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Continuing reforms are turning the former basket case into a powerhouse

by Russ Mould

The concept of Brazil acting as a haven for investors would have seemed laughable ten years ago. Yet in 2008 the BOVESPA has risen 1% against a 6% drop in the FTSE World index: the result of a major restructuring of the economy and equity market framework since 2000.

At the recent Brazilian Excellence Securities Transactions (BEST) conference in London, Paulo Valle, deputy secretary of the Brazilian National Treasury (STN), noted his country has delivered current account surpluses since 2004, paid off almost all external debts and built foreign exchange reserves of $195 billion. Inflation is down from a peak of 14.4% to around the government’s target of 4.5%, and public sector debt is forecast to drop from 41.6% of GDP to 35.9% by 2011, according to 2008’s budget.

Reforms implemented between 2001 and 2003 have tightened regulation, improved disclosure and enticed domestic and foreign investors, boosting liquidity. The BOVESPA saw 64 IPOs in 2007 – some 10% of the world total; in contrast to the period 1995-2003, when just nine firms listed, according to Sergio Weguelin, director of the Brazilian Securities Commission (CVM).

Onward and upward

An overhaul of the inefficient tax system has been introduced. Further cuts in social security spending will come in 2009, building on reforms in 1998 and 2003.

Then there is last year’s $280 billion Growth Acceleration Package (PAC). ‘We are investing in sanitation and water sources, plan to increase our electricity generation capacity by 40% by 2015, investing in increasing our oil production, and in railways, highways and ports’, said Valle.

The PAC targets Brazil’s formerly anaemic rate of GDP growth, which averaged 1.9% from 1999-2003. ‘Growth has lagged,’ confirmed Alasdair Ross, RiskWire Editor of the Economist Intelligence Unit (EIU), speaking at BEST. ‘But Brazil had its China-style economic miracle 40 years ago, moving from a poor nation to a middle-income one. It is hard, and undesirable, to keep growing at that pace’.

Valle says PAC is already helping. ‘GDP growth has accelerated for the past five quarters and has averaged 4.5% in the past four years. We expect to maintain at least 5% [growth] and investment grew 13.4% in 2007 – the highest rate in ten years.’

Seeing is believing

Urban Larson, who manages the Foreign & Colonial Latin American Fund, is also optimistic: ‘I was in Brazil in March and it feels like a different world compared with London or New York.’

Brazil is better insulated from external threats than it was in the 1990s. Even energy is less of a worry, despite the oil price touching $120. Nearly half the energy is from renewables, helped by a switch from coal to sugar cane ethanol. The Tupi oilfield, in which BG Group has a 25% stake, could make Brazil the world’s ninth-largest oil producer.

Tasks remain. ‘Brazil has been a fascinating and encouraging story, yet there are tremendous challenges ahead, which partly stem from its success in getting to where it is today,’ said the EIU’s Alasdair Ross during his BEST presentation.

Domestic credit expansion has sparked consumer demand, sucking in imports. Exports could suffer from a Real, at a nine year high of R1.66 against the dollar. The current account is back in deficit.

Rising food prices have begun to nudge headline inflation, so the COPOM, Brazil’s equivalent to the US Federal Reserve, has raised interest rates, with a 50-basis point hike to 11.75%. And the BOVESPA has really held up well due to exposure to commodities such as steel, sugar and soybeans and the excellent performance of iron ore giant Vale. ‘The outperformance has really been lead by commodities. There is a wide divergence between them and the other parts of the market,’ says Larson, ‘but if the world becomes a bit less risk-averse then the mid and small-cap stocks, which are mostly domestic plays, could catch up.’

In this respect the BOVESPA does not differ from the FTSE 100. It may be unwise to assume Brazil can completely ‘decouple’ from events elsewhere, in a global economic slowdown. But further relative outperformance still looks likely and UK firms such as Unilever and SAB Miller offer exposure to rising domestic consumer expenditure. Ocean Wilsons, through its 58.25% stake in Wilson Sons, remains an excellent play on economic activity, as the country’s third-largest container port operator.