Brazil turns the other cheek

14/11/2007 | Thierry Ogier

Brazilian finance minister Guido Mantega tells Emerging Markets he is unswervingly confident about the country's new-found resilience

Investors may be forgiven for thinking that Guido Mantega is an incurable optimist. True, the Brazilian finance minister has been presiding over a period of lasting economic recovery, and the Latin American powerhouse is now in a much better position to weather external shocks than it was a few years ago, even though such threats come from the world’s largest economy.

“In the midst of the turmoil, Moody’s gave us an upgrade,” Mantega tells Emerging Markets. “We are pretty close to investment grade. I believe that we will be able to get it next year.”

On the domestic front, traditional bottlenecks on the supply side will not create inflationary pressures, he says. President Lula’s long-trusted economic aide has also rejected the need to curb public spending, even though some critics (such as the former president of the central bank Arminio Fraga) have argued that Brazil would have to foot the bill sooner or later.

Mantega admits that the magnitude of the current financial crisis has been a cause for concern. “The recent turmoil has already moved more assets than during the 1998 Long-Term Capital Management crisis in the US. It’s a test to check the strength of various countries, and Brazil is coming out really well,” he says. “There is no involvement of Brazilian banks in the sub-prime mortgage market. There is no demand for liquidity, unlike in the US and in the UK. Banks are solid, and there is no capital flight.”

Mantega calls the Fed decision to cut its prime rate by half a percentage point on September 18 a “wise move”, which will soften the impact of the international crisis. Moral hazard is not part of his vocabulary, but he has argued that emerging market countries, such as Brazil, which have been the focus of instability during past crises, may now contribute to a return to some sort of stability.

“Brazil and other countries with current account surpluses can indeed help the most industrialized countries that have deficits. The US is already getting some help from China. It’s a kind of compliment from emerging markets to industrialized economies. Such economies undoubtedly have to adjust more than emerging markets,” he says.

Meanwhile, president Luiz Inacio Lula da Silva hammered a tough message during his European trip last month: “The United States needs to resolve the problem of its own crisis. It is a problem of economic policy in the US, of the greed of a few investment funds that wanted to buy risky assets as if they were in a casino,” he said.

“We will not agree to bear on our back the losses of a game in which we are not playing.” A few days ahead of his meeting with George W Bush in late September, he publicly teased the US president: “Bush, sort this crisis out, because we will not let it cross the Atlantic ... We will not stand as victims anymore.”

Brazilian central bank chief Henrique Meirelles often reminisces that during previous crises, when other countries were catching colds, Brazil was typically on the verge of pneumonia. Not any longer, he says. The greater resilience of the economy has largely been the result of a combination of cautious monetary policy and proactive debt management, while the central bank has been capitalizing on abundant liquidity to boost foreign reserves. Those have shot up from around $15 billion in 2002 to more than $160 billion last September. Such a level of reserves, coupled with a robust annual trade surplus (around $40 billion), has removed any possibility of insolvency on the foreign debt front.

Furthermore, the nominal deficit was down to 2.1% of GDP in July, and the domestic public debt-to-GDP ratio has been reduced to 44%. The debt profile has also continued to improve: dollar indexed securities have been all but removed (they accounted for only 1% last August); the proportion of the benchmark Selic rate-linked debt fell from 52% last year to 35% in August (and may fall to around 20%, according to Bradesco, a large local bank); while the share of pre-fixed securities increased from 28% to 36%.

IMF backing
The IMF too has embraced this somewhat sanguine take on Brazil. “I don’t see Brazil being particularly affected by the crisis,” says Anoop Singh, the Fund’s western hemisphere director. “It’s possibly the only country in Latin America that is revising its growth forecasts upwards.”

Brazil’s GDP grew 4.9% in the first half of the year compared to the same period last year, while the quarter-on-quarter growth reached 5.4% last June. The central bank has forecast a 4.7% GDP growth in 2007, although many market analysts think it may well hit 5%.

Mantega insists that Brazil has enjoyed 22 consecutive quarters of uninterrupted growth. “It is a sustainable cycle; it is not a spasm anymore”, he says. According to his worst scenario, the international turmoil could cost up to 30 basis points from next year’s GDP (the official forecast stands at 5%).

This year the performance has been pushed by consumer credit, which in turn has fuelled industrial activity, and investment, which is the key to boosting productivity and keeping inflation under control. Construction has been booming; the mortgage industry is finally getting off the ground, but, at a net worth of less than 2% of GDP, it can hardly be called a bubble. Annual sales of computers rose from 3 million units a couple of years ago to 10 million PCs and notebooks, which are being sold at much lower prices than before, thanks to the strengthening of the local currency, the real, on the foreign exchange market (imported components are cheaper than in the past). Foreign investor confidence is also strong, and the level of FDI has reached an all-time high of $35 billion in the 12-month period leading to the end of August (even without privatization).

Meanwhile, corporate financing has undergone a quiet revolution thanks to the deepening of the domestic capital markets. Within the past 18 months, private companies have been able to raise more funds from the stock exchange and the bond market than from the national development bank (BNDES), the state-owned institution that used to be the sole domestic source of long-term financing at a decent cost (Brazil’s market rates and spread have usually been much higher than in most other countries). Significantly, Brazil has accounted for 10% of the world’s IPOs during the first eight months of the year, according to Thomson Financial, with 46 transactions. Current market jitters may slow the IPO fever, but merger and acquisition activity are expected to remain brisk for some time.

As some investors were feeling the impact of a credit squeeze, the Brazilian steel-maker Gerdau managed to complete its $4.2 billion acquisition of Chaparral in the US in mid-September via its local subsidiary Gerdau Ameristeel. The deal agreement had been unveiled on July 10, but the sub-prime crisis delayed the final arrangements, as financial institutions demanded greater guarantees. A consortium of international banks (ABN Amro, JP Morgan Chase, and HSBC) finally agreed to finance two loans (a $1.15 billion six-month bridge loan facility and a $2.75 billion five- and six-year term loan facility) on September 12.

Danger zone
Yet, not all is rosy. The credit crunch may still bite, warns Luis Oganes, head of Latin America research at JP Morgan Chase. A fall in global economic activity may eventually take its toll on commodity prices, and reduce Brazilian companies’ creditworthiness.

Furthermore, many investors have remained critical of the lack of appetite of the Brazilian government towards structural reforms. The infrastructure programme, which was unveiled at the beginning of the year, has so far fallen short of expectations, and no federal private-public partnerships have materialized since Lula came to power almost five years ago.

The investment rate has increased to around 18% of GDP, but is still small, says Arminio Fraga, now a private equity investor. Lingering bottlenecks on the supply side may lead to inflationary pressures, while the government has increased public spending by some 10% every year. Many critics consider that such dynamics represent a serious risk.

Yet, Mantega is unrepentant: “A 10% increase in public spending every year is not a big deal, because if you have 4% inflation on the one side and 5% growth on the other, you get 9%. Economic growth also boosts tax collection, as well as initiatives against tax evasion and the increase in the number of formal jobs. As a result, our primary budget surplus has been higher than the target (3.8% of GDP this year).” Public funds, he says, are needed to finance the government social programmes to reduce inequality, and they are not designed to feed a bloated administration (as some critics argue).

Mantega is taking some comfort from the fact that the Brazilian government is able to implement what he called a social-developmentalist model (as opposed to “neoliberal policies”) in the midst of the global uncertainty. “When there was an excess of liquidity in the market, there was no differentiation among countries. Now Brazil is on the side of safer countries. When the crisis ends, we may actually be in a better shape than when it started. We are better positioned, and maybe investment grade will come sooner rather than later,” he says.

For an exclusive interview with Brazilian president Lula da Silva, please see "I did it my way".

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