Theodore Kahn on the financial markets’ love-hate relationship with Brazil.
I thought you’d never call
Depending on your financial newspaper of choice, you might think Brazil is either the darling or the red-headed step child of the investor community.
On Tuesday, the Wall Street Journal reported that investors are snapping up Brazilian bonds. It’s pretty easy to figure out why. After a rapid cycle of monetary tightening beginning in April 2013, Brazil’s benchmark Selic interest rate stands at 10.75 percent.
The Journal compares that rate with Mexico’s 3.5 percent and Nigeria’s 12 percent. The idea is that Brazil offers Nigerian returns with Mexican risks. (For those of you still stuck in the Tequila Crisis mindset, Mexico has been a paragon of prudent macroeconomic management for the last two decades.)
As a result, Brazilian debt has been among the top performers in emerging markets, returning 3 percent so far this year. So Wall Street should be collectively singing the country’s praises over caipirinhas at Fogo de Chao, right?
Not quite. On Monday Standard and Poor’s cut Brazil’s sovereign credit rating to BBB-, precariously close to junk territory. The ratings agency expressed concern over “fiscal slippage,” while a Goldman Sachs analyst decried the “visible erosion of policy credibility in recent years.”
This despite the fact that the government recently announced US$ 18.5 billion in budget cuts for 2014. Also, recall that Brazil ran a primary surplus of 1.9 percent last year.
Beware of fiscal slippage
This is not to say that there are not good reasons to be wary of Brazil’s prospects. Growth has been lackluster for three years now. Skeptics point out that the government has resorted to creative accounting maneuvers, one-off privatizations, and tax claims against some of the country’s biggest firms to prop up budget figures.
Still, the message from the markets seems to be something along the lines of “your fundamentals are solid, but we just don’t trust you. We’re more than happy to earn juicy returns on your debt, however.”
At the same time, high interest rates keep growth prospects low—part of what led to the downgrade in the first place. So maybe it’s understandable that Brazilian policymakers have at times felt besieged by the markets.
Of course, the Brazilian bond rally pales in comparison with the glory days that were the Chavez years, when investors in Venezuelan debt earned almost 15 percent annually over more than a decade. Despite all the anti-capitalist vitriol, el comandante never missed a bond payment.
Ye of little faith
Theodore Kahn is a PhD candidate at the Johns Hopkins School of Advanced International Studies. Follow him on twitter: @TheoAKahn
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An interesting take though it neglects some very important aspects of the Brazilian economy such as the current account deficit, high inflation, the depreciation of the Real and the removal of the tax on financial investments which all affect investors’ appetite for Brazilian bonds.
Points taken, but even with highish inflation and depreciation of the Real, investors seem to think Braziilan bonds offer a good return in this environment.
I think a more interesting and fundamental question is why Brazil is so vulnerable to high inflation, which necessitates the high interest rate (and provides the biggest potential threat to the PT, as we discussed). I have seen the argument that supply-side constraints due to poor infrastructure play a role, but this seems like a partial explanation at best. Thoughts?
FYI, that was me above…
We should also take into acount China’s Dagong Global Credit Rating, who has rated Brazil as “A” – given that the Chinese are now Brazil’s biggest trade partners, one would assume they know a thing or two about Brazil’s credit reliability.