These last few months have been of strong euphoria in the Brazilian economy as well as in our financial markets caused by a set of good news: basically a revised methodology for measuring our output, which pushed it up and generated important implications in our creditworthiness key indicators, both in the internal as well as in the external front. These changes also induced to revisions by the credit risk agencies, which lead to a strong decrease in our sovereign risk spread. This euphoria also caused the innumerous records in the stock exchange and also the strong appreciation of the BRL. Most of these improvements in our economic fundamentals have come from the external sector, mainly from the boost in our trade balance, which also generated current account surpluses.
But as I mentioned in my previous article, such improvement came in a context of unbalanced global economy with unprecedented United States external indebtedness. Calvo and Telvi (Current Account Surplus in Latin America: Recipe Against Capital Market Crises?) help us to focus a little more on the medium and long-run, forcing us to start thinking and producing scenarios and simulations for the Latin America countries in case of a stronger adjustment in the global economy. Based on this, I will mention rapidly three of them focusing specifically on Brazil. An important warning mentioned by them is that although the Latin America region has been producing current account surpluses, its net international investment position (NIIP) is still very negative. In the Brazilian case, even with the latest current account surpluses, our NIIP recent statistics show that we passed from a negative position of US$ 272 billion in 2003 to US$ 357 billion in September 2006, thanks probably to asset and liabilities revaluations and exchange rate swings. However, measured as proportion of the GDP the Brazilian NIIP had an improvement in the last three years: from 49.2% in 2003 to 35.2% in September of last year (*). Thanks to the current account surpluses and using the classical debt cycle terminology, we have seen Brazil passing momentarily from the condition of young debtor to mature debtor. However, the perspectives are that due to the appreciation of our real exchange rate, there could be a regression to current account deficits in the next years, which means we would go back to the young debtor condition (see chart).
There is no doubt that we have reasons to commemorate the recent indicators of the Brazilian external solvability. However, many of them were conquered within this unprecedented boom context, which in great part was not under Brazilian economic agents’ control. Moreover, there is a consensus that for most of the countries, their external situation in the years to come is strongly linked to the evolution of the fiscal and external imbalances of the American economy.
In a soft landing scenario, presently in course, the dollar continues to depreciate against most of the currencies. Besides a direct impact on the American trade balance, there would be also a positive effect on its NIIP, which tends to improve as the dollar depreciates. The value of the U.S. external assets will increase with the dollar depreciation and at the same time the value of its external debt will remain constant. Within this scenario, the Brazilian trade balance would slowdown from the current level of US$ 46 billion, but not much since there still is a robust growth in East Asia as well as some structural changes in our own trade balance. Although with fear of a possible energy shortage in the next years, the Brazilian economy is less dependent on oil and gas imports than it was in the past, which gives us a hedge against increases in future, oil and gas prices. There is still the new bio-fuel global market, which gives an important comparative advantage for the Brazilian economy and which will follow its path independently of global imbalances corrections. Still on the optimist side of the American imbalances, there is also Hausmann & Sturzenegger (2006) thesis regarding the existence of a possible dark matter, the difference between the measure of the net international investment position (NIIP) calculated by official statistics and their methodology based on the capitalized value of the net investment income (NII). According to this methodology the global imbalances would be substantially smaller than the one expressed by the official statistics, which would reduce enormously the need for correction. Based on this hypothesis, the soft landing scenario would be even more feasible. But there are less optimistic opinions regarding the size and speed of the necessary adjustments in the fiscal and external American imbalances. Roubini & Setser (2004) and Cline (2005) have two important works discussing this subject. According to them, the slowly realignment of the dollar will not be sufficient to correct the current account deficits and the increasing liabilities of its net investment position.
A less dramatic measure taken by the American economy would be a tight fiscal policy, which would be capable of reducing the fiscal imbalances and consequently the external one. On this scenario our external balance would deteriorate a little regarding the soft landing scenario but still with moderate impact on the Brazilian external solvency.
The worst scenario, however, would be investors leaving the dollar as the “flight to quality”, forcing a strong increase in the U.S. interest rates. This, on one side, would revert in part the dollar depreciation, aborting the expenditure switching channel; on the other side, it would cause a possible recession in the American economy, as well as in the rest of the world. This last deteriorated scenario would have strong impact both in our trade balance as well as in the income one. Differently from countries considered safe from the financial point of view, Brazil has probably no dark matter or even a ‘negative’ one. Doing a very simple calculation and taking the ratio of the sum of the income balance and the current unilateral transfers with the net investment position of previous year, we will get a yield cost of 6.3%, 7.5% and 7.0% for the years 2004, 2005, 2006, respectively. These values are much higher than the same ratios for US, UK and some other developed country. With a strong increase in the U.S. interest rate this yield cost could grow, affecting both the private sector, which is currently the main external debtor in Brazil, but also the public sector, which would have no other option than increasing its interest rate, aborting once more a stronger growth path. It is still very difficult to predict the size and speed of the corrections that will happen in the near future. We all hope that of the soft landing, being able to cope with the current imbalances of the global economy. In any case, it is urgent to start building more detailed scenarios for each of these possible outcomes. A good task for the next months…
(*) Data based on the Brazilian Central Bank, Press Releases, Foreign Sector, April 24, 2007. Cline, W. (2005), “The United States as a Debtor Nation”, Institute for International Economics, Washington DC. Hausmann, R. and Sturzenegger, F. (2006), “Global Imbalances or Bad Accounting? The Missing Dark Matter in the Wealth of Nations”, Center for International Development, Harvard University, Working Paper no. 124, January. Roubini, N. and Setser, B. (2004), “The US as a Net Debtor: the Sustainability of the US External Imbalances”, working paper, November.