The crisis from the subprime mortgages market in the US is about the last thing Brazil needs at the moment since it threatens much of the progress made in recent years. The economy is booming – retail sales are rising, inflation and interest rates are falling, formal employment is increasing, the trade balance and the Real are strong, and the prospect of obtaining investment grade shortly is almost a formality – but now the country has to contend with this problem which could jeopardize these achievements. However, one of Brazil´s most respected commentators, Tomas Malaga, thinks the country is now in a far stronger position to cope than it was in previous crises. Mr. Malaga, a Peruvian, has been chief economist of Banco Itaú since 2000 and has worked for a number of private companies and public bodies as well as academic institutions. He has a Ph.D from the University of California, Los Angeles.    

Tomas Malaga: We´re in a comfortable position this time because Brazil is not a debtor in terms of foreign currency and that makes a lot of difference. Brazil has taken important steps to improve the quality and structure of its debt. However, if the crisis gets worse then foreign investors will reduce their exposure to Brazil and this may mean losing some of its large foreign reserves. If that happens, then we´ll have a real test. Ideally, the government should be improving the fiscal side and aiming for a fiscal surplus. The government says it has not increased taxes but taxation is increasing as a proportion of GDP, as the economy grows and becomes more formal, with more companies and employees leaving the informal sector.  The government could be saving part of this extra revenue.

Malaga: These reserves are high and do provide protection. At least US$ 100 billion of this US$ 160 billion is an exchange of reserves for domestic debt. This year alone, around US$ 50 billion has come both from foreign investors on local government debt. These flows are less stable and if the crisis worsened they could leave and we would face a serious problem.

Malaga: GDP will grow at a much higher rate than we had imagined at the start of the year. This is because the method of calculating GDP was revised and also because the economy has grown faster than had been expected. Inflation has remained relatively stable and the Central Bank has cut interest rates at a rate which was faster than the market had expected. This has boosted the economy and we are projecting GDP growth of between 4.7% and 5% for 2007 and 2008 although it will be harder to maintain that rate in 2009.  

Malaga: Basically because the rate of investment is still not high enough to sustain growth at this level. The rate of investment has risen from about 14% of GDP to its current level of 17.4%. That´s an improvement but it is much less than in countries such as Chile, Colombia or Peru. This means that GDP potential should increase at most by 4% to 4.5%.

Malaga: Our fund stocks analysts are working with scenarios for the Bovespa reaching around 60,000 points by the end of the year. This compares with the current level of around 52,000 and is equivalent to an appreciation of 15% in Brazilian shares. The performance of the Bovespa depends on the continuing growth of international trade and higher prices for the commodities which Brazil exports.

Malaga: The main risk is that we will have an energy shortage. The government denies this and says things are under control but the private sector believes the risk is growing. Some companies are worried that any shortage will push up energy prices by 2009/2010. The government should be involving the private sector more in solving this problem. The situation is similar in other sectors, particularly transport and logistics. We have seen this with the air crisis but there are also problems with the roads, railroads and ports. The lack of investment in these areas puts Brazil in a weak position compared with other countries, particularly in Asia. This poor infrastructure causes companies great problems and additional costs in terms of logistics and inventories. It´s a problem but it also provides the government with an opportunity to work with the private sector since the government does not have the resources to handle it alone without jeopardizing the debt/GDP ratio.

Malaga: Looking ahead, I do not see any important reforms being made but, at the same time, I do not think any political party – the PT or the opposition - will try and alter the macroeconomic policies. All the parties realize the importance of economic stability. The opposition will try and exploit the discontent over taxation and the destination of these taxes, particularly among middle and higher income groups. However, I don´t see this leading to the kind of polarization that has happened in Venezuela. 

Malaga: It´s very important for a country to obtain investment grade and if things remain as they are, Brazil should reach BBB grade. The public debt is heading towards 40% of GDP, the fiscal deficit will balance out by 2009, the external debt is not a problem, thanks to exports, and the country has large foreign reserves. The foreign debt is now less than one year of exports. So I think it´s just a matter of time before Brazil obtains investment grade. Most of the impulse is happening now because credit spreads are below those of other emerging markets, and this gives companies and banks confidence. Part of this impulse has been expected but, as time goes by and things improve, this will help boost growth and we can perhaps achieve consistent levels of 6% to 7% a year. That is, provided that the necessary investments in infrastructure and human capital are concluded.

© John Fitzpatrick 2007