BRAZIL: The downside of up

With a presidential election due this year, growing economic strength does not necessarily guarantee a trouble-free future

  • By Thierry Ogier
  • 23 Mar 2010
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There’s a word for it: ufanismo – a unique blend of euphoria and nationalism that has long characterized a key part of the Brazilian psyche.

These days, gatherings of Brazil’s business and government leaders is as good an opportunity as any to witness ufanismo alive and well – less than a generation after the “Brazilian miracle” of the 1970s ended in hyperinflation and tears a decade later.

The locals have plenty of reasons to celebrate: Brazil’s economy defied the worst expectations on the way into the global crisis, swiftly bottoming out of a short-lived recession, and is now poised for solid expansion; the longer-term picture is made brighter still by vast new oil reserves set to be pumped from ultra-deep waters in the Atlantic.

Meanwhile Brazil is positioning itself as a superpower in the making, spending billions of dollars on fighter planes, helicopters and a nuclear submarine to step up its defence arsenal. The 2014 football World Cup and the 2016 Olympics, which Brazil will host, seem like the icing on the cake. Why should they resist a sense of triumphalism?

The president of the central bank, Henrique Meirelles – a key player in calming anxious foreign investors during past crises – reflects on the mood: “Brazil is no longer the country of frustrated desires; we have become a country that delivers the goods,” he said recently.

The country has come a long way: after a series of recurrent crises over the past 20 years, the Latin American giant is now widely praised for its macroeconomic performance and management in the midst of the global storm. Following GDP growth of 0.2% in 2009 and a 2% rebound in the last quarter of that year (in annual terms), it has emerged as a strong and stable force in the region with good economic growth prospects in 2010.

“We will be able to sustain annual GDP growth of more than 5% for the years to come because our macroeconomic fundamentals are balanced,” Guido Mantega, finance minister, tells Emerging Markets in an interview. Mantega has forecast a 5.2% expansion this year, while the central bank has a 5.8% estimate.

Others go even further: Goldman Sachs’ Jim O’Neill, the father of the term Brics (Brazil, Russia, India and China) and a perennial emerging markets bull, and former economy minister Antonio Delfim Netto both forecast 6% GDP growth in 2010.

Yet not everyone is convinced. Fears are rising over the still fragile global economy, where a double dip recession would leave few unscathed. Equally, sovereign risk in the eurozone could spill over into global markets, with severe knock-on effects for even the better-placed credits.

“There is no reason for euphoria,” says William Eid, a finance expert at the Getulio Vargas Foundation (FGV), a research institute in São Paulo. “If it gets worse, we are going down together as well. No one wants to acknowledge these risks; nobody wants to scare anybody,” he says.


Domestically, there are also pressure points. Twin deficits have resurfaced, and the gaps are larger than expected. The foreign trade surplus is narrowing while the current account deficit is widening.

On the fiscal front, the government has shown little intention of changing its expansionary fiscal policy apart from phasing out a series of tax breaks that fuelled the consumer market in times of crisis.

The markets turned a blind eye when the government decided to lower its primary budget surplus target of 3.3% of GDP to 2.5% of GDP in the middle of the crisis and eventually ended 2009 with a surplus – before debt interest payment – of 2.1%. The government also used some creative accounting to reach the headline figure of 2.5%.

Yet finance minister Mantega is adamant that the government remains committed to return to a surplus of 3.3% of GDP in 2010. “We are going to be on target, because the country is fiscally responsible and has little external vulnerability,” he says. “If needed, we will have to put a lid on expenditures, spending and consumption to achieve this fiscal outcome.”

Ilan Goldfajn, chief economist at Itau Unibanco in São Paulo, gives the government’s fiscal policy some credit. “There is no need to alter the target: it’s feasible,” he says.

Some analysts, including at the IMF, are sceptical. But Mantega says he has proved his critics wrong in the past and maintains the government will stick to fiscal discipline before and after the October elections. “Our nominal budget deficit will be one of the lowest among the G-20 in 2010 [2% of GDP], and our target is to zero it by 2012,” he says.

But Brazil ended 2009 with a relatively high budget deficit of 3.3% of GDP. The net debt to GDP ratio stood at 43%, up more than five percentage points on 2008 (37.8%), although it was down to 41% this January.

Moreover, the level of gross public debt is much higher. This includes Treasury loans to the Brazilian development bank (BNDES), which are not included in the net debt calculation. In 2009, the BNDES received 100 billion reais ($44 billion) and is due to receive an extra 80 billion reais this year. As there is a difference between the Treasury’s funding rate (the benchmark Selic rate – 8.75% per year) and the BNDES’ long-term rate (the so-called TJLP stands at 6% per year), this is likely to hit the primary budget performance.

The government’s exit strategy does not address this concern and reiterates the strategic importance of boosting the BNDES’ lending capacity to encourage investment, especially in infrastructure. “The BNDES has been our main anti-crisis weapon,” says Mantega. “What matters is the net debt, which is well below the standards of other countries. But the gross debt will fall too.”

Credit rating agency Fitch is among those that have identified a weakness here. “Brazil’s gross general government debt burden of over 70% of GDP will remain approximately 30 percentage points above Mexico’s, underscoring the need for Brazil to embark on fiscal consolidation as the economic recovery takes hold,” says Shelly Shetty, director at Fitch Ratings sovereigns group.

So far, Brazilian policy-makers have brushed off such concerns. Even the market friendly Meirelles has gone a long way to acknowledge that the BNDES “is part of Brazil’s strategy to boost investment”.

Meanwhile, domestic demand has remained strong. State controlled banks, such as Banco do Brasil, have sustained credit activity, which is now equivalent to 45% of GDP – a record high in Brazil. Other financial institutions have followed suit, and most have registered healthy profits. In 2010, credit activity is expected to expand by a further 21% according to Febraban, the Brazilian banking association.

The IMF view, however, in the words of one official, is: “There will be a need to cool things down a bit.” Indeed, some feel that the consumer boom, which has already led Brazil to become the world’s third largest market for computers and fifth largest for cars, may not last forever.

“Credit, retail and wages are growing faster than the long-term growth trend,” says Meirelles. The central bank has already restored most of the bank’s reserve requirements that it had lifted to restore liquidity during the crisis (71 billion reais out of around 100 billion reais).

But its exit strategy certainly includes a new round of monetary tightening, as market expectations have already put the 2010 annual inflation rate above the official target of 4.5%. Itau Unibanco says the consumer price index for the first quarter may reach 2%. “The central bank is going to increase base rates; there is no doubt about it,” says former finance minister Mailson da Nóbrega.


The level of public spending has remained an issue which is at the heart of the current electoral campaign. Former central bank president Arminio Fraga has long argued that a more balanced fiscal policy would alleviate the pressure on monetary policy. “My recommendation is not to step on the brake, but rather to take the foot off the gas pedal a little,” said Fraga, chairman of the BM&FBovespa exchange, late last year. “Don’t put so much pressure on monetary policy and interest rates and as a result on the exchange rate.”

The external accounts are expected to deteriorate – a thorny issue given the uncertainty surrounding the global economy. Last year, the situation improved, but Brazil registered a gap of $24.3 billion or the equivalent of 1.5% of GDP, down from 1.7% of GDP in 2008. Such modest deficit levels would be covered without difficulty by strong inflows of foreign investment.

Nevertheless, the strong economic recovery underway in Brazil points to a sharp deterioration in the current account this year (in excess of 3% of GDP), due to a strong rise in imports as well as profit and remittances, in line with an expected rebound in foreign direct investment.

The government expects FDI flows to reach $45 billion this year, but this may not be enough to finance the current account gap, and Brazil would again become dependent on short-term capital flows. “The current account deficit would be a problem if we did not have the foreign currency reserves,” says Mantega. “We knew that there was going to be an increase in the deficit because the Brazilian economy keeps on growing and importing, while the international economy is contracting. This leads to a discrepancy. Our trade balance got worse.

“Now, as the international economy recovers and with changes in exchange rates, our exports are going to grow again, and this deficit is going to be reversed in the next two years,” he says.

Nevertheless, in spite of strong foreign currency reserves – around $240 billion – a new bout of volatility in the international capital markets may expose Brazil’s vulnerability once more.

Paulo Nogueira Batista, an IMF executive director for Brazil and other Latin American countries who is close to Mantega, thinks increased dependency on the market’s moods is undesirable. True, the recent depreciation of the real in the foreign exchange market since the beginning of the year may point to a more benign scenario. But despite this, Nogueira advocates more restraint on the fiscal and the credit fronts, as well as stronger capital controls.

Mantega, who introduced a 2% tax on foreign fixed income and portfolio investments last October, says there is no need for additional measures. He called the IOF (financial transactions tax) “a moderate move that changed the somewhat irrational course of the market” and said the real is now “floating with less volatility”.

“We never changed the rules on capital exit,” says Aloizio Mercandante, a senator from the presidential PT party and one of Lula’s financial advisers. “Capital controls are not part of our agenda.”

  • By Thierry Ogier
  • 23 Mar 2010

All International Bonds

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1 Citi 315,565.94 1183 8.89%
2 JPMorgan 288,650.70 1316 8.13%
3 Bank of America Merrill Lynch 284,218.69 988 8.01%
4 Goldman Sachs 215,758.12 710 6.08%
5 Barclays 207,555.74 805 5.85%

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5 Credit Agricole CIB 22,617.86 130 4.72%

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