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Brazil’s Outlook for 2007

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We expect another year of status quo, but fortunately Brazil remains an investors' paradise.

BY WALTER T. MOLANO

In a ceremony marked by more pomp and circumstance, rather than the populist street celebrations of four years ago, Lula launched his second term in office—and set the stage for 2007. The thousands of destitute Brazilians that made the pilgrimage to Brasilia four years ago were noticeably absent this time. At the same time, Lula rejected Alckmin’s campaign mantra that his government and his government’s policies were populist. Nevertheless, Lula promised to accelerate the pace of economic activity to 5 percent year on year — even though he did not provide any insight as to how he would do so. Therefore, we expect another year of status quo.

The pace of Brazil’s GDP growth should accelerate slightly in 2007, to a range of about 3.5 percent y/y. Lower interest rates, with an expected SELIC rate of 11.5 percent by the end of 2007, should boost economic activity. Lula declared during his inauguration speech that he wanted to increase the level of credit to 50 percent of GDP, which means that the government will probably expand the number of collateralized consumer-lending programs—such as those that were provided to public sector workers and retirees. However, real interest rates still remain very high in Brazil, limiting the degree of credit expansion. Brazil is still traumatized by its hyperinflationary experiences of more than a decade ago, and it still pursues an austere macroeconomic policy mix. Tight monetary and fiscal policies, as well as a highly appreciated exchange rate, are the main reasons why Brazil is growing at a third of the pace of its peers.

INVESTOR'S PARADISE

Fortunately, Brazil remains an investors’ paradise. Brazilian exports continue to roar ahead, with an expected trade surplus of more than $40 billion in 2007, and international reserves of almost $100 billion by year-end. A continued rally in soft commodity prices and the expansion of the ethanol industry will boost embarkations. Brazil’s debt to GDP ratio will fall below 40 percent by the end of 2007, putting it on track for an investment grade rating. The rating agencies should approve the investment grade rating by the end of this year or the beginning of 2008.

Although Brazil may not be the most dynamic economy in the asset class, it has a level of consistency and stability that is improving domestic conditions and assuring international investors. The size of the Brazilian economy was $711 billion at the end of 2006, almost twice as big as it was at the start of Lula’s first term in office. Likewise, Brazil’s unemployment rate was 9.5 percent at the end of 2006, versus 12.2 percent at the end of 2002. The improved purchasing power of Brazilian households is the reason why the soft portuguese patois is constantly heard throughout the high streets of London, New York and Paris.

Lula may have been a disappointment for members of the Left, but he successfully consolidated the reforms that were enacted during the 1990s. His government must now focus its resources on improving social conditions in order to expand the benefits of the commodity boom to a broader spectrum of the Brazilian population. Lula declared during his inaugural speech that he wanted to provide universal access to Brazilian universities. However, Brazil needs to focus more of its resources on improving primary education in order to raise the literacy rate. It must provide better health services, thus reducing the mortality rate, and it must modernize its infrastructure in order to reduce transportation and transaction costs. The implementation of such measures will allow Brazil to attain that golden future that always seemed to be so elusive.

Walter Molano is head of research at BCP Securities.

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