Brazil: Farewell

 

Rio de Janeiro is one of the most visually stunning cities that I have ever visited.  The natural beauty of the mountains, rain forest, and beaches surrounds one the world’s largest cities.  Brazilians are proud of their country—Brazil hosted the soccer’s World Cup in 2014, and it will host the summer Olympic Games in 2016.  There is so much to be enthusiastic about when it comes to Brazil’s long-term economic and financial market prospects.  Brazil’s economy is in the top 10 in the world.  Brazil is the world’s fifth largest country by geography (trailing only Russia, Canada, the U.S., and China), and it boasts a supply of rich natural resources.  It is the world’s sixth most populous country, with more than 200 million people.  The country’s median age is just over 30 years old.

Many of these long-term positive elements have been overwhelmed by politics.  The Petrobras bribery scandal is shining a bright light on corruption in politics and industry.  The President faces the threat of impeachment.  Stubbornly high inflation and falling commodity prices have pushed the economy into recession.  The central bank policy rate of more than 13% has been crippling to investment.

Brazil is at a crossroads.  Even in the midst of scandal, many of Brazil’s politicians have recognized the importance of preserving Brazil’s investment grade credit rating.  A downgrade in credit rating in conjunction with the slowdown in China and potential rate hikes in the U.S. could severely exacerbate Brazil’s challenges.

The market is clearly pricing in these challenges, as the currency and equity markets have suffered.  It may be too soon to wade back into Brazil’s markets, but the existing challenges bear watching.  Market watchers expect the central bank to continue to raise rates another 25-50 basis points in the coming months, but markets will welcome the time when the central bank is justified in cutting rates.  Markets will start to look past the current political instability as it either resolves itself or as new candidates emerge for the next election cycle.  The bribery scandal will likely improve transparency and potentially reduce the rampant corruption. 

In many ways, Brazil reminded me of my visit to Turkey—concerns about politics, policy, inflation, and currency are temporarily overwhelming the long-term advantages and potential.  Time will tell, but understanding the issues from a local perspective may help us identify optimal entry points for investment in Brazil.