Brazil guide: Growth remains the target

2012 was always going to be a test of Brazil’s new president Dilma Rousseff. Taking power, just a couple of years into the global economic recovery and inheriting a booming domestic economy she faced an unexpected stress-test. In style, Rousseff is in many ways a contrast to her politically charismatic and massively popular predecessor Lula. In substance, the expectation was that Brazil’s first female head of state would continue with the market-friendly economic policies. In the first few months of this year the economy continued to grow strongly and, with the highest real interest rates in the world, money was flowing into the Brazilian economy. The government’s challenge was managing the flood of inward liquidity: it responded with higher IOF taxes designed to cool capital inflows and thereby stem the steady appreciation of the real, which was causing pain for exporters and domestic inflationary pressures (which in turn led to monetary tightening).

In the second half of 2011 the challenges changed, as Brazil faced the headwinds caused by the financial and economic crises in the developed world, increasingly driven by the crisis in the Eurozone. As in the 2008 global crisis – which Brazil’s economy and banking system passed through successfully (Brazil registered just one quarter of negative growth in the last quarter of 2008) – the country is enjoying relative strength. However, while Brazil’s emerging markets-orientated economy and highly regulated and robust financial system are proving resilient to the developed market woes, it is not entirely de-coupled. As 2011 draws to a close the government is easing monetary and so-called ‘macro-prudential’ measures to try to ensure growth of between 3% and 4%.

Economy

In 2010 Brazil’s growth was 7.5%, slowing to 3.5% (estimated) for 2011. In response, the government has recently been cutting the headline Selic interest rate, now at 11.5% from a cyclical peak of 12.5% in July, despite inflation still being well above the 6.5% top of its target range. The explanation for this early monetary easing can be seen in a bill the government sent to congress in October that aimed to include in the central bank’s mandate the goal of "delivering growth" - as well as its traditional sole task of targeting inflation (4.5% plus or minus two percentage points). In Brazil, with its history of hyper-inflation, the bill proved sufficiently controversial to be withdrawn, but the point had been made.

The reasons for the central bank’s relaxation of monetary policy are as unclear as they are proving controversial. One banker who has close knowledge of central bank president Alexandre Tombini tells Euromoney that he knows Tombini has recently spent a lot of time with Ben Bernanke, chairman of the US Federal Reserve. The source says: "I can only assume that Bernanke showed Tombini some truly terrible data that is going to come out about the US economy."

That is, in essence, the official explanation - that the coming economic slowdown and its deflationary pressures enable Brazil to cut interest rates now while being confident inflation will also fall into the target range in 2012. There are other theories, however, such as that the government is using the current economic crisis to make a politically-motivated bid to cut interest rates to mid single digits. According to Tony Volpon, managing director at Nomura Securities: "The government’s strategy is in effect an attitude of ‘let’s get there first and then we will see what we will do to hold down inflation’. We believe this will ultimately not work, and we also forecast Selic to rise later in the year. Nonetheless we believe the news today is another signal that bringing Selic to single digits is now not so much a target of monetary policy, but a much more important ‘decision of state’, a major policy imperative of the Dilma Rousseff government."

Consumer credit

The government is also signalling that pursuit of growth is now driving the economic agenda with the relaxation of some of the macro-prudential policies it had introduced to temper the rampant growth in consumer credit. On 11 November the central bank reversed controls it had introduced in December 2010 to cool the growth in consumer credit for vehicles (risk weights on loans with terms of up to 60 months will now be 75% or 100% compared to 150% previously) – this following data that showed a 12% fall in new vehicle sales in October 2011 compared to the previous month. Risk weightings for payroll loans up to 60 months and some unsecured consumer loans up to 36 months have also had their risk weightings reduced to 75-100% (from 150%).

A report from Barclays says: "Arguably, the Brazilian government’s recent initiatives have been much more consistent with a policy to sustain economic growth in the current global macro environment rather than in controlling inflation. So, if the government feels the need to add more stimuli to credit/economic growth at this stage (of the current global crisis), chances are they sense the risk of a more challenging macro scenario in Brazil has drastically risen - which could be viewed as a negative by some market participants. Indeed, we note recent domestic economic data has not been particularly exciting."

Barclays also notes that the relaxation in credit controls is not necessarily a positive for the banks that have been looking to respond to the slowdown by reining in the recent huge growth in consumer credit within their portfolios. However, the leading Brazilian banks are all reporting expected credit growth of about 15% next year and, although non-performing loans have been creeping up, there is the prospect for disciplined but strong banking growth. The growth in NPLs and the announcement from the banks of increased reserves against future bad loans has led to speculation that the consumer credit market in Brazil has entered bubble territory. However, a report from Nomura says that the average cost of consumer loan rate in early 2010 was 44.2%, rising to 46% in April this year as the central bank tightened monetary policy. So in Brazil, every real of new debt creates 46 cents of interest payments per year – exhausting the ability of consumers to take on more debt. Another necessary ingredient of a credit bubble is a link between credit and asset markets. In the housing booms of the US and UK the rising values of homes enabled consumers to continue to rack up more credit, backed by the rising asset values of their properties. But in Brazil, real estate lending accounts for just 8.3% of total credit. The vast majority of loans are short term (one-and-a-half years on average) and are granted for the purchase of durable goods that have very high depreciation rates. These assets can’t then be used to generate further lending and speculative purchases – unlike the spiral of property-based bubbles.

Brazil’s high interest rates and lack of collateralized lending are preventing a bubble. It’s true that Brazil’s consumers are stretching themselves – with best-guess estimates that one-third of disposable income is now spent servicing debt. But for Brazil to create a dangerous credit bubble it would need to have a much lower cost of lending, longer durations and a higher proportion of mortgage-based lending (or assets without high depreciation rates). None of this is on the horizon.

Capital markets

It is against the background of this macro-economic outlook that this guide focuses on Brazil’s capital markets and Brazilian issuers accessing the international capital markets. One chapter looks at how Brazil’s corporates have been active players in the international debt capital markets in recent years, accessing the relatively cheap rates on offer from liquid international investors. In August, when risk aversion threatened to close this funding source to all but the strongest corporate credits, bankers reported that many Brazilian companies responded by lowering capex plans and external debt needs. Since August, debt capital market activity has been reduced heavily when compared to recent years. Another chapter looks at Brazil’s equity capital market, which has had a difficult year. At the start of 2011 many analysts were predicting a big year for the Bovespa – with predictions of a large volume of IPOs and follow-ons from smaller companies that had been overshadowed in 2010 by the mega deals, such as Petrobras’s mammoth $74 billion follow-on. But initial deals struggled to meet price expectations, with many pricing below the IPO’s valuation bands and struggling in the after-market. The equity capital market did not recover its momentum before global risk aversion led to international outflows from Brazilian equity funds, which made a difficult market almost impossible.

There is also a chapter on the increasingly attractive and regulatory capital-free banking pursuit of advisory services in M&A, as well as an overview of the market for banks and financial services providers in Brazil and a closer look at the outlook for the hugely capital-intensive oil and gas sector in Brazil.