Brazil Heads for Investment Grade

After decades of crushing debt and dashed hopes, it may have turned a corner

It's an event that once seemed as likely as a snowstorm in Rio de Janeiro. With a booming economy, Brazil is just one step away from getting an investment-grade rating on its debt, potentially attracting billions from investors.

Despite vast land and natural resources and a young population of 190 million, Brazil has been an economic basket case, suffering from hyperinflation, a huge debt load, and political cronyism. Before President Luiz Inácio Lula da Silva took office in 2003, ratings agencies cut the grade on Brazil's debt, fearing the new government would succumb to spending sprees and put the country on the verge of defaulting once again.

Now Brazil is living up to its potential. Although government spending and taxation remain high, Brazil has paid back its loans to the International Monetary Fund and the goverment's foreign reserves now exceed its foreign debt. It is also the lucky beneficiary of the worldwide commodity boom in goods such as iron ore, sugar, ethanol, and soybeans. With the economy growing at a 5.4% clip in the second quarter, Brazil may be just months from getting a coveted investment grade. It's the last of the "BRIC" countries, a group that also includes Russia, India, and China, still in junk territory. "There's a new Brazil," says Shelly Shetty, a senior director at Fitch Ratings. "It's a combination of good fortune and management."

That rating could open the floodgate for investors, particularly big endowments, pension funds, and insurance companies that are restricted from buying junk debt. After Russia, Mexico, South Africa, and Chile made the grade, money from foreign investors soared by 79% to 354% in the following two years. Sobeet, a Brazilian research firm, estimates the country could get at least an extra $21 billion annually from foreign investors if it gets an investment-grade rating, boosting the stock market and the currency even further. "The big pension funds and endowments have all been sniffing around," says Ken Wainer, co-founder of Vision Brazil Investments. "It's best to get in early."

Perhaps more important, the higher debt rating would lower the country's borrowing costs, which would likely spark the economy even more. It is also critical for dealing with pothole-riddled highways, strained electric grids, and crowded ports. The government wants to raise $280 billion from public and private sources by 2010 to improve infrastructure. If it doesn't get enough interest, Brazil's growth could be crimped. "We need to make sure we have the conditions for a period of sustained growth," says Armínio Fraga, Brazil's former central banker and founder of management firm Gávea Investimentos. "The clock is ticking on reforms that are badly needed."

Wall Street, though, certainly seems committed. Goldman Sachs (GS ) opened new offices in São Paulo in March, a move that, along with the dozen or so other U.S. firms expanding their operations, has contributed to a hiring boom in Brazil's financial-services industry. "Some people said Brazil shouldn't have been included [with other BRIC countries]," says Goldman's chief global economist Jim O'Neill, who coined the term BRICs in 2003 and predicted they would be the world's largest economies by 2050. "I'd say it's now looking like the most interesting of the four."

By Joshua Schneyer

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