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Brazil Bulls Capitulate as State Intervention Spurs Outflows

Brazil's President Dilma Rousseff. Photographer: Jonathan Ernst/Bloomberg
Brazil's President Dilma Rousseff. Photographer: Jonathan Ernst/Bloomberg

May 9 (Bloomberg) -- Brazil’s efforts to boost economic growth with the most aggressive interest rate cuts are driving away investors, reducing equity valuations to five-year lows and fueling the world’s biggest currency tumble.

MSCI Inc.’s Brazil Index has dropped to the cheapest level since 2006 versus global shares as investors pulled $869 million from the nation’s mutual funds this year, the only country among the four largest emerging markets to post outflows, according to data compiled by Bloomberg and EPFR Global. Brazil’s debt handed foreign investors the worst losses since September last month.

Three months after saying Brazil was in a “sweet spot,” JPMorgan Chase & Co. is advising clients to reduce stock holdings as President Dilma Rousseff, 64, orders state banks to slash lending rates, threatening profits. The real is the world’s most overvalued major currency even after posting the worst slump in the past month, Morgan Stanley says. Stone Harbor Investment Partners began buying debt tied to consumer prices as six interest-rate cuts since August spur economists to predict inflation will top the central bank’s target for a third year.

“We would share market concerns that the central bank may move too far and cause an inflation problem down the line,” said Phillipe Langham, who helps oversee about $40 billion as a London-based senior emerging-market fund manager at RBC Global Asset Management and holds fewer Brazilian shares than are represented in benchmark indexes. Government interference in the economy may be “accelerating with pressure on bank margins,” he said.

Following Lula

The MSCI Brazil index sank 1.7 percent today to the lowest closing level since Dec. 19 while the Bovespa Index, the local-currency benchmark gauge for stocks, dropped 1 percent. The real touched 1.9717 against the dollar, the weakest level since July 2009, according to data compiled by Bloomberg.

The central bank has cut the Selic target 3.5 percentage points in the past nine months, the biggest drop in the benchmark rates of the world’s 25 largest economies, according to data compiled by Bloomberg. Policy makers may reduce the Selic to as low as 8 percent from 9 percent today, trading in rate futures contracts shows.

Savings Accounts

Rousseff, a former Marxist guerrilla, became Brazil’s first female president in January 2011 by vowing to maintain the market-friendly policies of Luiz Inacio Lula da Silva that helped gross domestic product expand 37 percent during his eight years in office. Rousseff has instead increased the government’s role to shore up Latin America’s largest economy, according to UBS AG’s Bhanu Baweja.

To weaken the real and protect exporters, Rousseff’s administration intervened in currency markets and raised taxes on foreign borrowing. She stepped up pressure on companies such as Vale SA to hire more workers. Last week, the government modified savings account rules to pave the way for record-low benchmark interest rates.

While the jobless rate in March was down from the year before and Rousseff’s approval rating among voters climbed to a record, investors are growing concerned that the policies will lead to faster inflation and lower corporate profits, Baweja, the head of emerging-market fixed-income and currency strategy at UBS in London, wrote in an April 26 report.

Lula Rally

The dollar-denominated MSCI Brazil gauge has dropped 26 percent since Rousseff and central bank President Alexandre Tombini, 48, took office while the Bovespa slumped 14 percent. That compares with the 4.5 percent drop in the dollar-based MSCI All-Country World index through today.

Brazilian government bonds returned 2.1 percent in dollar terms during the past year through yesterday, trailing a 4 percent advance for Latin American debt, according to JPMorgan indexes. Brazilian debt fell 3.9 percent in April, the second month of losses.

Rousseff’s struggle to win over investors contrasts with the success her predecessor had when taking office a decade ago.

Lula, tapping into a three-fold surge in the country’s commodity exports, cut the budget deficit, paid back $15.5 billion of loans to the International Monetary Fund ahead of schedule and accumulated a record $287 billion in international reserves. The MSCI Brazil index jumped 69 percent during his first 16 months as president, reversing a 37 percent plunge in the 10 months before he took office that was sparked by concern the former union leader would default on the country’s debt.

‘Inadmissible’ Rates

Rousseff, who said during a May 2010 speech to investors in New York that policy makers could “gradually” reduce the country’s 4.5 percent inflation target, has since shifted her focus to cutting interest rates. Economists forecast inflation will remain above 5 percent this year and next, according to a central bank survey released May 7. Consumer prices rose 5.1 percent in the 12 months through April.

The interest rates charged by Brazilian banks are “inadmissible,” Rousseff said in a televised address on April 30. She said in her weekly radio address on May 7 that Brazil’s banking system is so profitable “it can perfectly do its part” by reducing loan rates. State-owned lenders Banco do Brasil SA and Caixa Economica Federal said last month they will cut rates.

Itau Unibanco Holding SA and Banco Bradesco SA, Brazil’s biggest non-government government banks, are preparing cuts in interest rate on loans to companies and individuals, O Estado de S. Paulo reported today, citing the lenders’ chief executive officers.

Banks Retreat

Brazil’s 44 percent average interest rate for consumer loans in March compares with the 9.5 percent average U.S. personal loan rates on May 4, according to data compiled by Brazil’s central bank and Bankrate Inc.

Last week the government adjusted a 150-year-old rule setting minimum returns on savings accounts to make further reductions in the benchmark rate possible.

“As the easing gets extended, inflation concerns are being reignited,” Emy Shayo Cherman, an equity strategist at JPMorgan in Sao Paulo, wrote in an April 27 research report. “Regulatory risk will continue and will continue to have impact on equities.”

Cherman said investors should cut their Brazilian stock holdings to below their weighting in benchmark indexes, from a previous overweight position, and recommended lowering bank holdings. She said she likes CCR SA, a Sao Paulo-based toll road operator whose revenue is tied to inflation.

An MSCI gauge of Brazilian financial stocks has tumbled 26 percent during the past two months, the most among 10 industry groups. CCR jumped 7.4 percent during the same period.

Vale Ouster

Vale, the world’s largest iron-ore producer, whose shareholders include state-run pension funds and a unit of the government’s development bank, retreated 12 percent in Sao Paulo trading during the past three months and state-controlled Petroleo Brasileiro SA declined 21 percent.

Rousseff, who served as Lula’s energy minister and chief of staff, has called for higher taxes on mining companies and her administration prompted the ouster of Vale Chief Executive Officer Roger Agnelli last year after criticizing the company for not generating jobs. Government-imposed caps on Petrobras’s domestic fuel prices, designed to curb inflation, have led to losses in the refinery unit of Brazil’s biggest company by market value.

‘Giant ATM’

Petrobras is a “giant ATM machine” for the Brazilian government and its profits are being used to support local employment and investment rather than shareholder returns, Jim Chanos, the founder of New York-based hedge fund Kynikos Associates Ltd., said in a May 1 interview on Bloomberg Television. Chanos, the short seller who predicted Enron Corp.’s collapse in 2001, said he’s betting Petrobras shares will drop.

Vale and Petrobras, the Rio de Janeiro-based companies that comprise about 30 percent of the MSCI Brazil index, have also been weighed down by slowing economic growth in China, the country’s biggest trading partner. The S&P GSCI Spot Index of 24 commodities, which surged 84 percent during Lula’s first term, has climbed 2.6 percent since Rousseff took office.

The press office of the Presidency, the Finance Ministry, the central bank and Petrobras declined to comment in e-mailed statements.

The real has depreciated 22 percent from a 12-year high in July and was down 7 percent in the past month through yesterday, the worst performer among the 16 major and 25 developing currencies tracked by Bloomberg.

Real’s Slump

Higher costs for goods and services in Brazil relative to other nations signal the real’s decline isn’t over, Ruchir Sharma, who helps oversee about $287 billion as the head of emerging markets at Morgan Stanley’s investment management unit, said in a May 1 interview in London.

The Economist’s Big Mac index, which measures the local cost of McDonald’s Corp.’s burgers around the world, shows that the sandwich cost $6.16 last year in Brazil, a record 51 percent more than in the U.S. A Russian Big Mac was 34 percent cheaper than in the U.S. while China’s sold for 44 percent less.

Investors shouldn’t be surprised that Rousseff is stepping up government intervention, Alexandre Schwartsman, a Brazil central bank director from 2003 to 2006 who now works as a consultant in Sao Paulo, said in a phone interview.

Rousseff said in a February 2010 speech in Brasilia that her government would resume the state’s role of managing the nation’s development. Her approval rating rose to a record 77 percent in March from 72 percent in December, according to Ibope, which surveyed 2,002 people from March 16-19 for a poll that has a margin of error of plus or minus two percentage points.

Jobless Rate

Brazil’s jobless rate declined to 6.2 percent in March from 6.5 percent a year earlier, according to government data. The budget gap narrowed to the equivalent of 2.4 percent of gross domestic product from 2.5 percent when she took office.

After the economy grew 1.4 percent in the fourth quarter from a year before, the weakest pace since 2009, Rousseff’s policies are justified, said Ronaldo Patah, who manages 120 billion reais ($63 billion) as the head of fixed income at Itau Asset Management.

“They are doing the right job, protecting growth and employment,” Patah said in a phone interview from Sao Paulo.

The MSCI Brazil index trades for 1.5 times net assets, down from 1.9 times when Rousseff took office and 28 percent lower than the average level during Lula’s administration, according to data compiled by Bloomberg. The $886 billion gauge of Brazilian shares is valued at a 14 percent discount to the MSCI All-Country World index, the widest gap since September 2006, data compiled by MSCI and Bloomberg show.

Falling Valuations

The MSCI Brazil index has declined 13 percent since the central bank began cutting interest rates from a 2 1/2-year high in August, compared with an average rally of 68 percent in the first eight months of the three monetary easing cycles during the past decade, according to data compiled by Bloomberg.

The difference between yields on two-year and five-year debt increased to a record 143 basis points, or 1.43 percentage points, on March 14, a sign that traders are betting the central bank will be forced to reverse course and raise interest rates, according to data compiled by Bloomberg. The gap was 123 basis points yesterday.

The yield gap between inflation-linked bonds due in 2015 and similar-maturity fixed-rate securities, a gauge of investor expectations for annual consumer price increases, rose to 5.57 percent yesterday from a record low of 5.27 percent on Nov. 28.

Steffen Reichold, an emerging-market economist at Stone Harbor, said the firm, with $47 billion in assets, is buying inflation-linked bonds for the first time in “a while.”

“There’s a risk that the central bank pushes it a little bit too much,” Reichold said at the Bloomberg Link Latin America Investing Conference in New York on April 26.

To contact the reporters on this story: Michael Patterson in London at; Ye Xie in New York at

To contact the editor responsible for this story: David Papadopoulos at

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