.

Amongst the brethren of emerging markets, Brazil not too long ago presented the most excitement and opportunity. Everybody and everything wanted to be somewhat associated with Brazil’s rising star power—epitomized by being awarded in a short time span both the 2014 World Cup and 2016 Olympics. Excluding China, Brazil has received the most media attention and hype in the last few years, often touted as the next emerging market country that will soon transform into a bona fide superpower. Yet time has a funny way of determining things. Brazil, at the blink of an eye, is now confronting a different reality, a most despised and feared three-headed dragon: slow growth, a weak currency, and worst of all, inflation.

Since 2011, Brazil—much to her own chagrin—has produced slower growth and higher inflation than most Latin American countries. For example, in 2012 Brazil’s GDP was a meager 0.9 percent, way below their Latin American peers. Brazil’s much-endorsed main economic rival Mexico grew at a steady rate of 3.9 percent in 2012; Colombia’s GDP reached 4 percent growth; Peru produced an impressive 6.5 percent growth; curious Ecuador reached 5.1 percent; and lastly, Chile continued the momentum with a 2012 GDP growth of 5.6 percent. Thus, if Brazil has aspirations in being the first world power below the equator line, growth must at least be the in the 4 percent range during the next decade(s). If not, Brazil is very well aware that it will never reach superpower status in the near future.

Brazil’s troubles are of her own doing. In 2010, Brazil’s Finance Minister was stirring unnecessary drama by insinuating that the U.S. and developed countries were igniting a currency war by devaluing the U.S. dollar to boost U.S. exports, at the expense of cheap money searching for higher yields in markets like Brazil, Turkey, and Indonesia. Brazil’s made the case that a weak U.S. currency was hurting the Brazilian real, because the real was strengthening too quickly against the U.S. dollar and the EU; this therefore hurt Brazilian exports, stifling Brazilian manufacturing competitiveness and increasing the possibility of inflation. Two years ago I argued that emerging markets in Latin America must adapt to the ‘new normal’ economic environment instead of relying on antiquated tactics such as blaming Western powers for virtually everything. Brazil, however, insisted that their currency desperately needed central banking intervention, lowering interest rates in the pursuit of calming the real’s surge.

Be careful what you wish for. Since 2011, the Brazilian real had dropped in value against the dollar by approximately 20 percent. In layman terms, a 20 percent drop for any currency makes a very weak currency and creates many problems. For example, with a weak currency it costs more to import goods; consequently, prices will rise to offset the high import costs, fanning the flames of inflation. The counter-argument is that a weak currency can make exports more competitive. This is true; however, Brazil’s recent boom was overly dependent on China’s insatiable appetite for Brazil’s commodities. Fast forward to today: the demand from China has waned due to the Middle Kingdom’s restructuring of their economic model. Mindful that China cannot rely on exports forever, the country is, albeit gradually, creating an economy based on domestic consumption.

The quagmire Brazil faces is not an easy fix. Lowering interest rates and taxes and creating a business friendly environment for locals and international investors alike can boost economic growth. Brazil’s central bank did address the latter by removing the IOF tax on foreign bond purchases. It was a good start, but there was no reason anyway to levy a tax on foreign investors interested in purchasing Brazilian bonds.

This will invite more foreign money, but the problem is Brazil is promoting an image that it does not have full control their currency. Essentially they have exercised an unnecessary full circle: first, Brazil pursued foreign investors; then dissuaded foreign capital by enacting the IOF tax; and now after much huffing and puffing about the so-called currency war, removed the tax. What is tomorrow’s move going to be?

Uncertainty from the top creates uneasiness in the investor world. Yet, it cannot be overstated that foreign investment is not only needed, but a necessity if Brazil is going to continue to invest in much-needed infrastructure, R&D, and education. Also, Brazil has a current account deficit—meaning imports exceed exports—and with investor lacking confidence in Brazil, the economic malaise will only lengthen without foreign money entering Brazil.

However, lowering interest rates is not an option due to inflation rearing its ugly head. It is a catch-22 in its purest sense. In addition, Brazil dealt with horrendous hyperinflation during the 90s, and as a result Brazil, just like Europe, has an instinctual fear of inflation. The textbook method to combat inflation is to raise interest rates to cool the economy, and inflation will eventually slow down. This tactic will not work completely with Brazil because inflation is being compounded by a weak currency. Coupled with slow growth, raising interest rates could theoretically slam the brakes on economic growth. After all this, Brazil unfortunately has no choice but to raise interest rates to combat inflation.

In early June, São Paulo’s bus fares increased 10 cents. The increase was far from welcome, and students poured into the streets to express their frustrations. The protests escalated, and they soon became not only a protest of bus fares but also an eruption against the rising costs, corruption, and mismanagement of the 2014 World Cup and 2016 Rio Olympics. Chants such as, “The love is over—Turkey is right here”, reinforced the analysis that the anger is much more complex than just the bus increase of 10 cents. The bus fare was just the tip of the iceberg, the catalyst. Generally, Brazilians are a peaceful lot, but like any other society, once inflation kicks into high gear, social unrest will occur. This can exacerbate other political, social, and economic complications, such as the lack of economic inclusion, crime, rising unemployment, taxes, inflation, and corruption.

Brazil must act quickly before the problems worsen, and they become a liability during their grand “coming out” parties in 2014 and 2016.

Not all is lost in Brazil. It is considered the sixth largest economy of the world: it has a a strong presence in manufacturing aircrafts and submarines, coupled with leading innovation in deep water oil research and a strong presence in space research. Brazil is also one of the leading exporters of soybean, orange juice, oil, refined sugar, poultry, coffee, iron ore, and autos. Roughly half of Brazil’s population is middle class—an amazing achievement compared to China’s middle class only marking 10 percent of their population. Also, Brazil has been at the forefront of the transcending cash transfer programs such as Bolsa Familia, improving living standards and providing a safety net. According to the The Economist, Brazil admits more legal immigrants from the U.S. and Europe than the rest of Latin America, an acknowledgement that Brazil can be considered a destination for business and upward social mobility.

Now the challenge for Brazil is to harness its recent successes, solidify its current potential, and strategize prudently and effectively towards their future economic growth, so it can once and for all put to rest the never ending joke: Brazil is the country of the future…and it will always be.

This article was originally published in the Diplomatic Courier's September/October 2013 print edition.

About
Oscar Montealegre
:
Oscar Montealaegre is Diplomatic Courier’s Latin America Correspondent and the Founder of Kensington Eagle, an investment firm that specializes in private companies and real estate in the U.S. and Colombia.
The views presented in this article are the author’s own and do not necessarily represent the views of any other organization.

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Brazil Having Trouble Pulling its Weight

October 1, 2013

Amongst the brethren of emerging markets, Brazil not too long ago presented the most excitement and opportunity. Everybody and everything wanted to be somewhat associated with Brazil’s rising star power—epitomized by being awarded in a short time span both the 2014 World Cup and 2016 Olympics. Excluding China, Brazil has received the most media attention and hype in the last few years, often touted as the next emerging market country that will soon transform into a bona fide superpower. Yet time has a funny way of determining things. Brazil, at the blink of an eye, is now confronting a different reality, a most despised and feared three-headed dragon: slow growth, a weak currency, and worst of all, inflation.

Since 2011, Brazil—much to her own chagrin—has produced slower growth and higher inflation than most Latin American countries. For example, in 2012 Brazil’s GDP was a meager 0.9 percent, way below their Latin American peers. Brazil’s much-endorsed main economic rival Mexico grew at a steady rate of 3.9 percent in 2012; Colombia’s GDP reached 4 percent growth; Peru produced an impressive 6.5 percent growth; curious Ecuador reached 5.1 percent; and lastly, Chile continued the momentum with a 2012 GDP growth of 5.6 percent. Thus, if Brazil has aspirations in being the first world power below the equator line, growth must at least be the in the 4 percent range during the next decade(s). If not, Brazil is very well aware that it will never reach superpower status in the near future.

Brazil’s troubles are of her own doing. In 2010, Brazil’s Finance Minister was stirring unnecessary drama by insinuating that the U.S. and developed countries were igniting a currency war by devaluing the U.S. dollar to boost U.S. exports, at the expense of cheap money searching for higher yields in markets like Brazil, Turkey, and Indonesia. Brazil’s made the case that a weak U.S. currency was hurting the Brazilian real, because the real was strengthening too quickly against the U.S. dollar and the EU; this therefore hurt Brazilian exports, stifling Brazilian manufacturing competitiveness and increasing the possibility of inflation. Two years ago I argued that emerging markets in Latin America must adapt to the ‘new normal’ economic environment instead of relying on antiquated tactics such as blaming Western powers for virtually everything. Brazil, however, insisted that their currency desperately needed central banking intervention, lowering interest rates in the pursuit of calming the real’s surge.

Be careful what you wish for. Since 2011, the Brazilian real had dropped in value against the dollar by approximately 20 percent. In layman terms, a 20 percent drop for any currency makes a very weak currency and creates many problems. For example, with a weak currency it costs more to import goods; consequently, prices will rise to offset the high import costs, fanning the flames of inflation. The counter-argument is that a weak currency can make exports more competitive. This is true; however, Brazil’s recent boom was overly dependent on China’s insatiable appetite for Brazil’s commodities. Fast forward to today: the demand from China has waned due to the Middle Kingdom’s restructuring of their economic model. Mindful that China cannot rely on exports forever, the country is, albeit gradually, creating an economy based on domestic consumption.

The quagmire Brazil faces is not an easy fix. Lowering interest rates and taxes and creating a business friendly environment for locals and international investors alike can boost economic growth. Brazil’s central bank did address the latter by removing the IOF tax on foreign bond purchases. It was a good start, but there was no reason anyway to levy a tax on foreign investors interested in purchasing Brazilian bonds.

This will invite more foreign money, but the problem is Brazil is promoting an image that it does not have full control their currency. Essentially they have exercised an unnecessary full circle: first, Brazil pursued foreign investors; then dissuaded foreign capital by enacting the IOF tax; and now after much huffing and puffing about the so-called currency war, removed the tax. What is tomorrow’s move going to be?

Uncertainty from the top creates uneasiness in the investor world. Yet, it cannot be overstated that foreign investment is not only needed, but a necessity if Brazil is going to continue to invest in much-needed infrastructure, R&D, and education. Also, Brazil has a current account deficit—meaning imports exceed exports—and with investor lacking confidence in Brazil, the economic malaise will only lengthen without foreign money entering Brazil.

However, lowering interest rates is not an option due to inflation rearing its ugly head. It is a catch-22 in its purest sense. In addition, Brazil dealt with horrendous hyperinflation during the 90s, and as a result Brazil, just like Europe, has an instinctual fear of inflation. The textbook method to combat inflation is to raise interest rates to cool the economy, and inflation will eventually slow down. This tactic will not work completely with Brazil because inflation is being compounded by a weak currency. Coupled with slow growth, raising interest rates could theoretically slam the brakes on economic growth. After all this, Brazil unfortunately has no choice but to raise interest rates to combat inflation.

In early June, São Paulo’s bus fares increased 10 cents. The increase was far from welcome, and students poured into the streets to express their frustrations. The protests escalated, and they soon became not only a protest of bus fares but also an eruption against the rising costs, corruption, and mismanagement of the 2014 World Cup and 2016 Rio Olympics. Chants such as, “The love is over—Turkey is right here”, reinforced the analysis that the anger is much more complex than just the bus increase of 10 cents. The bus fare was just the tip of the iceberg, the catalyst. Generally, Brazilians are a peaceful lot, but like any other society, once inflation kicks into high gear, social unrest will occur. This can exacerbate other political, social, and economic complications, such as the lack of economic inclusion, crime, rising unemployment, taxes, inflation, and corruption.

Brazil must act quickly before the problems worsen, and they become a liability during their grand “coming out” parties in 2014 and 2016.

Not all is lost in Brazil. It is considered the sixth largest economy of the world: it has a a strong presence in manufacturing aircrafts and submarines, coupled with leading innovation in deep water oil research and a strong presence in space research. Brazil is also one of the leading exporters of soybean, orange juice, oil, refined sugar, poultry, coffee, iron ore, and autos. Roughly half of Brazil’s population is middle class—an amazing achievement compared to China’s middle class only marking 10 percent of their population. Also, Brazil has been at the forefront of the transcending cash transfer programs such as Bolsa Familia, improving living standards and providing a safety net. According to the The Economist, Brazil admits more legal immigrants from the U.S. and Europe than the rest of Latin America, an acknowledgement that Brazil can be considered a destination for business and upward social mobility.

Now the challenge for Brazil is to harness its recent successes, solidify its current potential, and strategize prudently and effectively towards their future economic growth, so it can once and for all put to rest the never ending joke: Brazil is the country of the future…and it will always be.

This article was originally published in the Diplomatic Courier's September/October 2013 print edition.

About
Oscar Montealegre
:
Oscar Montealaegre is Diplomatic Courier’s Latin America Correspondent and the Founder of Kensington Eagle, an investment firm that specializes in private companies and real estate in the U.S. and Colombia.
The views presented in this article are the author’s own and do not necessarily represent the views of any other organization.