Research & Advice

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Brazil

June 27, 2007

In the last half-decade alone there have been significant positive changes that have fundamentally changed Brazil in a manner to attract investors – perhaps for the next half-decade, if not longer.  There are three changes that separate themselves as the most important.

First, like with virtually every other nation on planet Earth, Brazil has been favorably influenced by the rapid growth of China and India.  There has been a tremendous demand for Latin American commodities such as soybeans, corn, meat, iron ore, and other raw materials.

While there is certainly more and more correlation amongst world markets every year, Brazil is not completely dependent upon Asian growth (don’t get too bogged down in the concept of one feeding the other – after all, the U.S. is tied to Asia as well as most every other emerging and industrialized nation).  But what Asia has done is allow Brazil to create a powerful platform from which it has launched other meaningful changes.  For example, Brazil has been running a positive trade balance of about $40 billion per year.  Because, in part, of that the country has had tremendous liquidity and credit growth (which I’ll discuss later)

Second, the government has done a very good job reigning in inflation over the last five years, currently at about a 4 percent rate.  Due to the tight anti-inflation controls interest rates have been able to come down, which has spurred a new consumer and business credit market (which I’ll also discuss later).  Between the two, lower inflation as well as lower interest rates, there has been a dramatic reduction in the cost of purchases and investment. 

As a result, not only are there new uses for plant, property, and equipment, but Brazilian corporations have become exposed to new efficiencies that are being used by their overseas brethren.  The result is not only a greater use of capacity, but also a more productive use.

Third, and this is more of an “it’s coming” change, Brazil is well poised to take advantage of an approaching boom in bio-fuels (even if that boom is not something that seems likely to gain foothold in the US, it is of conversation elsewhere).  In the 1970s Brazil was one of the pioneers of fuel alcohol and is currently the world leader.  Their locally-developed technology has resulted in almost all new cars being able to run on gasoline or alcohol, or a combination of the two.

To elaborate on the topic of liquidity and more accessible capital, as much as things have improved it is still fair to say that US citizens (as well as many other foreigners) would have our eyes widened if we were presented with loan contracts at Brazilian rates. Getting Brazilian interest rates down is a work in progress, and it is working.  For consumers, going back as recently as just a few years ago there was virtually no lending growth.  But as inflation has been put under control and as interest rates have subsequently dropped, lending has boomed. Brazilian banks are growing lending portfolios by twenty percent per year.

Housing, in particular, is doing very well due to lower interest rates. Brazil’s Selic (their version of the Fed Funds Rate) has dropped in the last couple years from 19.75% to 12% (the most recent rate reduction occurring last May).    In addition to lower interest rates there is also the generous subsidization of Caixa Economica Federal, Brazil’s government owned savings and mortgage bank.  It is Caixa’s job to promote development of the housing sector.  Caixa’s current floating-rate offering is 5.5% plus inflation.  Fixed rates for lower income housing are actually below the Selic; middle-market homes are closer to 13.5%.  Even more important is that not too long ago loans had to be paid back within a few years; today twenty-year mortgages are more common (thus making monthly payments much more affordable).

Caixa will hand out over $17 Brazilian dollars (or R$17B) worth of housing loans this year, up from just R$5B about four years ago.  At the beginning of the decade only about 26,000 people visited Caixa’s housing fairs.  In the last couple months over a half million people have made the visit.  The estimated housing deficit (as opposed to the excess inventory we have in the U.S.) is almost 8 million homes – there is a need for building.

In the capital markets, there have been huge strides in corporate governance.  Actions taken have cleansed the image for sovereign investors that use to view the stock market as not much more than a gamble.  And investor awareness is coming at an appropriate time since Brazilian stocks are trading at about 12.5-13 times trailing 12-month earnings (a fair valuation for a country with a real GDP growth rate of about 3.7% – “real” means “less inflation”).

The opening of Brazilian equity markets has dramatically impacted corporate funding (remember, companies go public to raise capital).  In 2002 no companies tried to go public; there were actually 29 de-listings.  In 2006 there were 26 issues raising a total of R$7B.  The next wave of cheap financing will be from the debt markets.  Brazil has had their credit rating lifted to one step below investment grade and is awaiting investment grade status.  At that point not only will the country be able to refinance outstanding debt very cheaply, but there will be new investors stepping up to and promoting the Brazilian marketplace.