Brazil could – should – have wonderful local capital markets. The country has so many of the necessary ingredients: it has large, well-run companies with evident growth potential in large local and regional markets that should be generating large capex plans. It has enormous infrastructure needs.
Brazil also has a big institutional investor base and many things that appeal to international investors when they are deciding where to allocate their capital – the first of which is sheer size. It has entrepreneurial and capable financial intermediaries, banks and a strong and vigilant regulator – and the tick-box rule of law.
However, Brazil has also suffered from woeful fiscal and monetary policy management in recent years. On February 24 fresh inflation data showed an acceleration to 7.4%, from 7.1% in the previous month, even as the market consensus prediction for GDP growth in 2015 was heading into negative territory (now -0.5% and still falling). This latest bad inflation print makes it highly unlikely that the central bank will, as had widely been expected, slow the pace of its monetary tightening cycle. Instead, Copom, the rate-setting committee of the central bank, is likely to raise the Selic base rate to 12.75% at the next meeting.
Think for a moment what impact the growing double-digit base rate has on the credit and equity markets.
With sovereign credit risk meeting a pension fund’s actuarial target, why would it invest in corporate credit – let alone equity? What incentive is there for an international investor to likewise move beyond the safe feast of government bonds? There is no rationale to take private credit risk. Recent inactivity in equity markets also speaks volumes.
When, a couple of years ago, the Selic fell to 7.25%, risk appetites awoke. Diversification began. Tenors lengthened. Liquidity priorities receded. Innovation flowered. It was almost beautiful while it almost lasted.
But of course it didn’t last. Instead of implementing the structural reforms and the macro discipline to create the conditions for a lower base rate, the government thought lower rates – and the financial and economic benefits they bring – would become a self-fulfilling act. Instead, the desire to persist with command-led lower rates overcame the need for a monetary response to rising inflation, severely wounding the central bank’s credibility and meaning the current cycle has had to be longer and steeper than otherwise would have been the case.
Sadly, the flowering of Brazil’s local markets remains a long way off.
The troubles at Petrobras have hurt all of Brazil’s borrowers but bankers in the country think the worst is now over and that the bad news has been priced in. The proof will come when issuers return to the markets, but who wants to go first – and can the local markets produce the goods?