Brazil: Inspecting the Couplings

Coupled, decoupled or recoupled are the buzzwords bantered about Sao Paulo. Investors, economists and bankers are trying to gauge what are Brazil’s vulnerabilities to the ongoing situation in the U.S. Optimists argue that the immense windfall produced by the commodity boom and capital inflows eliminated Brazil’s vulnerability to external shocks. Pessimists argue the opposite. They believe that Brazil never capitalized off the commodity boom, leaving many reforms on the shelf and failing to modernize its infrastructure. Moreover, they argue that much of the capital inflows were short term, and they can soon move in the opposite direction. Our view is on the pessimistic side, but we agree that Brazil has a hefty cushion of reserves that will mitigate the effects of the external downturn for a while.

Brazil’s GDP grew more than 5% y/y in 2007. This may have been a moderate expansion by BRIC standards, but it was a solid pace of growth for Brazil. Inflation was under control in 2007, registering an increase of 4.3%. Interestingly, the social situation saw a significant improvement last year. Brazil’s unemployment rate dropped to 8.4% at the end of last year. This was an 80 bps decline in one month’s time. There were many signs that the benefits were trickling down to the lower income strata. The level of homicides fell 10%, from the highs in 2003. Interest rates for consumer loans retreated by almost a third over the last two years—thus, improving the access to credit. The improvement in social conditions had a positive effect on Lula’s political support. His approval rating remained high, despite endless scandals and investigations. Most Brazilian businessmen were just glad that Lula did not do anything to spoil the economic expansion, but the president also failed to capitalize the windfall. There was little (to no) investment in infrastructure. Brazil’s roads, ports, railroads and rivers are a mess. There was a reversal in fiscal performance, when the congress refused to renew the CPMF extension—implying a $22.7 billion decline in government revenues. Brazil’s inability to take advantage of the external situation means that it will remain coupled and vulnerable to external events. However, the financial cushion created over the course of last 5 years should help soften the blow—at least for a while.

Brazil’s situation is comfortable. Although a 32% y/y increase in imports eroded the trade and current account surpluses during 2007, strong capital inflows pushed the country’s balance of payments higher—with international reserves ending the year at $185 billion. Foreign direct investment (FDI) doubled in 2007—reaching $37.7 billion. Brazil was the eighth largest recipient of FDI, outstripping Singapore and Mexico. It was ranked last among the BRICs, but Brazil saw the largest percentage increase—with massive FDI in mining, steel manufacturing and ethanol production. However, on a net basis, Brazil’s FDI balance was only $15 billion. Brazilian companies continued to invest heavily abroad, taking advantage of the strong Real (BRL) to accumulate strategic foreign assets. Portfolio capital inflows were also strong in 2007, with more than 50 local IPOs. This netted $9 billion for the country’s balance of payments. Capital inflows boosted growth and helped improve Brazil’s socio-economic indicators.

2 Responses to "Brazil: Inspecting the Couplings"

  1. Tom Trebat   February 7, 2008 at 8:51 am

    Walter, thanks for this. Regarding Brazil’s own multinationals, should we start paying more attention to their strong growth? In addition to an accumulation of foreign assets, these companies could be seen as the front edge of Brazil’s next major export push. The foreign subs of Brazil companies open up conduits to innovation, technology, management, and market connections that Brazil has never had. That makes it easier for all sorts of Brazilian companies to follow their lead. Or is that too far-fetched?

  2. Cleber   February 7, 2008 at 9:43 am

    It is very hard to believe that Brazil will be decoupled of the rest of the world.When we go to any shop in Brazil we can notice that there is no hi tech product made in Brazil. If we look to a cell phone, to a camera, to a computer, to an mp3 player or any other hi tech product we need to import it.Brazil doesn’t have any self branded car. When we need sophisticated machines we need to bring then from abroad. All that we know how to do is to assemble products projected outside the country.Otherwise we know very well how to make simple products as clothes, shoes and basic products like mining and grow agricultural products.The possibilities to Brazil to grow with the rest of the world going into recession are to avert our commercial surplus. In that case our imports will grow up, maybe with higher Dollar and our exported items like iron and agricultural stuffs going down in price and volume.But Brazil knows this track very well. It knows the consequences of doing that. And I think it will be avoided.First because there will be a lot of short investment going away, second that the Brazilian citizens that lives abroad and use to send about US$ 10 billions a year to the country is already stopping doing it, and third there is a lot of people hired to work in those exporters companies, and there are a lot of these people that will be fired.Due to that and a lot of other small things that drive us to conclude that decouple is not programmed to occur this moment.