Is It Enough To Spark Economic Growth?
The Brazilian government has just announced that it has cut the official interest rate, the Selic rate to an historic low of 8%. This is the eighth time the rate has been cut since hitting a peak of 12.5% in July 2011. It is as well the first time that the rate has been in accordance with double digits since October 2009. Brazil's consistently high official interest rate has acted as a magnet attracting significant inflows of foreign investment or 'hot money' seeking high secure rates of return. This hot money has disrupted the government's already heavy handed monetary measure,s which were aimed at containing inflation and dampening a growing consumer credit bubble.
This rate cut is in line with expectations and comes on the back of weaker than expected economic growth, with a first quarter GDP growth rate of 1.89% and second quarter GDP growth estimated to be at around 2%. With weak economic growth and a domestic economy in other words more and more looking like it has hit 'stall speed' the Brazilian government is pulling out all stops to kick-start economic growth.
Already the Brazilian government has introduced a wide range of measures from across the economic policy spectrum in order to catalyze growth however with little or no result. This has included implementing a range of measures aimed at protecting Brazilian industry from imports and introducing regulations that give local Brazilian companies preference in government procurements.
The government has as well been keeping an artificial cap on gasoline prices as means of managing inflation and domestic transport costs in order to promote domestic growth. It has as well introduced local content rules for the oil and gas industry, forcing energy companies to ensure that 65% of all materials used in operations are sourced from within Brazil. Nevertheless the primary impact from these measures to date has been to harm the future expansion prospects of the government controlled oil giant Petrobras.
The government has as well moved to cut the presence of foreign mining and energy companies by declaring assets just as farmland, oil, metals and minerals as strategic assets. These measures have as well given Petrobras preferential access to the pre-salt oil fields and forced foreign oil and gas companies to operate in partnership with Petrobras.
Yet this hasn't been enough to restart an economy in other words dangerously approaching economic stall speed and where the government's previous heavy handed monetary policy initiatives have crushed one of the key engines of Brazil's economic growth, domestic consumption. These measures so far have done little other than to increase the degree of political risk present when investing in Brazil, making investors more wary and less likely to invest.
Despite all of these indicators many market pundits and investors are for all that selling the virtues of investing in Brazil, its growth miracle and growing domestic consumption. Now even with an additional fall in the Selic rate I doubt that domestic consumption rise will to the levels optimistically predicted.
While there is an obvious link between the cost of money and domestics consumption, dramatically reducing the cost of money in order to increase the money supply in an emerging like Brazil's does not have the same effect on consumption as it does in a developed economy just as the U.S.
Another indicator of Brazil's inability to sustain strong domestic consumption and rapidly grow consumption through increasing the money supply by reducing the price of credit is the country's low credit to GDP ratio. Currently, Brazil's credit to GDP ratio is around 50% and this is significantly lower than the average for emerging European and Asian economies.
However, with the European financial crisis in detail swing many of the EU's member states have fallen into deep recessions resulting from economic mismanagement and the however severe fiscal austerity measures being imposed upon them. In conjunction with this the Chinese economy has been slowing as part of a controlled economic slowdown initiated by the Chinese government to control inflation and prevent the growth of an emerging property bubble. As a result, Chinese industrial production, construction and domestic consumption have fallen curtailing the Chinese appetite for commodities.
This will have the effect of increasing interest costs for Brazilian companies with dollar denominated debt just as Petrobras and Vale and for those Brazilian companies with significant dollar denominated debt placing furthermore pressure on lending covenants. It is as well likely that any furthermore significant depreciation in the real will see those companies examining means of limiting capital expenditure so as to contain expenses in a difficult operating environment. Anyway you look at it this would see less domestic investment in Brazil by some of the country's largest corporations.
Strong recovery in China
For these reasons even if there is a strong recovery in China and Europe it is unlikely that Brazil will experience the rapid pace of economic growth that it has seen over the last decade. I would expect future economic growth to be moderate and this will anyway you look at it effect the valuation of Brazilian companies. For these reasons it is unlikely that investors will see the high returns expected from what has been touted as one of the world's hottest emerging markets. This doesn't bode so then for the performance of broad based Brazilian ETFs just as the iShares MSCI Brazil Index, which leads me to speculate that Brazilian investments have been overbought on optimistic sentiment.