It will take more than rhetoric for Brazil to regain credibility in global markets. A new fiscal plan might be part of the solution, but investors are likely to demand a lot more. By Thierry Ogier
Once again, its crunch time for Brazils policymakers.
Officials from Latin Americas biggest economy have, in recent months, embarked on yet another frenetic round of marketing, this time in a bid to convince the world that Brazil does not deserve to be ranked among the countries most vulnerable to rising US interest rates – the Fragile Five, as Morgan Stanley dubbed Brazil, India, Indonesia, South Africa and Turkey in a report last summer.
But its a message that not everyone is buying: at a congressional hearing in February, US Federal Reserve chairwoman Janet Yellen referred explicitly to Brazil as among the emerging markets most vulnerable to a reversal in capital flows.
President Dilma Rousseff and her team are likely to need more than words in trying to convince markets that their claims about Brazils economic health and prospects hold water. The finance ministry has already been spurred into action, announcing in February that it will cut 44 billion reais ($18.5 billion) from this years budget as policymakers look to rein in inflation and shore up fiscal management amid warning of a rating downgrade.
But political leaders must also show that their hands are not tied when it comes to taking tough economic measures in the run up to Octobers presidential election, at a time when anxiety in global markets is running high – especially over the fate of emerging markets.
New normal, or new perils?
Luiz Awazu Pereira, deputy governor at the Brazilian central bank says the broader implications of a changing external environment are “quite clear.” “The normalization of US monetary policy will be better for everybody,” he tells LatinFinance in an interview.
Brazils central bank, he says, was proactive in responding to the US Federal Reservess decision to wind down its bond-buying program – a move that has led to widespread unease across emerging markets. As Pereira puts it: “The response has been conducted in a cool-headed manner in Brazil. We understood that this movement of euphoria would at some point lead to a reversal, and that we would need to have the instruments, reserves and policies ready to soften the transition towards something that we think is fundamentally positive to the global economy.
“As the worlds largest economy is showing signs of recovery, we understand that this entails some volatility. But lets acknowledge that this has a positive impact in the medium to long term.
“There is a trend towards asset price realignment which tends to favor US assets. So a bunch of portfolio managers are moving towards lower risk assets. There is going to be some price realignment of emerging market assets, but if you do not differentiate among emerging markets, and put all of them together, it may not be analytically correct.”
Yet markets have been differentiating – and not in Brazils favor. In Latin America, the gap in credit default swap rates between Brazil and Mexico has tended to widen to Mexicos advantage. While Moodys upgraded Mexicos sovereign rating from Baa1 to A3 in February, Standard & Poors put Brazils BBB rating on its list of potential downgrades in June last year.
Pereira acknowledges that investor perceptions of Brazil have soured, but insists the country is well insulated – not least given its stockpile of foreign exchange reserves. “There has been a general deterioration in external market perceptions of Brazil, but this is related to a rather short-term view,” he says. “We are in a different league. Just consider the ratio between international reserves compared to short-term external debt liabilities.”
Indeed, at the end of last year, Brazil had a ratio of international reserves to short-term external debt of 11.2 – well ahead of Turkey (0.9), South Africa (1.8), Indonesia (2.0) and also ahead of countries outside the Fragile Five, such as Mexico (2.5) and Russia (2.9), according to the Brazilian central bank.
The central bank has nevertheless come under intense pressure since initial talk of tapering last April: the real fell by 14% in 2013, taking policymakers by surprise and forcing action to shore up the exchange rate. Last August, the central bank launched a $60 billion currency swap; originally designed to last until year-end, it was extended until June.
This also followed the banks abrupt face on monetary policy last April, when it began hiking rates in the face of stubbornly high inflation – 5.9% in 2013.
Pereira insists the central bank not only acted as it should, but did so with more foresight than other emerging markets. “We are not behind the curve; we are not reacting to a phenomenon that we did not anticipate,” says Pereira.
“We acted preventively by maintaining macroeconomic stability when we started increasing interest rates last April, and then through a program of hedging since August. Entities with liabilities in dollars and those who just wanted clarity on the exchange rate were able to plan accordingly and were given the means to continue operating with some peace of mind. This has been working very well and it brought some peace to the market.”
Other emerging markets, however, “needed to react a bit more aggressively”, he says. “We dont mean to be arrogant but we were the first ones to be able foresee the possible worsening of the crisis and to anticipate global monetary tightening in August,” says Pereira. Since then Brazil has raised its base rates by 350 basis points to 10.75%, while Turkey more than doubled its one-week repo rate in late January.
Pereira says: “Here, we are awake: on alert, 25 hours a day, eight days a week. No one is sleeping at the wheel. Theres no rest, and this is how it should be. We know what our weaknesses are, and what our potential is. We do react on time, and we know where we are going. There is no complacency: there is no denial – just a period of transition.”
Trouble at home
Nevertheless, private-sector economists say Brazil is facing a credibility problem which has taken its toll on the currency. The central bank may have started tightening monetary policy early, but inflation has remained relatively high (the benchmark consumer price index softened to 5.6% in January, below the 6.5% target ceiling, but it is still higher than the central inflation target of 4.5%).
A combination of low economic growth (2.3% in 2013, a slight pick up from 1% in 2012) and high inflation has sapped investors confidence – undermined further by what many see as lax fiscal policy. Brazil failed to hit its primary fiscal surplus target of 1.9% of GDP in 2013, well short of its 2.3% objective, and down from 2.4% in 2012.
Meanwhile, the twin deficits are back with a vengeance: in 2013, the nominal budget deficit amounted to 3.3% of GDP and the current account deficit amounted to 3.7% (up from 2.4% in 2012). Foreign direct investment is strong, but no longer large enough to finance such a deficit. This is not healthy when volatility is back in the international capital markets. Risk premiums have soared.
These developments are all a result of poor economic policy choices, says Marcos Lisboa, vice president of Insper, a São Paulo business school, and a former finance ministry official. “Brazil is paying the price for having adopted the wrong set of policies in recent years,” he says. “This has led to a mediocre economic performance.”
“From 2008, the government has resuscitated the old development agenda of the past, including protection for sectors that are not competitive. This has brought two negative consequences: its deteriorated the fiscal accounts significantly and it was detrimental to productivity.”
The government boosted the role of BNDES, the national development bank, as part of its post-Lehman counter-cyclical policy measures. Massive fund transfers from the treasury to BNDES have weighed on the gross public debt burden, which amounted to 66.1% of GDP in 2013, according to the IMF (the Brazilian government uses a different methodology and says its gross debt has declined from 58.8% of GDP in 2012 to 57.2% at the end of 2013).
The BNDES accounts for 8% of overall gross public, according to João Carlos Ferraz, a BNDES director. Last year, the BNDES received 39 billion reais ($16 billion) from the treasury, compared to 100 billion reais in 2009, and it says the amount of transfers will continue to decline.
“Sobriety and caution are the main characteristics of economic policy,” says João Carlos Ferraz, a BNDES director.
But deeds speak louder than words. “Patience towards Brazil has already run out,” says Monica Baumgarten de Bolle, a former IMF economist and now director of Casa das Garças, a liberal economic policy institute in Rio de Janeiro. She reckons the primary budget surplus target should be increased to 2.5% of GDP and that around 50 billion reais needs to be slashed from the budget in 2014.
The governments latest commitment to achieve a fiscal target of 1.9% of GDP in an election year has divided opinion. Marcelo Carvalho, Latin America chief economist at BNP Paribas in São Paulo, says that policy rebalancing “is a good point. But there is a great deal of skepticism whether they are going to deliver or not. It is a challenging situation.”
However, some are still ready to give the government the benefit of the doubt. “The proposed adjustment is a decent one, it is credible,” says Octavio de Barros, chief economist at Bradesco in São Paulo. “There is no room for bluffing”.
Others say Brazil would have to gain from adopting a multi-year fiscal target, in order to avoid permanent short-term anxiety, especially when an election is looming.
“Everything is a matter of choice,” says Baumgarten. “If the government chooses to go down the wrong route, we are going to suffer. No one has the patience to wait and see whether things will eventually fall into place. Either they do, and we manage to get through US monetary transition, or they dont. Then we will have to deal with a lot more market turmoil.”
“The market is expecting a lot more than a signal,” says Márcio Garcia, an economist at both Rios PUC University and MIT in the US. “This government has already sent various signals in the past that did not turn into concrete actions.” He cites the finance ministrys “creative account having undermined its credibility “The finance ministry team did everything to conceal the actual results, so it is hard to believe them,” he says.
But these are difficult times for Brazils political economy. Consensus over economic policy has broken. The central banks Pereira still refers to three basic pillars of orthodox economic policy – fiscal discipline, inflation targeting and a floating exchange rate – but investors are calling for deeper change in fiscal and quasi-fiscal policy in Brazil. This wont be easy to achieve in an election year.
Yet Garcia says such a change is vital. It would contribute to an orderly depreciation of the real, while taking some pressure off monetary policy, he says. Expansionist fiscal policy and absence of structural reforms are seen as a threat to the sovereign ratings.
“The probability of a global capital market crisis has increased a lot, as the US central bank is withdrawing excess liquidity it had introduced in the past,” says Garcia. “But economies that are unbalanced are actually relatively small – Argentina, Venezuela, even Turkey – so in the end it is no big deal.
“The Brazilian economy is in a reasonably good shape, after all. So if you correct domestic economic policies, you may register a fairly good performance again.”
“Tapering is a redefining moment on the global stage; there are more positive points than negative ones,” says BNDES Ferraz.
Outsiders express much deeper worries, however. Tony Volpon, head of emerging markets research for the Americas at Nomura Securities, for example, thinks that simply relying on an as yet fragile recovery in developed economies to lift all boats, rather than tackling underlying domestic economic challenges, will prove to be a serious mistake.
“The next five years will be tougher than the last five years for Brazil,” he says. “If you fool yourself into thinking you dont have to make the hard decisions because you are going to get bailed out by stronger US growth, you havent understood the dynamic of what has been going on,” he says.
Volpon says there has already been a four percentage point increase in the cost of financing Brazils domestic public-sector debt over the past five years.
But the central banks Pereira says fears are overblown. “To adopt a doom and gloom rhetoric regarding emerging markets – saying they will enter in all-out crisis – is not serious from an analytical point of view,” he says.
“One may well say it is part of a trading strategy, but you have to keep cool – and differentiate.” LF
Fonte: Latin Finance – 01/03/2014
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