003.

Nomura | Region Views

Fig. 3: Export shares to China
21 18 15 12 9 6 3 0 Jan-01 Dec-02 Nov-04 Oct-06 Sep-08 Aug-10 % Brazil Mexico

3 May 2012
Fig. 4: Export shares to the US
30 25 20 15 10 Brazil (lhs) Mexico (rhs) % % 92 89 86 83 80 77

5 Jan-01 Dec-02 Nov-04 Oct-06

Sep-08 Aug-10

Source: Nomura, Haver Analytics.

Source: Nomura, Haver Analytics.

Mexico, on the other hand, remains deeply connected to the US through trade links. Although the US share of Mexican exports has declined steadily for a decade, the latest data shows that Mexico still sends over three quarters of its exports north of the Rio Grande (Fig 4). While exports to economies outside North America now account for 18.4% of total exports, the US factor remains the single biggest determinant of Mexicos foreign trade.

Fig. 5: Terms of trade

290 Index (1977 = 100)
Brazil Mexico

240

190

140

90

40 Jan-77

Jan-82

Jan-87

Jan-92

Jan-97

Jan-02

Jan-07

Jan-12

Source: Nomura, Haver Analytics

Soaring Chinese commodity demand and prices offered a windfall to Brazil, as the countrys terms of trade began a phenomenal rise in 2002, shortly after Chinas admission into the World Trade Organization (Fig 5). Brazils terms of trade also recovered quickly after the financial crisis and hit new highs, along with metal prices. Import prices, on the other hand, remained relatively subdued, given most imports are consumer and capital goods. While Mexicos terms of trade improved 16% since 2000, it pales in comparison with Brazil. Although 15% of Mexican exports are oil, Mexico also imports a fair amount of gasoline, thus the explosive growth in oil prices does not provide a major boost for Mexican terms of trade.

Nomura | Region Views

3 May 2012

Industrial production: Manufacturing powerhouse of Mexico vs. deindustrialization in Brazil

The rise in Brazils terms of trade has brought along very positive wealth effects. Nonetheless, it also created its share of problems. The countrys real effective exchange rate (REER) has been continuously on the rise, staying above its 10-yr average over the past six years, even during the financial crisis. Mexico, on the other hand, has never had a REER out of sync with its long-term average, and the currency became even cheaper after the crisis (Fig 6).

Fig. 6: Real effective exchange rate: Brazil vs Mexico

50 40 30 20 10 0 -10 -20 -30 -40 Jan-04 Jan-06 BRL MXN % deviation

Fig. 7: Unit labor cost in local currency terms

230 210 190 170 150 130 110 90 1Q 2001 1Q 2003 1Q 2005 1Q 2007 1Q 2009 1Q 2011 Brazil Mexico Index (Q1 '01 = 100)

Jan-08

Jan-10

Jan-12

Source: BIS, Nomura

Source: Add Source Here

While the appreciating exchange rate has made Brazil much richer in general, and Brazilian consumers in particular, the country is quickly getting expensive, at a faster rate than Mexico, in both local currency and US dollar terms. Fig 7 indicates quite clearly the strong increase in Brazilian unit labor cost, versus a very slow change in Mexico. Exchange rate divergences made matters even worse in USD terms, with BRL appreciating almost 50% since end-2002, while MXN depreciation more than 25% over the same period.
Fig. 9: Contribution by industrial sector to GDP growth
4 3 2 1
Brazil Mexico

Fig. 8: Labor productivity: Brazil vs Mexico

25 20 15 10 5 0 -5 -10 % y-o-y

percentage points

Mexico - industry Brazil - industry

0 -1

-15 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

1Q 2010

3Q 2010

1Q 2011

3Q 2011

Note: Data for Brazil is industrial sector productivity and for Mexico is manufacturing sector productivity. Source: Nomura, IBGE, Banxico

Source: Nomura, Haver

Although Brazil has become more expensive, it fails to become more productive at the same time, especially for its industries. After a strong recovery from the financial crisis, while Mexico is still

Nomura | Region Views maintaining productivity growth of around 2-3% y-o-y in the manufacturing sector, growth in Brazilian industrial productivity has stalled or even fallen in negative territory (Fig 8). We believe this is largely due to falling levels of investment in Brazils industrial sectors, which in turn is the result of rising labor cost and increasing foreign imports squeezing Brazilian businesses.

3 May 2012

Consequently, contribution of the industrial sector to GDP growth collapsed in Brazil, from around 3.5 percentage points (pp) in Q12010 toward negative in Q4 2011, while Mexican industry has steadily contributed around 1pp to GDP growth (Fig 9). As Mexico managed to fend off Chinese competition over the past 10 years and gradually developing itself into a manufacturing powerhouse, signs of deindustrialization are becoming increasingly clear in Brazil.

Domestic demand and credit growth: Mexicos turn?

As the industrial sector is suffering in Brazil, economic growth has mainly been driven by robust domestic demand. While Brazils momentum in domestic demand does not significantly surpass Mexico before 2005, as shown by retail sales, Brazilian growth has consistently outpaced that of Mexico after 2005 (Fig 10). More recent data, however, indicate that the growth in retail sales could be converging towards the 5-7% region for both countries.
Fig. 11: Credit as percentage of GDP: Brazil vs Mexico

Fig. 10: Retail sales (3m moving avg): Brazil vs Mexico

15 10 5 0 -5 -10 Mar-01
Brazil Mexico

% y-o-y

48 44 40 36 32 28
Mar-09 Mar-11

% GDP
Brazil Mexico

Mar-03

Mar-05

Mar-07

24 1Q 2005

1Q 2007

1Q 2009

1Q 2011

Source: Nomura, Haver

Source: Nomura, Haver, BCB

While the commodity boom and the subsequent wealth effect in Brazil explains part of the story, we believe credit deepening also made significant contributions to domestic demand in Brazil. Credit-to-GDP ratio in Brazil almost doubled over the past seven years, now standing at close to 49%. While in Mexico, credit deepening proceeded slowly before the crisis, while the credit-toGDP ratio never exceeded its pre-crisis level (Fig 11). Recent developments, however, have been particularly encouraging for Mexico. For instance, the legal framework for creditors has been strengthened. Consumer credit growth has rebounded strongly after hitting a bottom in Q2 2009, and the data shows 18% y-o-y in Mexico as of Q4. In Brazil, on the other hand, consumer credit growth has slowed down significantly to around 20% (Fig 12). Brazils sky high lending rates is acting as a constraint to further credit deepening, as we argued in More evidence of credit growth hitting the wall. Default rates have already been on the rise, and Brazilian consumers are using over 22% of their disposable income

Nomura | Region Views for debt service. In contrast to the tapped out Brazilian consumers, Mexicans seem to be in a much better shape, which should provide another boon for Mexican domestic demand.
Fig. 12: Consumer credit: Brazil vs Mexico
50 40 30 20 10 0 -10 -20 1Q 2002 % y-o-y
Mexico Brazil

3 May 2012

1Q 2003

1Q 2004

1Q 2005

1Q 2006

1Q 2007

1Q 2008

1Q 2009

1Q 2010

1Q 2011

Source: Nomura, Haver

Fiscal and debt dynamics: Sound fundamentals

Beginning with the floating of BRL in 1999, Brazil has been pursuing a primary fiscal surplus target. Although the constraint of primary fiscal surplus target has been loosened in the past, especially during the second term of President Lula, when the full target became hard to meet (2010) or by changing the target itself (2009), overall fiscal discipline has largely been preserved in Brazil. Since President Dilma Rousseff took office in January 2011, fiscal policy has been relatively tight, distinguishing Brazil from more developed countries with higher debt-to-GDP ratio and larger fiscal deficits (Fig 13).
Fig. 14: Budget balance: Brazil & Mexico vs US & France
3.0 0.0 -3.0 -6.0 -9.0 Brazil 2000 2002 2004 Mexico 2006 2008 2010 -12.0 2000 2002 2004 2006 2008 2010 % of GDP

Fig. 13: Primary budget balance: Brazil vs Mexico

3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 % of GDP

Brazil France

Mexico US

Note: Primary budget balance is budget balance excluding interest rate payments Source: Nomura, Haver

Source: Nomura, Haver

Mexico, on the other hand, had a primary fiscal surplus until 2008, which turned into a small deficit the following year. By law, the fiscal balance of the central government has to be zero, which means that overall public sector deficit (including state-owned companies) usually does not exceed 2.5% of GDP. For the past three years, Mexico recorded both a primary deficit and a fiscal deficit, though both amounts are small relative to GDP (below 3%) and both have improved last year (primary deficit: 0.54%; fiscal deficit: 2.51%). Comparing with the deficit situation in major developed economies, both countries are in very healthy positions fiscally (Fig 14).

Nomura | Region Views

3 May 2012

On the debt front, net debt-to-GDP ratio has also evolved positively in Brazil, from as high as 64% in 2002 to below 40% as of 2011. The reduction is due to the fall in gross debt-to-GDP ratio, buying back of FX-denominated debt, and accumulation of international reserves. In fact, Brazils net external debt is now negative, meaning the government has more FX reserves than FX-denominated debt.
Fig. 16: Gross debt-to-GDP ratio
Mexico Brazil

Fig. 15: Net debt-to-GDP ratio

70 60 50 40 30 20 10 1Q 2001 1Q 2003 1Q 2005 1Q 2007 1Q 2009 1Q 2011 % GDP

70 60 50 40 30 20

% GDP

Mexico Brazil

10 1Q 2006 1Q 2007 1Q 2008 1Q 2009 1Q 2010 1Q 2011

Source: Nomura, Haver

Source: Nomura, Haver, Banxico

Mexico, on the other hand, has had fairly low ratios of net-debt-toGDP until the financial crisis, when the ratio jumped from around 13% in Q3 2008 to over 28% in Q1 2009. A number of factors contributed to this sudden change: 1) increases in borrowing, especially around end-2008 and early-2009; 2) over 50% depreciation of MXN during the same period, thus pushing up the local currency value of FX-denominated debt; 3) contraction in nominal GDP, as the economy shrank sharply; 4) fast falling international reserves, which led to a rapid increase the net external debt. As the Mexican peso stabilized around mid-09 and the central bank of Mexico started to accumulate international reserves, the netdebt-to-GDP ratio stabilized and is now around 30%, a still low level versus major developed countries.

External Accounts: Strong inflows, for different purposes

Fig. 17: Current account dynamics (Brazil)
25 20 15 10 5 0 -5 -10 -15 -20 -25 1Q '09 3Q '09 1Q '10 3Q '10 1Q '11 3Q '11 bn USD Others Workers' remittances Factor income balance Services trade balance Goods trade balance Total

Fig. 18: Current account dynamics (Mexico)

12 8 4 0 -4 -8 -12 bn USD Others Workers' remittances Factor income balance Services trade balance Goods trade balance

1Q '09

3Q '09

1Q '10

3Q '10

1Q '11

3Q '11

Source: Nomura, Haver

Source: Nomura, Haver

Nomura | Region Views

3 May 2012

Both Brazil and Mexico have small and manageable current account deficits. Latest figures put Brazils deficit at $52.4bn (12m sum, as of Feb 2012), or 2.1% of GDP; for Mexico, the deficit was $8.8bn (for 2011), or 0.8% of GDP. The negative income balance has become an increasingly big drag on Brazils current account dynamics, while large and stable workers remittances provided a cushion for Mexicos current account (Fig 17 and 18). Brazils large income deficit reflects that payments on foreign-held Brazilian assets far exceed Brazilian-held foreign assets, because 1) foreigners hold far more assets in Brazil than Brazilians abroad, therefore Brazil has a negative net foreign asset position; 2) Brazilian assets tend to offer higher rates of return For Mexico, workers remittances in 2011 were 2% of GDP, and have remained very stable over the past three years despite ups and downs in the US economy. If the US housing recovery stabilizes and the construction sector picks up, then we could see an upside potential for remittances.
Fig. 20: Financial account dynamics (Mexico)
USD bn 60 45 30 15 0 -15 Jan-09 Jan-10 Jan-11 Jan-12 Other investment Portfolio investment Net direct investment

Fig. 19: Financial account dynamics (Brazil, 12m sum)

175 150 125 100 75 50 25 0 -25 Jan-08 bn USD

Loans & trade credit Portfolio FDI

4Q 2Q 4Q 2Q 4Q 2Q 4Q 2Q 4Q 2007 2008 2008 2009 2009 2010 2010 2011 2011

Source: Nomura, Haver

Source: Nomura, Haver

Both Brazil and Mexico receive sizeable foreign financial inflows to help offset current account deficits. Brazils financial account has a surplus of $94.2bn (12m sum) as of February 2012, or 3.8% of GDP, far above the $52.4bn (12m sum) current account deficit. Mexicos financial account had a surplus of $52.4bn (4.5% of GDP) in 2011, also way more than the $8.8bn current account deficit. There has been a marked shift in the composition of financial inflows over the past two years. For Brazil, while FDI continues to rise, portfolio inflows fell rapidly (Fig 20). Loans and trade credit has been stable recently. We believe the IOF tax on both equity and bond inflows have played a major role in reducing portfolio inflows (more discussions below). The story of Mexico is precisely the opposite of Brazil. Before 2010, the bulk of the financial inflows were FDIs, averaging more than 95% from 2007 to 09. Since 2010, portfolio flows have constituted the majority of financial inflows, averaging more than 75% (Fig 22). Although current data do not show any upward trend in FDI yet, we believe there is still room for further FDI growth, which could be a big upside. There have been recent announcements of new FDI in the

Nomura | Region Views auto and aerospace sectors.

Fig. 21: Brazil: Timeline of IOF tax announcements

3 May 2012

Fig. 22: Mexico: Foreign ownership of local-currency government bonds (20d moving average)
50 % 45 Cetes Bonos Total Bonds

Date Oct 19 2009 Oct 04 2010 Oct 18 2010 Apr 06 2011 Jul 27 2011 Dec 01 2011 March 10 2012

Action 2% IOF on equities & fixed income 4% IOF on equities & fixed income 6% IOF on fixed income 6% IOF on foreign loans up to 2 yrs 1% tax on ANY onshore derivative transactions IOF tax on equities scrapped 6% IOF on foreign loans for up to 5 yrs

40 35 30 25 20 15 10 5 0 Jan-08 Jan-09

Jan-10

Jan-11

Jan-12

Source: Nomura

Source: Nomura, Hacienda of Mexico

In our view, foreign financial inflows are crucial to the Brazilian economy, which is savings constrained and in need of investments in the commodities and infrastructure sectors. The government is fully aware of this, but attempts to pick and choose real-economy oriented, longer-term flows over yield-seeking, shorter-term ones. The series of tax measures aimed at controlling inflows fully reflect this (Fig 21). We think as long as the doors are open to the some types of flows, others will find their ways into Brazil through one means or another, eventually frustrating the government efforts at capital controls and FX intervention. Though the process could be fairly drawn-out. We expect portfolio inflows into Mexico to remain strong in 2012, given better prospects of growth in Mexico (January 2012 GDP is 4.4% y-o-y) as long as the US avoids a double dip and the relatively higher yields in Mexico (10-year government bond yield is 6.07%). Also Mexicos less regulated and easily accessible securities market compared with other LatAm countries should attract more foreign investment into Mexico (Fig 22). But this also exposes Mexico to risk of capital flight should the external environment deteriorate.

Conclusions: A changing of the guard?

We believe that the era of relative outperformance by Brazil in Latin America is over. Fundamental to our conclusion is our view that the changes brought about by the decade-long commodity boom have led more to a one-time change in the level of growth and wealth, and not a permanent increase in Brazils growth rate. This is a result of adopting, these last ten years, a growth model based on consumption, to the growing detriment of investments. Thus we see the recent growth slowdown in Brazil as having a structural component, not being solely cyclical in nature. It is true that the government of Dilma Rousseff has taken measures to address these issues, but we believe they are, at best, palliative in nature and only hard to implement structural reforms will lead to higher sustainable growth as seen in these last few years. Equally difficult, there has to occur a change in economic strategy, as the government is still beholden to the view that the solution to what ails Brazil is more demand, more consumption and more credit. The next decade will likely prove to be much more difficult and frustrating than the last one. On the other hand, we see external and internal changes in Mexico that will likely lead to better economic performance. To begin with, the same

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Nomura | Region Views dynamics seen in China that have so far helped Brazil and hurt Mexico these last ten years have decidedly turned, and will likely continue to do so going forward. There is also in this expectation the view that a decade long period of relative decline in the United States economy will, if not revert, at least see slow growth. But the changing of the guard in Latin America, with Mexico taking the lead, is not only due to changing external circumstances. Domestically, two powerful factors are also showing diverging trends. First, the huge difference in competitiveness between Brazil and Mexico will, over time, work in the favor of the latter. Second, after years of inaction, Mexican society seems hungry for change and reform, and we believe that chances are very high of this happening. Unfortunately, the opposite is the case in Brazil, where years of growing wealth have led to a feeling of entitlement in the Brazilian society. After years of being told by the government that Brazil could have everything at the same time, it will be hard to create a new consensus around reforms that will demand sacrifices. We believe divergent political and reform dynamics will be just as important as facts on the ground or divergent external factors, though all three should work in Mexicos favor. What are the broad market implications? If we are right we believe we will not only see a falling difference in growth rates, but also a period of higher growth in Mexico than Brazil. In addition, we will likely see structurally higher foreign exchange rates in Mexico than in Brazil, and a much smaller interest rate spread. While these conclusions are obvious, we should note that differences in the two countries structure will impact how far these changes will go. In the case of exchange rates, it will likely remain the case going forward that Brazil will remain a commodity exporting power house, while Mexico will continue to rely on manufacturing exports. In this case, as seen over the last ten years, BRL will quite likely continue to track commodity prices, and can see periods of relative strength even as growth falters. In effect, we can see in Brazil a scenario where strong commodity prices strengthen the currency even as domestic factors that amplify this wealth effect falter, and so growth underperforms. The case of Mexico is in many ways the reverse, and so more Asian-like: its strong growth will depend on maintaining a relatively competitive exchange rate. These differences mean that while we believe that the relative difference between BRL and MXN should close, although this movement could be gradual. In a benign global environment with relatively healthy performance in both China and the United States, both currencies could do quite well, despite the divergent trends we are expecting. As the effects of the current global deleveraging cycle fade, both countries are poised to do well. Nonetheless, ten years from now, we are confident Mexico will likely be seen as having become the most dynamic economy in the region.

3 May 2012

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Nomura | Region Views

3 May 2012

Disclosure Appendix A-1

ANALYST CERTIFICATIONS
We, Tony Volpon, Benito Berber, George Lei and Tanuja Gupta, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Important Disclosures

Nomura research is available on [Link], Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. Important disclosures may be read at [Link] or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email grpsupporteu@[Link] for help. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. ADDITIONAL DISCLOSURES REQUIRED IN THE U.S. Principal Trading: Nomura Securities International, Inc and its affiliates will usually trade as principal in the fixed income securities (or in related derivatives) that are the subject of this research report. Analyst Interactions with other Nomura Securities International, Inc Personnel: The fixed income research analysts of Nomura Securities International, Inc and its affiliates regularly interact with sales and trading desk personnel in connection with obtaining liquidity and pricing information for their respective coverage universe. Valuation Methodology - Global Strategy A Relative Value based recommendation is the principal approach used by Nomuras Fixed Income Strategists / Analysts when they make Buy (Long) Hold and Sell(Short) recommendations to clients. These recommendations use a valuation methodology that identifies relative value based on: a) Opportunistic spread differences between the appropriate benchmark and the security or the financial instrument, b) Divergence between a countrys underlying macro or micro-economic fundamentals and its currencys value and c) Technical factors such as supply and demand flows in the market that may temporarily distort valuations when compared to an equilibrium priced solely on fundamental factors. In addition, a Buy (Long) or Sell (Short) recommendation on an individual security or financial instrument is intended to convey Nomuras belief that the price/spread on the security in question is expected to outperform (underperform) similarly structured securities over a three to twelvemonth time period. This outperformance (underperformance) can be the result of several factors, including but not limited to: credit fundamentals, macro/micro economic factors, unexpected trading activity or an unexpected upgrade (downgrade) by a major rating agency.

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