BY WALTER T. MOLANO
A few years ago, the notion of Brazil being investment grade was ludicrous. Today, it is not a question of “if,” but “when.” The rating agencies are the only ones with skepticism. They are giving all the benefit of the doubt to Colombia. Of course, Bogota is undoubtedly more fun than Brasilia. Still, the markets are dragging the rating agencies to realize the vast improvement in Brazil’s credit worthiness. Countless academic studies demonstrated that credit ratings lag the market, except when there is good business to be done—as was the case in Argentina, Enron, WorldCom and (now) mortgage-backs. Nevertheless, the market knows very well that Brazil is one of the new powerhouses of the emerging markets.
Brazil is sizzling. In addition to the booming export sector, domestic demand is soaring. Industrial production rose 6 percent y/y in April, and local economists are raising their 2007 growth forecasts. At the beginning of the year, most analysts expected the Brazilian economy to grow about 2.5 percent. However, the projections now range between 4 percent and 4.2 percent, and inching ever closer towards our initial forecast of 5 percent. The reason for our early optimism was simple. The Brazilian consumer was going to come on line in 2007. One of the emphatic messages from the 2006 presidential campaign was that Brazil needed to grow at a faster pace. Therefore, the central bank was given a mandate to accelerate the easing of monetary policy. In early June, the COPOM cut the SELIC by 50 bps to 12 percent. The COPOM slashed 775 bps off the highs, inducing local banks to look for other sources of income. Not surprisingly, consumer lending is on the rise. New vehicle registration jumped 29 percent y/y in May, retail sales are soaring and a housing boom is in the works. Moreover, the COPOM has ample room to cut.
The 12-month inflation rate at the end of May was 3.18percent. Our year-end CPI forecast is 3.5 percent, with an official target of 4.5 percent. Brazil’s real interest rate is more than 8 percent, one of the highest in the world. Therefore, there is plenty of room to cut. We believe that the SELIC could be in the high single-digits (8 percent to 9 percent) by year-end. Such a scenario will incentivize the banks to move aggressively into the consumer-lending market. With a population of more than 180 million, Brazil is one of the more interesting consumer markets in the developing world. This is the reason why so much money is flowing into the capital account. In addition to channeling funds into the commodity sector, multinationals are refocusing their efforts on the Brazilian consumer market. Many luxury retailers are reporting that their Brazilian operations are among the most profitable in the world. The interesting thing is that Brazil’s current account balance is solidly in the black despite a large increase in imports. Brazil’s current account is expected to finish the year with a surplus of $10 billion. Furthermore, Brazil’s capital account is also in the black, pushing the level of international reserves above $130 billion.
INVESTMENT GRADE ALREADY
Like Russia, Brazil is becoming wealthy. The large accumulation of reserves is appreciating the Real. It is tightening bond spreads and giving the credit rating agencies a headache. Like Russia, Brazil is converting its wealth into international clout, while moving into more value-added sectors. Brazil is a world leader in soybean, iron ore, paper and pulp, steel and ethanol. The latter was recognized this year by the Bush Administration, as well as the G-8. Brazil was recently invited to attend the G-8 meetings in Germany, and the deliberative body will most likely incorporate it into the group—along with India, China and South Africa. In everyone’s eyes Brazil is investment grade. It is only a matter of time until the rating agencies complete the formality.
Walter Molano is head of research at BCP Securities.