As long as external conditions persist, Brazil will realize the destiny that was always so illusive.
BY WALTER T. MOLANO
After spending his first term preserving price stability, acquiring the confidence of market participants and securing a second term in office, Lula is refocusing his efforts on accelerating Brazil’s economic activity. The government launched its Program for the Acceleration of Growth (PAC) as an initiative to spur public sector investment, particularly in infrastructure and social programs. The government estimates that public and private investment will top R$500 billion over the next four years. The government is also trimming corporate taxes, as a way to promote growth. Brazil has the highest tax burden in Latin America. In order to fund the investment program, the government trimmed R$ 16 billion from administrative expenditures. It also reduced the primary fiscal surplus to 3.75 percent of GDP from 4.25 percent. Although the investment should boost the level of economic activity, the government decided to dampen expectations by reducing its GDP growth target to 4.5 percent year on year from an initial level of 4.75%. Most economists believe that Brazil will grow less than 4 percent y/y in 2007. However, we believe that the level of economic activity will rise above 5 percent.
Brazil is becoming a global powerhouse. Companies in strategic sectors, such as steel, iron ore, energy, grain processing, beef, poultry, paper, pulp and finance are becoming market leaders. The aperture of the Brazilian economy and the turn in the commodity cycle highlighted many of Brazil’s latent comparative advantages. As a result, Brazilian firms are roaring ahead. Petrobras, for example, posted the best performance in the global oil sector—reporting a 22.3 percent y/y increase in profits in 2006. This was in comparison to Exxon, which posted a 9.5 percent increase and Royal Dutch Shell’s 0.5 percent increase. One of the reasons for Petrobras’ impressive performance was its 31 percent y/y increase in investment. Petrobras will expand investment 63 percent y/y in 2007. The aggressive bidding by CSN for Corus, the impressive pricing power wielded by CSN, and the growing clout of local beef producers are some examples of the pole position for many Brazilian firms. Moreover, capital is pouring in. The Brazilian central bank is working at full tilt to prevent further appreciation of the Real, intervening to the tune of $300 to $500 million per day. At the current pace, we believe that the central bank could have more than $120 billion in international reserves by the end of this year. The shift in external conditions is forcing the credit rating agencies to soften their position on Brazil, paving the way for an eventual upgrade to investment grade.
In addition to investment and exports, consumption could be the next major engine of growth. Brazilian interest rates are tumbling. Many local analysts believe that the SELIC could drop to 11.5 percent by the end of this year, but we believe that they could go into the single digits. Lula is maintaining Henrique Meirelles at the head of the central bank, but he may have to cut interest rates even more than most people expected. Brazil’s inflation rate is lower than the U.S., and most analysts are cutting their year-end CPI projections below 4 percent. This means that a SELIC rate in the high single digits would still be considered to be a tight monetary position. Not surprisingly, Brazilian banks are preparing for a spurt in consumer credit. They are working hard to unify lending contracts in order to streamline the securitization of mortgages. The large Brazilian banks are also merging with mid-sized institutions in order to get better access to the micro-credit markets. All of this points towards a faster pace of GDP growth. The expected surge in GDP will make Brazil the undisputed regional powerhouse. The U.S. government is taking note, and it is doing its best to woo the regional giant as an ally to maintain order and discipline among the smaller nations. Most Brazilians are skeptical. This is not so surprising -- after so many false starts. However, as long as external conditions persist, Brazil will realize the destiny that was always so illusive.
Walter Molano is head of research at BCP Securities.