Good prospects for Brazil

With more than 16 months of import cover, Brazil?s international liquidity position is excellent. Solvency is also robust, with moderate foreign debt service ratios.
Analisis Credito y Caución
Madrid - 12-mai-2011

In 2009, Brazils economy experienced a mild recession [0.6% GDP contraction], due mainly to falling industrial output [-7.4% year-on-year] caused by a sharp drop in exports and investments [-10%]. However, since Q4 of 2009, the country has seen a strong and broad-based recovery, thanks to a rebound of exports to Asia, investments and buoyant consumer demand. Industrial output and exports grew 11.5% year-on-year in 2010 and retail sales generally were exceptionally strong last year, increasing in volume by 10.9% year-on-year as a result of labour market improvements, with many new jobs both temporary and permanent being created. Credit conditions remain flexible and financing costs have reached historic low levels, providing a stimulus to household consumption, which increased 7.0% in 2010. While exports of goods and services increased 11.5% last year, imports rose substantially more: by 36.2%.

This rebound slowed down towards the end of last year, especially in Q4, suggesting a slowdown of economic growth in 2011. In January 2011 industrial output increased by only 0.2% on the previous month after decreasing 0.8% in December and 0.1% in November 2010.  However, with a 2.5% increase on the previous quarter, expenditure on household consumption accelerated once more in Q4 of 2010, while GDP grew by just 0.7%. The boom and high export revenues have led to the Real gaining nearly 40% against the US$ over the past two years, favouring imports while causing increasingly worries for Brazilian exporters of manufactured goods. At the same time, inflation has risen steadily since August 2010 and, with the economic upswing and higher food prices, increased to 6% in February 2011: its highest rate since November 2008 and above the Central Banks target of 4.5%.

To stem the currency appreciation, the Brazilian government imposed capital control measures in October 2010, such as higher taxes on foreign investors´ fixed income purchases, and, in January this year, reserve requirements on short US$ positions held by local banks.

The new Administration has also taken urgent action to address the overheating economy, which owed much to increased public spending in the past couple of years. Massive government loans and tax breaks helped to avoid a deeper recession during the credit crisis, but much of the 2009 stimulus was directed at employing public sector workers and increasing pensions and social benefits, instead of improving the countrys poor infrastructure. And even as the economy began to show strong signs of recovery last year, public spending remained high in the run up to the October 2010 parliamentary and presidential elections. Government spending accounts for more than 20% of Brazil's gross domestic product, and public sector debt exceeds 60% of GDP. The new Administration emphasized the continuing struggle against poverty, but with more disciplined economic policies and fiscal measures to reduce the public sector deficit. The government has announced cuts of 50 billion Reais [US$ 30 billion] in budgeted spending for 2011 in order to cool down the overheated economy.

External economic situation: Good liquidity and solvency

The government has reduced the level of public foreign debt considerably and improved its public sector debt profile by bond swaps, issues of real-denominated bonds to foreign investors, pre-payments [US$ 15.6 billon to the IMF and US$ 2.6 billion to the Paris Club] and debt buy-backs [Brady bonds worth US$ 6.6 billion]. As a result, there is a longer debt maturity and much less currency risk, as government debt is denominated mainly in Reais. Private sector [corporate/banking] debt now accounts for two-thirds of total foreign debt.

The large trade surpluses are set to decline, as imports are increasing even faster than the robust export performance. As a result, the current account deficit on the balance of payments will reach 3.1% of GDP in 2011 and 3.5% in 2012. This level of deficit is not alarming given that massive capital inflows, both investment and portfolio, are more than sufficient to cover these shortfalls. These capital account surpluses underpin the Real exchange rate, which appreciated significantly in the course of 2010.

Prospects: Good

While fiscal tightening is necessary to avoid overheating in the economy and to reduce the public sector deficit, the government faces the fact that less than 10% of the yearly budget consists of items that can be cut, while payroll, health care and education spending are fixed. This has raised concerns that the government might cut public investments in infrastructure, the improvement of which is essential for sustained long term growth [the poor state of many roads, airports and harbours and overstretched power supply systems have already prevented additional growth].

However, the government has given assurances that no current infrastructure projects will be cut: no doubt because Brazil will host the FIFA World Cup in 2014 and the Olympic Games in 2016. One solution that they may be considering is increasing the involvement of private investors in infrastructure improvement.

GDP is forecast to cool down to 4.3% this year and 4.7% in 2012, still driven by domestic demand [consumption and investment] and exports [mainly to Asia]. Inflation is forecast to rise to 6.1% this year, and the central bank is expected to increase its benchmark interest rate further and/or take additional measures to curb credit growth: such as an increase in reserve and capital requirements. Inflation is expected to slow down in the second half of 2011 and to fall to 4.7% in 2012. Overall, between 2011 and 2015, GDP growth is set to be between 4% and 5%.

The electronics sector is expected to grow by around 12% in 2011, although interest rate increases and the appreciation of the Real against the US$ may negatively affect this forecast, thus reducing the competitiveness of Brazilian industries. In 2010 electronics turnover totalled 124 billion Reais, a year-on-year growth of 11%. Automotive sales increased 11.9% year-on-year in 2010, to 3.52 million vehicles, while vehicle imports increased by as much as 35%. The forecast for sales in 2011 is a 5% increase, to 3.63 million vehicles. The increasing affluence of Brazilians is mirrored in the rising expenses for hygiene and beauty articles - one of the best performing sectors, with average growth of 10.5% per year over the past decade. In 2010 turnover increased by 12.7%, with Brazilians spending 43.4 billion Reais on these products. Of that spend, 46% came from working/lower middle class people, a substantial increase since 2002 when that share was just 27%.

With more than 16 months of import cover, Brazils international liquidity position is excellent. Solvency is also robust, with moderate foreign debt service ratios. Adequate foreign capital inflows will prevent the widening current account deficits from jeopardizing this solid liquidity and solvency position. Exports from Brazils huge offshore oil reserves will underpin the external position in the longer term as the sub-salt fields off the Brazilian coast are estimated to hold over 13 billion barrels of oil.

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