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Brazil: Inspecting the Couplings

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BY WALTER T. MOLANO

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 situation is comfortable. Although a 32 percent 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.

Brazil’s GDP grew more than 5 percent 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 percent. Interestingly, the social situation saw a significant improvement last year. Brazil’s unemployment rate dropped to 8.4 percent 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 percent, 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.

Walter Molano is head of research at BCP Securities.

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