Brazil: the pitch is on the crowded side

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By:
Rob Dwyer
Published on:

IMF conversations positive but with a streak of caution.

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It is clear from this year’s IMF/World Bank conference in Washington that Brazil is generating excitement. 

Perhaps I should amend that: the Brazilians that I spoke to during that week (and there were more side events and conferences hosted by Brazilian banks this year than any other that I can remember) were very excited. 

They told me that that excitement was caused by the level of positivity about the country that they were feeling from the international finance community.

It seemed to me that there was a slight disconnect between the excitement of the Brazilians and the non-Brazilians I spoke to about the outlook for the country: I would characterize those latter conversations as ‘positive but with a strong streak of caution’.

What I think we could all agree on is that the sentiment about Brazil was more positive than at any time in the last decade – and certainly since I arrived in São Paulo at the end of 2010.

Then, Brazil closed out the year with annual growth of 7.5%. I remember lots of first meetings with bankers who would tell me that the long-term growth for the country in the coming decade was 5%. 

There were also – I am sure I am remembering this correctly – liberal use of the words 'easily' and 'at least'.

In the face of such consensus and, yes, excitement, and being new (and admittedly ‘green’), I jotted the forecasts down largely acceptingly.

Now, we all know that Brazil didn’t grow at 5% a year for the next decade, and that the excitement at that time wasmisplaced.

Is this time any different?

Positivity

There are certainly structural reasons for optimism. 

The government is almost about to pull off a good pensions reform that will bring an element of discipline to a runaway fiscal story. 

It is too late for a worryingly high debt burden for an emerging market economy, but at least that debt is in local currency (and the interest rate servicing it is low and falling in a seemingly sustainable way).

There is good news, too, about the central bank. Discussions in Washington DC revealed a real desire from the government to move to bank independence, and that will only improve financial management and international risk perception.

The government’s post-pensions policy agenda is positive too: tax reform, deregulation and a wave of privatizations would be good. 

Though the question still remains, will the government get in its own way? The president’s fight with his own party will damage governability and increase execution risk in 2020, which will be a crucial year for the reform agenda in Brazil.

That in-fighting is also affecting BNDES – André Laloni, the director for divestments, resigned on the eve of the meetings, citing personal reasons, and his departure will complicate and slow the bank’s programme of privatizations and assets sales that, regardless, was a source of much positivity in Washington DC.

Many I spoke to still want to see further reform at the bank. For example, its new financing rate has been an important step towards creating a rate against which the market can compete, but it still needs to apply spreads to reflect project or sponsor risk. 

Some I spoke to who had met the new head of BNDES were pleased with the noises made, but still wanted to see a public and clear articulation of the redefinition of its role back towards one more easily recognizable as that of a development bank.

The macro position is also supportive of the optimism about Brazil. 

Some economists say that Brazil’s re-emergence from being a  basket case won’t be helped by the drag from slowing global growth. 

That’s true, of course, but perhaps the attraction caused by its relative potential could outweigh that? 

Brazil still has large nominal rates (by today’s standards), inflation is controlled, and it has large FX reserves and a small current account that people I spoke to said could grow to between 2% and 3%. 

This macro solidity – combined with the surprising lack of pass-through inflation to date – is why I’m more inclined to disregard those who warn that further cuts to the Selic rate will be counterproductive because it will cause inflation through FX depreciation (as the remaining carry investors depart the scene).

Fragility

There was also a strong sense in Washington that almost everywhere around the world international investors have been deferring decisions (foreign direct investment and even capital flows) due to uncertainty: largely because of trade and geopolitical events. 

But if the Fed rate continues to dall in 2020 the easy option of a US Treasury safehaven may break down and force active allocation in markets that offer yield – and growth. 

(Some Brazilians think next year’s consensus growth forecast of 2.1% could be exceeded – and I heard both 'easily' and 'at least' again a couple of times a piece).

This talk, of course, reminded me of 2010. The positive forecasts of that time were to be blown out of the water by politics – the Mensalao and more specifically the Lava Jato scandals created obstacles to growth and arguably led the government to keep the fiscal tap on too long (the one it had turned on to respond to the global crisis).

That political fragility remains. Non-Brazilians highlight tremendous execution risks, while those from Brazil concede there is risk.

And after 10 years of living in Brazil, I realise that the emergence of a grey swan event (because can any Brazilian swan be said to be black?) that means the country blows an open goal is always a possibility. 

The future may look bright, but we have been here before.

The ‘Brazil’ pitch is getting crowded, but it’s not all over yet.