Brazil is no stranger to economic and financial crises: over the years, South America’s largest economy has fallen victim to its share of blow-ups and chaos – home-grown and imported. But in recent years, the country has become an apparent beacon of stability, having staged a staggering economic recovery under the administration of left-wing president Luiz Inacio Lula da Silva.
“It is true that some financial investors did not believe it and adopted a defensive posture during the [political] transition,” Lula told Emerging Markets during an interview last October. “We kept our commitments [to the international community]; we strengthened stability and laid out conditions for sustainable growth.”
The rebound, Lula explained, was largely the result of a blend of sound fiscal and monetary policies, a flexible currency regime and an unprecedented run of global growth. Strong Chinese demand, the rise in commodity prices and abundant global liquidity in international capital markets have all played in favour of the president’s policies in recent years.
An upside-down world
The big question has always been how Lula and his team would fare in the face of a full-blown crisis of international finance. But Brazil’s policy-makers insist that the national economy is now better placed than ever to deal with the headwinds of a global economic downturn, in the wake of a US recession and financial market meltdown.
“It’s like the world has been turned upside down,” finance minister Guido Mantega tells Emerging Markets. “Emerging markets used to be considered the ugly duckling. Now we are responsible for the dynamism of the international economy and for the accumulation of reserves.”
Mantega – once widely perceived by the market as a heterodox economist capable of derailing the government’s economic reform process – can barely contain his jubilation as he runs through the lengthy list of positive macroeconomic indicators: from an average annual GDP growth of 4.5%, up from near stagnant levels earlier this decade, to a dramatic surge in foreign reserves, up to $200 billion from $60 billion two years ago. “Today, Brazil represents a field of opportunities for those who do not have opportunities in the most industrialized countries where there is slow growth,” he says.
Take care
But not all analysts share Mantega’s optimism. Marcelo Carvalho, chief economist at Morgan Stanley in Sao Paulo, forecasts that the trade surplus will be halved to $20 billion this year. He warns against complacency in today’s environment: “People got spoilt with the abundance we’ve seen in recent years. There has been a change in the environment. The capital account will take a hit, and this will have implications for the currency.”
He adds: “There will be a weakening of commodity prices as global demand is clearly slowing down.”
Other statistics are already causing concern at home and abroad. Brazil’s current account – the sum of imports, exports, services, interest on foreign debt and other transfers – has slipped into deficit this year as imports have risen more quickly than exports. The central bank has revised down its deficit forecast to 0.9% of GDP in 2008 – the first time in five years that there will be a gap in Brazil’s current account.
“The main concern is the speed of the deterioration. There will be implications for investor perception,” says Carvalho. “Maybe those who got too excited will now have to revise their views.”
Foreign portfolio investment is also expected to fall sharply from $26 billion to $12 billion due to financial markets volatility, according to the central bank.
Permanent position
Yet Mantega argues that unlike in previous global crises, capital is here to stay. “Capital flows are sustainable because we are not talking about risk investment anymore. In the past, Brazil experienced growth jointly with an increase in the public deficit and inflation. People were investing but were ready to exit as soon as the going was getting tough,” he says. “Now, we have stability and one of the lowest inflation rates among emerging countries.”
Despite a drop in portfolio flows, foreign direct investment is expected to remain strong at $32 billion. While Brazil’s current account has deteriorated, its capital account has gone strongly into the black. It showed a surplus of $7.5 billion in January, including $4.8 billion in foreign direct investment.
In order to stem the appreciation of the Brazilian currency, a tax on foreign investment in fixed income securities was reintroduced in mid-March.
Mantega also points to the health of the domestic financial sector. “Brazilian banks are much more profitable than in other countries. The car industry enjoys return rates that also help to cover losses of certain companies in their domestic markets. Why would capital flows be volatile if we have solid conditions that may extend such growth during several years?” he asks.
Local support
Bankers are by and large full of praise for Lula’s economic performance. “In spite of the international crisis, Brazil is doing extremely well, which is the important thing as far as the ability to attract investment is concerned,” says Jose Olympio Pereira, managing director of Credit Suisse investment banking in Sao Paulo. “It’s a new world, a world that we are not accustomed to... we live at a time when the decline of the US is not impacting global growth as it did before because of the dynamics of China and India – and even Brazil.”
Adds Olympio: “There is no indication that China, India or the emerging world will slow down to the point that it will have a significant [negative] impact on commodity prices. Iron ore price negotiations this year are a very good indicator of that.” Still, the indirect impact of the US crisis on other metals and grain prices is potentially damaging.
Brazil’s GDP growth, which expanded by 5.4% last year, is also driven by a large domestic demand and growing credit activity. “Brazil has become the darling of the financial market,” says former central bank governor Arminio Fraga.
Roberto Setubal, president of Itau, one of Brazil’s largest banks, adds that Brazil’s current position bodes well in this period of heightened global anxiety. “Every crisis initially creates some mistrust, but Brazil is going through an extraordinary moment and should go through this period very well. This will be positive for the growth outlook in Brazil.
“The greatest concern regarding the real economy has to do with domestic issues (rather than the international context) as the level of economic activity is so high that it may lead to an increase in interest rates,” he adds.
A watchful eye
Yet, ever mindful of the deteriorating global climate, the central bank, run by veteran banker Henrique Meirelles, remains vigilant. “The situation in the US is bad, but we can handle this with serenity,” says Meirelles, who predicts that financial turmoil may shave some 70 basis points off the GDP annual growth (the central bank forecast 4.5% economic growth in 2008). “The initial impact on emerging markets has been smaller than expected, but it is too early to say that we are out of the woods,” he adds cautiously.
It is exactly this kind of watchful stance that has worked to Brazil’s advantage in recent years.
“The current crisis clearly shows the great benefits of piling up foreign reserves. Sure there is a cost for this, but it has been much inferior to the benefits. Figures are here to prove it; the country is more resistant and can avoid volatility,” says Meirelles.
Now it’s time to put that theory to the test.