Brazil is being held back by a strengthening currency, the fastest inflation in six years and an increase in government spending, damping growth prospects in the world’s second-largest developing economy.
The country risks becoming a “prisoner of its own hype” as it faces the twin dilemmas of a currency that’s strengthened 47 percent versus the dollar since the end of 2008 and consumer price increases above the central bank’s target, Christopher Sabatini, senior policy director for the Council of the Americas, said today at the Bloomberg Brazil Conference. Brazil has “hit the limit” of sustainable growth, said Augusto de la Torre, chief economist for Latin America at the World Bank.
“We have a very bright prospect, creating a euphoria,” de la Torre said at the conference in New York. “The expectations have exceeded the capacity. In Brazil, you’ve hit the limit.”
The benchmark Bovespa stock index fell 12.5 percent this year through yesterday on concern quickening inflation may damp domestic demand while a slowdown in global economic growth could cut prices for commodity exports. Foreign investors pulled 866.1 million reais ($549 million) from Latin America’s biggest equity market this year through July 5, according to the exchange.
The Bovespa’s decline shows the “true story” of Brazil as the country heads for a cycle of boom and bust amid an unsustainable surge in corporate borrowing, said Simon Nocera, co-founder of San Francisco-based hedge fund Lumen Advisors LLC.
Brazilian stocks are unjustifiably pricing in “outrageous” growth while the country is hobbled by a shortage in skilled labor, among other problems, Nocera, a former economist at the International Monetary Fund, said today.
“In this environment, the Bovespa is the only indicator that is telling you the true story about Brazil,” Nocera said. “You still have some sectors of the Brazilian stock market pricing in growth of 20 percent,” which is “simply outrageous.”
Brazil’s economy is about to have “a modern democratic recession” as the central bank raises interest rates too fast, said Michael Shaoul, chairman of Marketfield Asset Management.
“We are in a situation where the central bank will do too much for too long,” Shaoul said at the Brazil conference. Marketfield sees risks over the next nine to 18 months and is short-selling fast-growing banks and consumer stocks, he said.
Amid the pessimism, BlackRock Inc. and Pacific Investment Management Co. see attractive investment opportunities because of economic growth and high relative interest rates. The Bovespa’s valuation dropped to 9.9 times analysts’ earnings estimates last week, according to data compiled by Bloomberg. MSCI Inc.’s gauge of 21 developing nations’ equities traded at a ratio of 11 times earnings.
Will Landers, manager of the $1 billion Latin America Fund at BlackRock, and Curtis Mewbourne, head of portfolio management at Pimco, say the government will be successful in taming inflation, removing an obstacle to gains in asset prices.
“Brazil is slowly moving in the right direction,” Landers said at the New York conference today. “Inflation has been the main issue for the stock market underperforming.”
Alan Gandelman, chief executive officer of ICAP Brazil, said the recent decline in the Bovespa has provided a great opportunity to buy Brazilian stocks based on valuations.
The Bovespa fell for the seventh day in eight today, dropping 1.6 percent to 59,679.35 at 4:20 p.m. New York time and reaching the lowest closing price since May 25. The real weakened 0.1 percent to 1.5774 per U.S. dollar.
Economic growth, which reached 7.5 percent last year, will slow to about 4 percent this year, according to central bank estimates, after President Alexandre Tombini raised the benchmark Selic rate at all four policy meetings this year, to 12.25 percent, as part of efforts to tame inflation.
Art Steinmetz, chief investment officer in New York at OppenheimerFunds Inc., said that Brazil will eventually be able to bring down real interest rates, which measure the cost of borrowing relative to inflation, bolstering the economy.
“We expect over the coming years a secular decline of real rates,” he said at today’s conference. “It’s entirely possible for us to be long-term investors.”
Consumer prices rose 6.71 percent in June from a year earlier, the fastest pace since 2005.
Brazil offers attractive returns even as capital controls meant to curb gains in the currency limit access to some investments, said Pimco’s Mewbourne.
“We continue to see very good opportunities,” Mewbourne said at the conference, highlighting companies such as Vale SA, Petroleo Brasileiro SA and Embraer SA. “We see high growth rates. We are witnessing a transition of a low-wage country to middle class.”
Brazil’s job market is growing, supporting the consumer market, Zeina Latif, a senior economist for Latin America at RBS Securities Inc. said at the conference.
Still, jobs could be imperiled if Brazil’s strong currency reduces employment by making exports more expensive in dollar terms, hurting manufacturers.
The central bank last week changed currency rules to reduce banks’ exposure to currency risk and combat the real’s rally. Brazil will require that banks make non-interest bearing deposits with the central bank equivalent to 60 percent of short dollar positions that exceed $1 billion dollars or their capital base, whichever is smaller. In March, President Dilma Rousseff’s administration increased to 6 percent a tax on new corporate loans and debt sales abroad by banks.
Brazil is boosting spending on infrastructure as it develops the biggest oil fields in the Americas since 1976 and prepares to host the 2014 soccer World Cup and 2016 Olympic Games. Expenditures to improve airports, ports, highways and the power grid are set to rise to 160 billion reais by 2012 from 121 billion reais in 2009, according to the Sao Paulo-based Association of Infrastructure and Industries.
The country’s efforts to contain inflation are at odds with a surge in lending by state development bank BNDES, said Mauro Leos-Lopez, an analyst at Moody’s Investors Service. Brazil’s credit rating is unlikely to be upgraded again this year without fundamental changes to its macroeconomic structures, and major reforms probably won’t go through “any time soon,” he said.
Moody’s rates Brazil Baa2, the second-lowest investment grade, one step up from Panama, Peru and Colombia.
“For them to move to the A category, something has to change fundamentally,” he said. “We are not too optimistic about reforms in Brazil. It’s hard to see major fundamental changes in Brazil any time soon.”
Brazil’s economy may still run into credit problems even though the nation’s debt levels are low compared with other Latin American economies, said Lisa Schineller, a sovereign analyst at Standard & Poor’s.
A rapidly growing debt burden, weak lending practices and high interest rates all pose risks to consumer borrowers that need to be monitored, Schineller said at the Bloomberg Brazil Conference in New York today.