Brazil’s economic downturn provides opportunity for shrewd investors

Brazil’s economic downturn provides opportunity for shrewd investors

Brazil’s economy, generally considered one of the safest bets among emerging markets, is on shaky ground. While many investors are fleeing, shrewd investors can take advantage of opportunities at steep discounts.

Last week, a Brazilian survey of economists adjusted forecasts for Brazil down once again, trimming GDP and industrial output expectations and predicting higher inflation throughout 2014. Just the week before, Brazil’s central bank signaled it will continue its tight monetary policy as inflation continues to rise above target levels. Should investors be wary or is this an opportunity to preempt future growth?

Investors looking for yield in growth markets have long flocked to Brazil, thanks to its relatively stable political and economic environment. However, recent monetary and fiscal choices coupled with continued domestic unrest over corruption and public services have made Brazil a potentially risky bet.

Though policymakers recently voted to slow short-term interest rate increases from 0.5 percent to 0.25 percent, central bank President Tombini has now raised rates over 350 basis points since April of 2013. Brazil’s Q3 economic contraction last year was the first in four years, and with prices rising in December and February, many believe that Tombini’s commitment to tightening may not be enough.

But with the US Federal Reserve looking to wind down its asset-purchasing program, the Brazilian real depreciating against the US dollar and persistently low growth, Brazil may be left with few options.

Brazil is routinely grouped with the world’s biggest emerging economies, the so-called BRICs. And while it is the world’s sixth largest economy, it wields neither strong export-led growth, nor has it attracted long-term investments in infrastructure or human capital.

Much has been made of the potential of its age-demographic dividend, but without an emphasis on innovation or productivity in its rapidly growing services sector, government-managed stimulus and efforts to reduce inequality could go to waste.

In an effort to head off recent capital flight, President Dilma Rousseff promised to cut R$44 billion from this year’s budget. Interestingly, this comes just a few years after 2009’s attempt to slow capital inflows and will be particularly tough to carry out in an election year for Rousseff, a member of Brazil’s left-leaning Workers’ Party.

Considering the magnitude of last year’s protests following cuts to public services, few believe Rousseff will follow through on the painful cuts needed to shrink a too-big fiscal imbalance and restore faith in Brazil’s macroeconomic stability.

Furthermore, whoever is chosen as Brazil’s new leader in the October election– in which Rousseff is up for reelection– will be forced to carry out the kind of fiscal rebalancing hinted at over the last few weeks. Budget cuts marked both former president Luiz Inácio Lula da Silva’s inaugural year, and Rousseff’s in 2011, and considering the pragmatic leftist administration currently in place, Rousseff’s opponents would almost certainly reduce spending even further if elected.

World Cup infrastructure projects were expected to inject tens of billions of dollars into the economy. But with many projects behind schedule or over-budget, optimism surrounding the world’s premier soccer event has diminished. Still, demand for consumables and luxury services should ramp up during the mid-summer months thanks to an influx of tourists and consumer demand.

Finally, the bearish equities market– the São Paulo Bovespa stock exchange is down over 20 percent from last year– has driven some to ignore the precarious market with an eye towards opportunities at a steep discount. In particular, private equity investors view the drop in share prices along with continued depreciation of the real as attractive for investors paying in dollars. Furthermore, Brazilian companies desperate for capital are looking for support from non-traditional creditors.

Yes, Brazil is on shaky political and economic ground, but with a keen eye to the risks at hand, shrewd investors can ignore the herd, and reap rewards.

Categories: Economics, Latin America

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