Top Brazil Challenges (Other Than Soybean Prices)

October 24, 2014 12:00 PM
 
Top Brazil Challenges (Other Than Soybean Prices)

Whoever wins Brazil’s presidential runoff election this Sunday won’t have much good news to deliver on the outlook for the world’s second-largest emerging market.

Power Hour Noon LogoBrazil is in recession, and annual inflation is above the ceiling of its target range. A widening budget deficit threatens the country’s investment-grade status, and business confidence hovering around five-year lows has driven investment to the lowest rate among the BRICS nations, which include Russia, India, China and South Africa.

To put the economy back on track, either President Dilma Rousseff or opposition candidate Aecio Neves will have to cut spending, lift caps on government-controlled prices and allow the currency to weaken, said Nicholas Spiro, managing director of London-based Spiro Sovereign Strategy. Such measures, which traders bet will include raising the highest interest rate in the Group of 20 nations, could fuel unemployment and cut wages for the first time in more than a decade.

“Regardless of who wins, you’re looking at a bleak post- election environment for the average Brazilian,” Spiro said in a telephone interview. “Even in a best-case scenario, it’ll take Brazil at least 2-3 years to bounce back.”

Rousseff has taken the lead over Neves in polls for the first time since the first-round vote, according to two opinion surveys published yesterday. Her support was 48 percent compared with 42 percent for Neves in an Oct. 22-23 Datafolha poll and 49 percent against 41 percent for Neves in an Ibope poll. Both surveys, which previously showed the candidates statistically tied, have a margin of error of plus or minus 2 percentage points.

Slower Expansion

Latin America’s largest economy is forecast to expand 1 percent next year, according to the latest central-bank survey of analysts. That is half the average pace during Rousseff’s first three years in office and a quarter of the pace during the two terms of her predecessor, Luiz Inacio Lula da Silva. Gross domestic product contracted 0.6 percent in the second quarter after a revised decline of 0.2 percent in the first three months, helping to erode tax income and widen the budget deficit to 4 percent of GDP.

Neither candidate’s press office responded to e-mails seeking comment on their outlook for the economy next year.

Much of the presidential campaign focused on economic policy, with Rousseff rejecting Neves’s proposals to cut subsidized lending by state banks and reduce the number of ministries. She would build an additional 3 million low-cost houses and increase the number of students who’ve received free vocational training to 12 million from 8 million.

Neves Pledge

She also criticized Neves’s designated finance minister, Arminio Fraga, for a rise in inflation, debt and interest rates when he was head of the central bank in 1999-2002. While Neves has pledged to bring inflation back to the center of the target within two to three years, Rousseff said high interest rates fuel unemployment.

While the jobless rate hovers near a record low at 4.9 percent and was a major talking point in Rousseff’s campaign, there are signs the labor market is beginning to lose steam. Job creation in the nine months through September slowed by 30 percent from a year earlier. Annual wage increases were 1.5 percent for the month, adjusted for inflation, compared with 2.5 percent in August.

Unemployment could rise and real wages, whose growth has exceeded labor productivity, could fall next year for the first time in a decade, said Alberto Ramos, chief Latin America economist at Goldman Sachs Group Inc.

Consumer confidence in October dropped to its lowest level since April 2009, the Getulio Vargas Foundation reported today.

‘Fake Prosperity’

“It was, in part, a fake prosperity because that wage growth wasn’t sustainable,” Ramos said in a phone interview.

To protect wages and prevent inflation from eroding purchasing power, the government delayed increases on fuel and other government-regulated prices, which climbed 5.3 percent in the year through September compared with a 6.75 percent rise in consumer prices. The central bank targets 4.5 percent inflation with a margin of plus or minus two percentage points.

Domestic issues will be exacerbated by a more challenging international environment, which Rousseff has blamed for much of Brazil’s slowdown. Global growth is faltering, and an increase in lending costs in the U.S. could increase capital outflows. Commodity prices -- which account for 50 percent of Brazilian exports -- are down this year, by 39 percent for iron ore and 17 percent for soybeans.

Falling Prices

Falling oil and gas prices may delay industry investment, said Marcelo Campos Magalhaes, president of PetroReconcavo SA, an oil company drilling in the northeastern state of Bahia. Simplifying regulations and allowing more private-sector participation -- particularly in smaller, marginal fields owned by state-controlled oil company Petroleo Brasileiro SA -- could boost output significantly, he said.

Moody’s Investors Service lowered its rating on the company to Baa2 on Oct. 21, the second-lowest investment grade, citing lower prices, local currency weakness and high debt leverage.

The next government must improve the business environment to attract investment, Alejandro Werner, head of the International Monetary Fund’s Western Hemisphere department, said in an Oct. 10 interview. It was 18 percent of GDP last year, well below India’s 31 percent and China’s 48 percent.

Brazil ranked 116th out of 189 countries in the World Bank’s 2014 report on the ease of doing business, with companies spending 2,600 hours a year to deal with taxes versus 369 in the rest of Latin America.

Declining Real

To offset a series of disadvantages Brazilian companies face -- from an unwieldy tax structure to inadequate infrastructure -- the next government should eliminate currency intervention and allow the real to depreciate, said Nelson Hubner, head of Curitiba, Brazil-based smelter and parts maker Hubner Group.

The real has lost 5.2 percent against the U.S. dollar this year, compared with a 22 percent decline for the ruble and 1 percent gain for the baht. The currency traded at 2.49 per dollar at 10:30 a.m. local time.

“At home, the market is stagnating and my profit margin on exports is zero,” Hubner said in a phone interview. “Would you invest to expand?”

Such a scenario has credit-rating companies concerned.

“The weakness in investment highlights the challenges Brazil is facing in making the transition to an investment-led growth model, which is increasingly necessary given the constraints on increases in wage income and credit that have been supportive of private consumption in recent years,” Fitch Ratings said in an Oct. 16 report

More Aggressive

Its rating for Brazil is BBB. Standard and Poor’s downgraded Brazil to BBB- in March, the lowest investment grade.

Most traders appear to expect that Neves would tackle Brazil’s economic problems more aggressively than Rousseff. Between mid-March and early September, when polls showed a rising possibility for an opposition victory, the Bovespa stock index rallied 38 percent only to slide back 17 percent as Rousseff bounced back.

“We think there’s a big difference between the two” candidates, said Geoffrey Dennis, head of global emerging-market strategy at UBS Securities LLC. “Dilma’s second term may be a bit better, but we can expect more structural reforms under Aecio.”

With neither candidate projected to win a large majority, the next president will have a limited mandate to carry out unpopular austerity measures. Congressional elections on Oct. 5 reduced support for Rousseff’s coalition while also failing to give Neves’s alliance a clear majority. This worsens the outlook for tax, labor and other bills to improve the investment climate, according to an Oct. 20 report by Eurasia Group.

Yet delaying budget cuts, price adjustments and a currency depreciation will only inflict larger costs down the road, said Goldman’s Ramos.

“The adjustment is unavoidable; the question is whether it will be fast and less painful or protracted and probably more painful.”

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