Brazilian stocks rode a “wave of optimism” to a record high last year, says Marcelo Azevedo in Folha de S. Paulo. Markets were relieved that the newly installed left-wing administration of Luiz Inácio Lula da Silva had promised to keep spending under control. This year has been trickier. In January it was apparent that US interest rates would stay higher for longer. That has squeezed emerging markets such as Brazil, which struggle to attract the attention of US-based investors when dollar bonds are already paying well. In April, Brazil’s government compounded the problem by relaxing fiscal targets, further spooking investors.
Are investors losing confidence in Brazil?
The local bovespa stock index has dropped by 5% this year, while the real has been among the worst-performing emerging market currencies this year. A bigger welfare budget has seen state spending rise by 6% above inflation since Lula took office, Rafaela Vitoria of Banco Inter tells the Financial Times. Brasilia has backpedalled on pledges to achieve a primary budget surplus (meaning that government tax revenue exceeds expenditure, excluding interest costs), say Michael Pooler and Beatriz Langella, also in the Financial Times.
At 76% of GDP, Brazilian public debt is already high for an emerging economy. Brazil is in a more precarious position than its peers, Thierry Larose of Vontobel Asset Management tells Craig Mellow in Barron’s. “Debt service already eats up nearly 30% of Brazil’s state revenue, compared with 15% for Mexico.” Instead of tightening the purse strings, Lula’s first instinct has been to blame the central bank for supposedly keeping interest rates too high.
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“Global investors have soured on the Brazil story”, but on an average of just 7.5 times earnings – a roughly 25% discount to the historical average – the market does contain some “deep value plays”. And, as Larose notes, “Lula has a track record of shifting pragmatically before things get out of control”.
The president may have just pulled off one such pivot, says The Economist. Between 1 January and mid-June, the real had plummeted by 17%, but Lula has since thrown his weight behind finance minister Fernando Haddad, who wants to keep spending tight. That has calmed markets, helping to spark a mini-rally in Brazilian assets in recent weeks.
An immediate crisis is not imminent. The “central bank has $360 billion in reserves” and “almost all the public debt is in local currency”. But an economic model built on “high commodity prices” and “subsidies to favoured businesses” will do nothing to cure “stagnant” productivity or improve the “deficient” education system and infrastructure. The population is ageing and pensions already account for “44% of federal spending”. Brazil is “walking on the financial wild side”.
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