Brazil Rising
Emerging markets are often touted for their potential but often fail to deliver. Brazil is showing and delivering its potential now. As emerging markets go, Brazil has a compelling story for the rest of the global economy. Blessed with natural resources in agriculture and energy products, Brazil has emerged as a commodities powerhouse in everything from soybeans to ethanol to oil. Its financial sector has steadily improved, attracting international investment, with more coming.
Yet behind the current commodities and economic boom is a steady hand from the Central Bank of Brazil, which has conquered the days of hyperinflation and steered the country to solid and consistent growth.
"The country is now enjoying what we call the dividends of stability," says Henrique Meirelles, president of the Central Bank.
"The economic policy is geared toward building an efficient and productive market-based economy, coupled with successful social programs," Meirelles adds. "Our policy framework of inflation targeting, floating exchange rate and primary fiscal surpluses has enhanced economic performance and increased resilience against shocks."
In short, Brazil certainly deserves a leading position in the BRIC countries of Brazil, Russia, India and China.
"Brazil has three things- water, food and energy," says Terry McCoy, director of the University of Florida's Latin American Business Environment Program. "None of the other BRIC countries has those in such abundance. So the long-term outlook given those criteria, is very good."
With gross domestic product hitting $1.65 trillion this year and growth in the 4 percent to 4.5 percent range, Brazil does not post China's eye-popping double-digit growth. But that's part of Brazil's allure: an economy that is chugging along but unlikely to overheat or bottom out. Inflation estimated at 6 percent this year is expecting to cool to 4.6 percent next year, according to the Economist Intelligence Unit. Growth also is expected to slow a bit to 3.6 percent in 2009. Partly due to that moderate economic growth outlook, foreign direct investment over the first four months of 2008 was $12.4 billion, well on its way to surpass 2007's record $34.6 billion. With a new "investment grade" rating from Fitch and Standard & Poor's in April (see sidebar), Brazil may see even more foreign money pour into the economy.
Brazil also has focused on lowering its debt as well, even after the left-leaning Worker's Party- Partido dos Trabahadores or PT- candidate Luz Inacio Lula da Silva was elected president and took office in 2003. Brazil's external debt has plunged from more than 100 percent of current-account receipts in 2003 to an estimated 3 percent this year.
This is the recipe for a country that is now the world's 10th largest economy- the ability to balance economic consistency over many years with enormous growth potential still ahead.
"It's been a huge turnaround led by careful policies," McCoy says.
HOW DID WE GET HERE?
While da Silva enjoys much of the credit for today's economic success, it is helpful to look back to see how the turnaround began. In 1993, Brazil was caught in a vicious round of hyperinflation of 30 percent per month, and its foreign debt was enormous. This predicament spurred a 1993 economic plan by Fernando Henrique Cardoso, then minister of finance. Cardoso is credited with introducing the Plano Real (Real Plan) to halt hyperinflation, which ultimately spawned the creation of Brazil's current currency- the real.
Gustavo Franco, a memeber of the team which created the Plano Real, marks that period as the start of Brazil's economic resurgence.
"The turning point was sometime back when we won the war against hyperinflation," says Franco, who also served as president of the Central Bank of Brazil from 1997 to 1999. "The year 1994 was when we finally left hyperinflation behind."
That was also the year Cardoso was elected president. He led two terms of fiscal and monetary discipline and set the stage for further economic growth and improvement. Da Silva kept a prgmatic economic approach when he took office in 2003, despite many investors' fears that his party's principles would unwind years of economic control.
"Many thought Lula would be a setback," Franco says. "People feared that old reforms would be thrown away and inflation would return. It was the biggest test for Brazil and showed that alternating political parties in power would not un-invent things that were so costly to do during the Cardoso years. Great merit goes to President Lula for not undoing anything."
Da Silva's practical approach to capital market principles also enabled the economy to grow programs, such as the very successful "Bolsa Familia" (Family Stipend) program for the poor, which provides financial aid on the condition that recipients' children attend school. "The Bolsa Familia is a big departure from what's been done in the past," says Carol Graham, a senior fellow at the Brookings Institution. "Brazil right now is a good story."
The central bank under the direction of Meirelles has continued to battle inflation, which has kept growth moderate and inflation in check.
"Our monetary policy is geared towards making inflation converge to target within the time horizon set byt he National Monetary Council, which means 4.5 percent in 2009," Meirelles says. "We stand ready to take the necessary measures to ensure convergence to the target."
COMMODITIES BOOM
Much of Brazil's economic power comes from its agricultural sector, where the country is the top producer of soybeans, surpassing the United States in 2005. It is world-renowned for producing sugarcane-based ethanol, a fast-growing commodity due to record high crude oil prices and international efforts to lower carbon dioxide emissions. Brazil also is on the cusp of becoming a major producer and rxperter of curde oil and natural gas, with recent discoveries of major oil reserves off the coast.
Brazil's equity, interest rate and derivatives markets are in a great position to take advantage of such trends. Commodities volumes on the recently merged BM&FBOVESPA represent just 1 percent of the exchange's total volume. CME Group's 5 percent equity stake in BM&FBOVESPA also aims to expand Brazil's exposure to the U.S. market and vice versa.
Through the partnership with BM&FBOVESPA, Brazilian customers will have access to all CME Group electronically traded products, while CME Group customers will have direct access to BM&F products via CME Globex. Both exchanges also will work on new products, which could further expand commodity trading on BM&F and CME Group.
"Brazil is a great example of CME Group's strategy around the globe," says Neal Brady, CME Group managing director, product development."We see Brazil's economy growing, and per capita income levels are rising. We're also seeing trade liberalization and capital flow liberalization, so it's easier to move money in and out of the country. In the case of BM&FBOVESPA, Brazil has a thriving domestic derivatives market with a track record of a decades-long high volume in its interest rate and financial contracts."
BRAZIL MAKING THE GRADE
On April 30, Standard & Poor's Rating Services (S&P) raised its long-term foreign currency sovereign debt credit rating on Brazil to investment grade. That rating boost means a lot for Brazil, a country that battled its way back from hyperinflation and massive debt 15 years ago and is now grabbing the attention of global investors.
The investment grade rating reflects a number of positive macroeconomic factors for Brazil, says Lisa Schineller, the S&P analyst who covers Brazil. First, the country has maintained a strady economic plan under two presidents, Fernando Henrique Cardoso and Luiz Inacio Lula da Silva. That plan incorporates a strong dimension of inflation-fighting economic policy by Brazil's central bank and a floating exchange rate for the currency.
In addition, Brazil's net external debt has shrunk to less than 10 percent of its current account receipts, and its debt profile has fallen in line with similar low investment grade countries (see chart). S&P previously upgraded the Brazilian real to investment grade in May 2007.
"We see a good track record- almost a 10-year track record- of a pragmatic policy commitment by Brazil's government that includes changes in government," Schineller says. "Brazil's macroeconomic framework has withstood political transition and is consistent. These policies have brought macroeconomic stability to the economy in recent years. While the policy mix is not perfect, the picture hangs together."
Schineller adds that Brazil's economic policy has become more predictable, with fairly transparent institutions within the economy. One recent example of central bankin prowess came in April, when Brazil's central bank started raising interest rates given overheated domestic demand even though the global economy began to slow.
"The central bank recognized this sooner than some of its critics and began tightening in April,"Schineller explains. "It was controversial at the time. But clearly, it's been fully confirmed that Brazil needed to start a tightening cycle. To us, that was a reinforcement of this pragmatic policy framework."
Brazil still has room for improvement. The country still has large net government debt and interest burdens, high budget spending and an overly complex tax structure. Brazil's investment climate could be strengthened further by lowering import tariffs and by promoting more labor flexibility and mor eprivate investment in energy and infrastructure.
Still, the country is attracting healthy and growing amounts of foreign direct investment. The investment grade rating may attract even more foreign portfolio invesment from managed funds and pension funds, which tend to have restrictions on lending in non-investment grade countries.
"The investment grade rating opens the doors for a much bigger pool of money to be invested in Brazil," Schineller says. "Over times, that can have a positive impact, namely, by lower borrowing costs for the government and/or companies in Brazil and can trickle down to the consumer as well."
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