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Sunday, 22 October 2017

Life after the party

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Brazil has lost its lustre among global investors as they fret about deteriorating fundamentals and a heavy-handed government. 

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The headline that flashed up on trading screens on February 27: “Brazil – not in technical recession” was a relief both to Latin America-focused investors, and to lawmakers in the capital, Brasilia. But it was hardly a ringing endorsement of the country’s prospects.

Yes, Brazil’s economy grew in the final quarter of 2013, beating expectations to expand by 0.7% year on year. But that mirrored the performance over the same period of the UK, a slightly larger and, per capita, far wealthier economy.

Unless Brazil puts in a remarkable – and unlikely – return to form over the next year, President Dilma Rousseff appears set to oversee the feeblest set of growth figures of any first-term President since Fernando Collor in the early 1990s. You now have to go back to 2010, when GDP expanded by 7.5%, to find a year when Brazil’s growth figures impressed on the upside.

Most tip even the modest expansionary figures from last year’s final quarter to be little more than a dead cat bounce. Analysts fret over the effect that higher interest rates (hiked by the central bank on eight separate occasions since last April, to 10.75% at end-February 2014) will have on a stuttering exports sector and consumer spending.

Gloom…

It’s extraordinary, indeed, how hard it is to find anyone even modestly upbeat about the region’s largest economy.

“I’m highly negative and highly pessimistic about Brazil,” said Sam Aguirre, a senior managing director in Sao Paulo at business advisers FTI Consulting.

”With Brazil it’s more an issue of growth and concerns about long-term currency depreciation”

“You have falling commodity prices, inflation, high interest rates, and a misdirected monetary policy. The slowdown in China will hurt energy and commodities exporters, and from a consumer perspective, rising interest rates will dampen demand for retail goods.”

A sputtering, imbalanced economy also generates some extraordinarily incongruous data. In 2012, for instance, the country boasted virtually full employment, yet only grew by 1%, pointing to very low rates of domestic productivity.

…with flecks of light

The gloom is sprinkled with a few flecks of sunlight. The Real had a poor start to the year, with investors fretting as the US Federal Reserve started unwinding some of its easy-money policies, before regaining lost ground in late February. The economy is not, despite its recent malaise, fundamentally weak, thanks to solid foundations built notably by Rousseff’s predecessor Luiz Inacio Lula da Silva. “Brazil has low external debt, very low short-term external liabilities, and a high stock of [foreign exchange] reserves,” said Goldman Sachs analysts in a February 24 report.

Miguel Kiguel, director of Buenos Aires-based EconViews, a pan-regional economic consultancy, said from the point of view of yield-chasing fixed-income investors, Brazil remained “a good story, a very solvent country. It won’t face problems in terms of debt obligations. With Brazil it’s more an issue of growth and concerns about long-term currency depreciation”.

“I’m sure there will be bumps in the months ahead, and we may see protests during the World Cup, but the angst over Brazil is overblown,” agreed Said Attila Coach, senior country officer, Brazil, at Credit Agricole.

Yet these are glints rather than shafts of sunlight. Weighed down by an absurdly heavy public sector, Brazil’s economy is no longer even the big beast in its own backyard. Those honours now go to Mexico’s economy, which, though smaller and less blessed with natural resources, is enjoying its own hot streak. (See Brazil chapter.)

Slap in the face

Moody’s gave Mexico a slap on the back on February 5, rewarding its aggressive structural reform programme by granting it an A grade rating for the first time in its history. Brazil by contrast faces a slap in the face, as Moody’s warned of a credit rating downgrade in 2015 unless the next government does more to implement much-needed policy changes. The implicit rebuke by the ratings agency – rewarding Mexico for its ambitious plans to liberalise and deregulate key sectors (energy, telecoms), while scolding Brazil for marginalising private-sector players – was clear.

Indeed, the Rousseff regime has, if anything, increased in recent years the public sector’s hold over an economy already in thrall to giant state-run corporates and banks.

Hostility

“President Rousseff has increased the size and reach of the government and created a relatively hostile environment for private investments,” said Jorge Mariscal, chief investment officer, emerging markets, wealth management at UBS. “In the last few years, growth has been achieved via subsidised government lending to corporations and by subsidising consumer credit and housing. This is coming to an end as interest rates rise internally and globally.”

Add to that mix moribund commodity prices, as demand for everything from soybeans to iron ore drags in China, and you have the basis for very low growth.

Brazil’s President, said Mariscal, “is now realising that the current economic model is hampering Brazil’s ability to grow, and we recently saw her taking action to cut spending, and limit the budget deficit, which is a step in the right direction”.

In late February, finance minister Guido Mantega pledged to trim public spending by US$18.5bn and announced a new, more modest primary surplus goal of 1.9% in 2014, down from 2.3% a year ago. Many, however, remain sceptical over Rousseff’s ability to convince Congress to cut discretionary spending in an election year.

And other problems lie ahead. Inflation may have eased in recent months, falling to 5.6% in January 2014, but, as is the case in Argentina, where inflation is unofficially running at upward of 25%, many doubt the veracity of official data. The government has used “all manner of mechanisms … most notably strategic tax cuts and price controls – artificially to bring down inflation without tackling the underlying problem”, said Eamon Aghdasi, an emerging markets strategist in New York at Societe Generale.

Markets have come to realise that even though the official rate of inflation is now below 6%, the so-called real rate of inflation is probably far higher”.

There are also increased concerns that the government is turning to quick and unusual fixes to patch up holes in its balance sheet. Brazil missed its fiscal targets last year, as state spending continued to outpace tax revenues. The budget deficit hit a record high of US$65bn in 2013, the largest in 11 years. A rattled government appeared to turn to dubious methods to boost revenues towards the end of 2013, pressuring authorities to cut last-gasp deals with leading corporates over long-standing tax disputes.

“These unorthodox measures have raised eyebrows among investors and somewhat dampened sentiment,” said Aghdasi.

It’s a party…

Looking ahead, the country at least has the chance to wow the world at one of its favourite pastimes: throwing a big party. Yet even the World Cup this summer and the Olympic Games, hosted by Rio de Janeiro in 2016, could prove a double-edged sword. Both events place the nation firmly under the magnifying glass.

“People will see the amazing side of Brazil, but they’ll also see the creaking infrastructure,” said UBS’ Mariscal. From tourists to corporate chiefs and fund managers, anyone attending either of the great sporting galas will witness both Brazils: the prosperous one with a sizeable middle-class, and the one that lacks the sort of quality infrastructure every country needs to be truly competitive.

The best outcome, some believe, would be a government, embarrassed by creaky infrastructure, forced to push through the sort of reforms – deregulation and liberalisation, opening key sectors to private firms and foreign investors – so seemingly successful in the likes of Mexico, Peru, and Colombia. Evidence of a change at the heart of an innately protectionist government with a natural aversion to the private sector could be enough to get Brazil moving again.

The economy, as well as its increasingly moribund capital markets need the help. The number of mergers and acquisitions deals slumped in 2013, to 611, from 823 the previous year. Thomson Reuters data show total inbound M&A volumes nearly halving in just two years, falling to US$21.9bn in 2013 from US$39bn in 2011. The number of equity capital market sales also tumbled by more than 50% over the same period, to just 49 in 2013, with total debt issuance volumes declining 13% year on year in 2013 to US$35bn.

…but I’ll cry if I want to

Nor has 2014 begun any better. No IPOs were filed with securities regulator CVM in the first two months of the year, but plenty were postponed. Autos fleet outsourcer Ouro Verde shelved a planned US$400m IPO in February, as did transport and infrastructure specialist Invepar, which is seeking to raise up to US$833m. Both said publicly they were waiting for the turmoil affecting many leading emerging markets to subside. 

Yet who knows when this will happen. Brazil is losing its lustre among global investors, just as developed world economies make a timely return to form. For the region’s largest economy, already suffering from a slowdown in distant China, the timing could hardly be worse.

“It could be five years before we see growth properly on the rise again,” said FTI Consulting’s Aguirre. “The party is over in Brazil, and frankly it’s been over for quite a while now.

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