Brazil is one of the Latin American countries that most benefited from the realignment of the global economy. One of the first Latin American countries to embrace China and the commodity boom, Brazil witnessed a dramatic improvement in its balance of payments. Brazil’s exports surged, producing trade surpluses in excess of $40 billion and international reserves north of $130 billion. Brazil became the undisputed leader in Latin America. At the vanguard of trade and regional policy, it imbued the Lula Administration with the vitality to withstand a barrage of scandals and corruption allegations. Now, the Brazilian economy is poised to break through the 5% y/y GDP growth mark—an impenetrable barrier that vexed Brasilia for more than a dozen years. However, there are some worrisome signs that Brazil could be in for a sudden slow down if there is a reversal in the external environment.
A close look at Brazil’s balance of payments shows a worrisome picture. At first glance, there is nothing to worry about. Exports are soaring, thanks to the boom in grain and other soft commodity prices. Brazil’s trade surplus in 2006 was $46 billion, and it should be north of $43 billion in 2007–despite a 15% increase in imports. However, that is where the good news stops. A look at the rest of the current account does not paint a pretty picture. In 2006, Brazil had a service deficit of $21 billion. Meanwhile, thousands of Brazilians are using the strong currency to visit destinations abroad. Brazil is not doing anything to make itself attractive as a tourist destination. Argentina leaving Brazil far behind as it develops a thriving services sector by focusing on tourism, media services and call centers. At the same time, Brazil lags its regional peers in transfers. As a result, Brazil’s current account surplus in 2006 was $13 billion, or 1.2% of GDP. The current account balance in 2007 is projected at $10.9 billion, or 0.9% of GDP—hardly the robust picture one would expect for one of the world’s commodity exporting powerhouses.
The situation becomes even more worrisome when one looks at the capital account. Although portfolio investment is pouring into the country by the billions, as Brazilian companies launch new IPO’s, net foreign direct investment (FDI) in 2006 was negative! It was true that the 2006 data reflected the aggressive foreign acquisitions made by Brazilian mining and steel companies. Nevertheless, on a net basis, the FDI number affirmed that Brazilian firms saw more prospects abroad rather than within. Couple that with the IPO wave, where corporate were quickly selling stakes in their own companies, it was not exactly a vote of endorsement by the Brazilian business community. The preliminary 2007 numbers suggest a better situation in the capital account, with net FDI inflows of $15 billion. Nevertheless, we need to wait for the year-end numbers before we can draw a final verdict. The appreciation of the Real will not do anything to make Brazilian assets more attractive. Moreover, the Lula Administration did little to nothing to improve the hostile taxation and regulatory environment.
All of this suggests that Brazil is vulnerable to a change in the international environment. Brazilian risk is priced for perfection. However, a sharp decline in commodity prices could leave Brazil in a delicate position. It does not have much margin for error on the current account, and it is not doing anything on the capital account to improve its external competitiveness. At the same time, the Lula Administration is spending all that is receiving. This means that the slightest deterioration in the external environment could leave Brazil in a “full stop” position, or even worse throw the economy into sudden reversal.