Ripple effect

Brazil has rebounded strongly from the crisis, signalling a clean break from the past. But its aggressive policy response may have set off a fiscal time bomb

  • By Thierry Ogier
  • 06 Oct 2009
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For Brazil’s authorities, discussions on the impact of the global financial crisis on emerging market economies are increasingly irrelevant when applied to Brazil. The country appears to have shrugged off the economic downturn and is now on the verge of a new growth cycle.

Apart from a few corporate disasters due to bad bets in exchange rate derivatives at the end of last year, the Latin American giant has rebounded better, and more quickly, than most could have expected. Moody’s became latest ratings agency to upgrade Brazil to investment grade in September.

“Brazil will show solid growth rates in coming years,” Henrique Meirelles, governor of the Brazilian central bank, tells Emerging Markets in an interview. “The second quarter annualized GDP growth rate was 7.8%. Expectations for the third quarter are also very positive,” he says.

Finance minister Guido Mantega says: “Brazil has completed a negative, recessive cycle in just two quarters – Q4 2008 to Q1 2009 – while other countries have had to cope with negative growth for four or five quarters.”

Brazilian president Luiz Inacio Lula da Silva is triumphant over the way the country has overcome the financial crisis. Lula has repeatedly complained that he used to be ridiculed by critics when he predicted that the global crisis would only cause a ripple when it hit the Brazilian shores.

“The time when Brazil was catching pneumonia when the US was catching a cold is over,” he says. “The time when Brazil was sinking every time Russia was in crisis is over. That’s over too. This country has learnt self-respect. Brazil was the last country to be hit by the crisis and will be the first one to emerge from it.”

And planning and budget minister Paulo Bernardo Silva tells Emerging Markets that although “public debt is going to increase this year following six consecutive years of decline, it has been a relatively small price to pay to rescue our economy and keep it out of the global turmoil.”

Trouble in store

But not everything is rosy. The Brazilian government has made a deliberate policy option to boost public spending to support domestic demand, while a decline in interest rates has alleviated the pressure on debt servicing. The official primary surplus target was slashed to 2.5% of GDP in 2009, from 3.8% last year, and is 3.3% of GDP in 2010.

“The government has used this to increase current public spending. They are setting up a fiscal time bomb here,” says Gustavo Loyola, a former central bank president. Such public spending will weigh permanently on the budget, he argues, and may curtail much-needed investment in infrastructure, especially if the economic recovery is not as strong as the 4.5% GDP growth that is expected by the government in 2010.

Angel Gurria, the OECD’s secretary-general, noted last summer: “Brazil is facing structural challenges to strengthen its long-term growth potential. One issue that has to be addressed without delay is related to the increase in the share of public spending to the GDP. This is a concern that has to be addressed.”

Moreover, fiscal accounts have deteriorated faster than expected due to a sharp 7% decline in tax revenues during the first half of the year, compared to the same period in 2008. The primary surplus target only amounted to 1.8% of GDP in the 12-month period leading to the end of June, while the net debt-to-GDP ratio has been increasing steadily since last December and reached 44% in July 2009.

“The debt dynamics may not get out of hand, but they are wasting a great opportunity to reduce the tax burden and increase public investment,” says Loyola, now a consultant with Tendencias in Sao Paulo.

There will be a price to pay, he warns. “Fiscal exaggerations will probably demand a more conservative attitude from the central bank, which has already had an impact on interest rates and more broadly on the yield curve.”

Indeed, Brazil may not be facing the kind of solvency issues that it used to have to deal with. This, in itself, is a considerable improvement.

Nevertheless, the long-term sustainability of Brazil’s broader current fiscal strategy looks questionable, according to Marcelo Carvalho, Morgan Stanley’s Brazil economist. “Relying on a steadily rising tax burden to compensate for steadily rising fiscal spending does not seem to be a strategy that can be sustained indefinitely without entailing an undesired crowding out of the private sector,” he says.


Government officials dismiss such fears, and Mantega has repeatedly shrugged off concern about fiscal complacency, while the IMF has acknowledged that Brazil still has further leeway to implement counter-cyclical policies – both monetary and fiscal – if circumstances demanded them.

In its latest Article IV consultation review, the IMF highlighted “the importance of instituting a sound medium-term fiscal framework and efforts to reinvigorate the reform process, including with respect to tax and pension reform. A gradual reduction of revenue earmarking and expenditure rigidities would also be desirable.”

A relaxed Mantega would rather sound more upbeat. “If you hear comments about our fiscal problems, don’t believe them. When I was appointed in 2006, people were saying that I was not going to hit the fiscal target, that I was a big spender – but we have had a series of the best fiscal performances on record since,” he says.

“Last year was excellent, and we put an extra 0.5% in the sovereign fund. Without the crisis, we would have a zero budget deficit this year.”

But times have changed. According to the IMF’s forecast, the budget gap should expand to 3.2% of GDP in 2009, before falling to 1.3% of GDP next year.

Taking action

While some economists predicted a long and deep recession due to its new position in the global economy, the Brazilian government acted on the monetary and fiscal fronts, with the support of the international financial community. The strength of the Brazilian banking industry and the size of the domestic market allowed the economy to bottom out.

Central bank chief Meirelles says credit was the key: “We acted directly on the transmission channels of the crisis.” The central bank signalled that it was ready to sell up to $50 billion in derivatives – it was able to do that because it was already $22 billion long in the futures market, he says.

It also lent its reserves to banks, lowered their compulsory reserve requirements in local currency terms to restore liquidity and boosted their export credit lines. “We tackled the roots of the problem,” he says, instead of relaxing monetary and fiscal policies immediately.

The Brazilian central bank’s policy record and its hard-won credibility also helped.

“The central bank acted quickly internally to supply liquidity in the interbank market – especially to smaller banks that were having problems funding their portfolios – and help bigger banks absorb those portfolios if they wanted to buy them,” says John Welch, chief economist of the private banking division of Itau Unibanco in New York.

As panic threatened to spread from the capital and foreign exchange markets to the real economy, the Federal Reserve announced a $30 billion swap agreement with its Brazilian counterpart last October. This helped avert a collapse of the real.

The Brazilian currency has since appreciated strongly. “Brazil used to be fragile from the exchange rate point of view,” says Mantega. “Any crisis would trigger a capital flight and a lack of confidence. Now maybe for the first time in 30 or 40 years, we have not had such a reaction. There was some capital flight as in other emerging markets, but on a small scale.”

Foreign reserves have reached a record $210 billion. This key shock absorber has also confirmed Brazil’s position as a net external creditor.

Brazil was late to loosen monetary policy compared to other countries, but that was part of a cautious strategy. “This would have only created collateral effects,” says Meirelles, as domestic demand was already rising strongly at the time. The central bank eventually slashed its benchmark Selic rate by 500bp between January and July to 8.75% – its lowest level ever.

“They may not have cut interest rates immediately, but what they tried to do is to settle down the foreign sector first,” says Welch. “They were able to show that some normality was underway in the foreign exchange rate market, and this opened the path for the central bank to cut interest rates aggressively.”

The new dynamism

Mantega is adamant that orthodoxy is not enough to explain why Brazil stomached the global recession better than previous crises. “The difference is not only the product of macroeconomic stability – the three pillars of inflation targeting, floating exchange rate and fiscal stability,” he says.

“If it were only for that, Brazil would not have reacted so well to the crisis. Brazil has benefited from a new dynamism thanks to state policies to promote investments.”

Tax breaks boosted domestic car sales as well as those of other durable consumer goods, such as domestic appliances.

Meanwhile, public-sector banks were sent to the front line to address the widespread credit crunch. “They were able to respond more strongly than private banks, which have been more cautious and conservative,” says Mantega. “They increased credit, especially BNDES [the state-owned national development bank]. The result is that we are getting used to the quick action of the state in counter-cyclical policies.”

Along the way, BNDES received a 100 billion real ($55 billion) funding boost from the Treasury, including 25 billion reais to support investment in the oil industry.

Lula sacked the president of Banco do Brasil, the largest state-owned bank, in April because its spreads were still considered too high. In Lula’s view, institutions like Banco do Brasil have to lead the crusade for lower bank spreads. By July, Banco do Brasil had regained its position as Brazil’s largest bank in terms of assets, which it had lost last year to Itau Unibanco.

Still expanding

As a result, the domestic credit market has kept expanding, albeit at a lesser rate than before the crisis. The credit to GDP ratio, which was barely around 20% of GDP five years ago, reached 45% this July. State-owned banks account for nearly 40% of outstanding loans, according to central bank records.

“The very fact that state-owned banks took greater risks just when the financial system needed credit was interesting,” says William Eid, a financial academic from the Getulio Vargas Foundation. “The government gambled on state-owned banks, forced them to supply credit, and it can celebrate a decision that proved correct.”

Nevertheless, some private-sector banks, such as Itau Unibanco, have argued that the trend was not sustainable. Non-performing loans have also been increasing – payment arrears of more than 90 days rose to 5.9% this July, compared to 4% before the crisis impacted Brazil – which has forced banks to raise the level of provisions and curb their earnings.

Meirelles, meanwhile, warns against excess optimism but says that, although confidence is rebounding, euphoria is unlikely to accompany it. “Markets are more cautious and more realistic than in the past. Hedge funds and investors are more cautious on carry trades; they are not betting on movements only in a single direction, and that is positive.

“Investments in the stock market are already back to pre-crisis levels but on a much more sober basis than before. We are calling people’s attention to keep it that way and not to risk too much volatility, as we had in the past.”

  • By Thierry Ogier
  • 06 Oct 2009

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 24 Jul 2017
1 Citi 253,106.92 930 8.89%
2 JPMorgan 230,914.50 1036 8.11%
3 Bank of America Merrill Lynch 221,389.46 762 7.78%
4 Goldman Sachs 171,499.26 554 6.03%
5 Barclays 169,046.60 646 5.94%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 25,935.16 104 7.16%
2 Deutsche Bank 25,125.19 81 6.94%
3 Bank of America Merrill Lynch 22,023.57 59 6.08%
4 BNP Paribas 19,315.94 110 5.34%
5 Credit Agricole CIB 18,706.93 106 5.17%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 JPMorgan 12,578.87 55 8.17%
2 Citi 11,338.07 71 7.36%
3 UBS 10,682.06 44 6.93%
4 Goldman Sachs 10,419.53 53 6.76%
5 Morgan Stanley 10,194.88 57 6.62%