In the past decade, Brazil has been often thought as the B of the Bric countries –Brazil, Russia, India and China – since the acronym was created by Goldman Sachs in 2001. Yet, the largest Latin American country represents a powerful long-term investment story on a stand alone basis too.
“It’s an overplayed joke but the whole joke about Brazil in the past was that it is the country of the future and always will be,” says Phil Guarco, chief investment strategist for Latin America at JP Morgan Private Bank in New York. The joke was perhaps true until President Luiz Inácio Lula da Silva was elected in 2003, as the country was facing a major financial crisis. The local currency, the real, was weakening terribly and the Brazilian sovereign debt had just been downgraded to B2 level by Moody’s and single B+ by Standard & Poor’s.
In less than eight years, the situation has changed dramatically. Brazil is perceived as a stable democracy, fiscal management has improved remarkably since 2003 and this year under President Dilma Rousseff, who took over from Mr Lula, the primary fiscal surplus is expected to be above target. Brazil government debt is just 40 per cent of GDP, which is roughly half of that of the US or France, which still have Aaa ratings from at least two ratings agencies (in the case of France from all three major agencies). The capital market has proved to be well regulated during the financial crisis. The economy is growing at steady pace and the middle class is rapidly expanding.
The question is whether this is just one of the many cyclical changes Brazil has been subject to in its history, because of its strong dependence on the price of commodities, which it exports, or, rather that the country is now where it should be, argues Mr Guarco.
Brazil is still a relatively closed economy. Total exports in Brazil represent only 24 per cent of the total GDP, the remaining 76 per cent is dependent on the internal economy. Yet, the recent super-cycle in commodities has really served as a jump start for the local economy, observes Mr Guarco.
Like many developing countries, Brazil’s story is the story of the emerging middle class. Around 47m people will have enlarged the middle class ranks between 2003 and 2012, fuelling the domestic economy’s growth. “The real Brazil play over the medium to long-term is the consumption story driven by a transition from being an emerging market economy to a middle class economy,” says Mr Guarco.
But a number of short-term challenges are present. High inflation negatively affects the outlook for growth – GDP growth is expected to be just below 4 per cent this year – and is having a negative impact on the stock market. Hyper inflation has been one of the long-term problems for Brazil, which over the past 25 years was forced to take 6 zeros off their currency. While inflation reached an annualised rate 6.6 per cent in July, higher than its target of 4.5 per cent, it is still only a tiny fraction of the kind of hyper inflation Brazil has had in the past.
The Brazilian Central Bank has been tightening monetary policy and has also increased banks’ reserve requirements to try and reduce credit growth. “There is this sort of rhetorical battle between the Brazilian Central Bank and the market, and the credibility of the Central Bank continues to be questioned,” says Gustavo Rangel, chief economist, Brazil ING Financial Markets in New York.
The Central Bank favoured this new route over hiking interest rates, which would drive the currency to appreciate. And a strong currency, which is the other major problem, is hurting the manufacturing exports industry.
Equity markets in Brazil have been greatly hit by the uncertainty in the financial markets and the sovereign debt crisis, as well as investors’ worries on inflation. Foreign investors have been withdrawing money from the equity market since 2009, even though the prices are attractive and country macro-economic indicators are very positive, says Otávio Vieira, CIO at Sao Paulo’s Safdié Gestão de Patrimônio.
“We are suffering shock-waves from Europe mainly,” he says. “Risk aversion in the world is very high and investors are profit taking, because Brazil has offered good returns since 2002, the currency has been appreciating and the stock market was skyrocketing. We see a lot of opportunities in the Brazilian equity market, but the volatility will probably continue, because it is linked to the sovereign debt crisis in Europe and, to an extent, in the US. But it is a very good moment for long-term investors to build their equity portfolios.”
