Will Brazil be an early casualty of new era?

Posted: June 20, 2013 in Brazil, BRICS, Global Economy
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As we slowly move towards a post QE world, or at least post US QE world, things start to look very different. Countries that seemed unstoppable a few years ago look vulnerable. Perhaps the three countries to suffer the biggest knocks in recent days have been Brazil, Turkey and South Africa – all have seen their currencies fall sharply. In two of these countries we have also seen street protests.

Yesterday it was Brazil’s turn to be seen in an unpleasant limelight, as Brazilians took to the street to protest over a multitude of woes – among them the cost of hosting the forthcoming World Cup and the Olympics. Meanwhile credit ratings agency S&P has downgraded Brazil’s sovereign debt outlook – it is still rated as BBB, but now it is under a negative outlook.

Look beneath the surface and the threats to Brazil look worrying indeed.
For one thing, Brazil’s current account has fallen from a small surplus in 2007 to a deficit worth around 2.3 per cent of GDP in 2012. What Brazil needs is more investment, higher domestic savings to partly fund the investment, and a cheaper currency to give exporters an advantage. Alas it also needs much lower inflation. The IMF has forecast Brazilian inflation at 6.1 per cent this year. Interest rates are currently at 8 per cent. To fight off inflation, Brazil needs a strong currency. Do you see the dilemma?

The savings ratio in Brazil is the lowest amongst both the BRICS and in Latin America. Part of the problem is a very generous state pension scheme. This needs to be reduced, but street protestors may not be too happy with that idea.

At face value, government debt in Brazil does not seem so bad. In fact net debt is 35 per cent of GDP. Wouldn’t the US and the UK love it if their equivalent measure was so low? It is just that net debt is made up of gross debt minus assets, and many of the assets that count towards Brazil’s net debt are highly illiquid and risky. Capital Economics reckons a better measure of net debt would be around 50 per cent of GDP.

Brazil is posting a primary budget surplus, meaning government receipts are greater than expenses before interest on debt – but, thank to high interest rates, Brazilian public debt is rising.

And there is a much deeper woe. Commodity prices have been falling of late, and many, including the World Bank for example, are now forecasting a new phase in what’s called the commodity super cycle, as the massive levels of investment into commodities during the up phase of the super cycle leads to greater supply.

The last few years have been characterised by high commodity prices, poor economic performance in the developed world, and cheap money. As we enter a post QE world, it appears we may also enter a phase of lower commodity prices. For Brazil this may be a perfect storm.

This does not mean that the Brazilian growth story is over, but remember markets tend to overreact and Brazil may be one of the big victims of post QE over-reaction.

© Investment & Business News 2013

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