Brazil’s economic comeback offers investment potential

Country has achieved political stability under President Lula da Silva, and recent growth is impressive. But reform fatigue is a risk.

Once considered an economic basket case, Brazil — buoyed by a strong economy, aggressive government policies and a popular two-year-old administration — has shaken off the ghosts of its turbulent past and begun to flex its muscles. Doubts remain, however, whether the South American powerhouse can hold its own in the same league as China and India, the world’s other two emerging economic giants.

Brazil’s comeback could mean another source of potentially solid growth for investors. The country’s stock market has historically outperformed those of both China and India. But the risks are relatively greater, albeit more sovereign than structural.

Its growing economic clout has not gone unnoticed by the world’s richest nations. Britain, which holds the rotating presidency of the Group of Seven, has invited Brazilian officials to London to meet with G7 finance ministers. The move undoubtedly gives credence to Brazil’s emerging status.

Goldman Sachs Group Inc., the New York-based investment bank, sees Brazil as one of four countries — together with Russia, India and China — that has the greatest potential to become a leading global economy within the half century, “much larger than many investors currently expect,” it says. Goldman forecasts that by 2050, Brazil will be the fifth-largest economy in the world, bigger than all the G7 economies except the U.S. and Japan.

Brazil didn’t just vault onto the global scene.
It has the world’s fifth- largest population, almost 182 million, and accounts for almost half of the GDP of South America. However, it has been plagued by political turmoil, currency crises, hyperinflation, high debt levels and volatile economic conditions.

After devaluing its currency, the real, in 1999, it introduced tough austerity measures that included spending cuts and emergency taxes, which were largely successful in reducing the national debt and keeping inflation in check. The country was fortunate to avoid the effects of contagion from the 2001 Argentine crisis, especially given that Argentina is its largest regional trading partner. However, political uncertainty returned in 2002 when Luiz Inacio Lula da Silva, the left-leaning Workers Party of Brazil candidate, defeated the
government-annointed candidate in presidential elections.

“Slightly more than two years ago, Brazil was the last place international investors wanted to be,” says Markus Koebler, portfolio manager at Natcan Investment Management Inc. in Montreal. “[Lula da Silva] might have been popular with Brazil’s poor, but was an unpopular choice with the international investment community.”

The stock market dramatically reflected that reality. The MSCI Brazil price index (US$) plunged to its lowest level in 10 years.
“However, Lula da Silva has done all the right things,” adds Koebler. “He has surprised his critics on how well he has handled the economy and has become relatively popular. The country’s macro-economic picture has been aided by Chinese demand, but Lula da Silva has made gains in other areas, including much needed administrative cuts — which are good for Brazil.”

Lula da Silva’s popularity was enhanced by the appointment of several respected business and financial figures to key government jobs.

Since the end of 2002, the MSCI price index has risen by more than 650 points, closing 2004 at a record high of 1046.6 points. For the one-, three-, five- and 10-year periods ended Jan. 26, 2005, the Brazil MSCI index was up 22.2%, 27.7%, 7.3% and 8.7%, respectively, outperforming the MSCI emerging markets index in each time frame.
Gillian Manning, global markets economist at TD Bank Financial Group in Toronto, says Lula da Silva has “instilled confidence in Brazil’s monetary and fiscal framework. As well, industrial production has been impressive and the country is benefiting from a stronger external position due to its large current account surplus.”

Incidentally, last year Brazil posted its highest trade surplus on record, US$33.7 billion, leading to a current account surplus of almost US$11.7 billion. In 2003, Brazil posted a trade surplus of US$4 billion, compared with a peak deficit of $33 million five years earlier. The turnaround has been due largely to a 35% increase in exports to developing countries in the past five years.

“Strong demand from China and the rest of Asia and higher commodity prices fuelled economic growth last year,” says Manning. “The economy grew by over 5% in 2004, recording one of its best years in recent times.”

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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