Brazil In Focus: Is The Growth Story Real?

November 19, 2010

Brazil’s success story is for real, but so too are the problems its new president will face.

 

Brazil’s newly elected president will inherit a country next year that is as transformed as it is unchanged, and investors need to understand both storylines.

Most investment strategies focused on emerging markets today include exposure to Brazil, which is now among the 10 biggest economies in the world. In the past decade, the Brazilian government has successfully broken out of a recurring cycle of inflation and currency devaluation by reducing foreign debt, while shrewdly developing the shop-till-you-drop impulse many Brazilians share.

Exchange-traded funds like the $11 billion iShares MSCI Brazil ETF (NYSEArca: EWZ) reflect these positive changes, posting a fivefold gain in the past 10 years, while its rough U.S. equivalent, the $81 billion SPDR S&P 500 ETF (NYSEArca: SPY), shed 15 percent in the same period. Still, EWZ is a perfect metaphor for Brazil’s top-heavy corporate sector—the ETF has fewer than 50 large companies.

Investors may rightly be drooling over all the infrastructure projects in the works that Brazil needs to pull off to successfully host the World Cup in 2014 and the Summer Olympics in 2016. But behind the veneer of modernism and dynamism lurks the same corruption that has dogged Brazil for generations.

And even though nearly 30 million people have been pulled out of poverty since 1992 and now enjoy adequate urban living conditions, about a third of Brazilians still lack access to adequate housing, potable water, and subsist with less than half the minimum wage, according to data compiled by Brazil’s statistics office, IBGE. Brazilian society, as a whole, continues to be characterized by stark inequalities in terms of income distribution and opportunities.

Now, as President Luiz Inacio Lula da Silva’s successor Dilma Rousseff prepares to take office Jan. 1 amid IMF projections that South America’s biggest economy will average 7.5 percent in annual growth in next few years, or five times faster than any developed nation, the question lingers: Is this growth story sustainable?

“The Brazilian government has realized that ideology matters, but producing economic results matters more,” a portfolio manager in New York told IndexUniverse.com on condition of anonymity. “Brazil has a lot of problems with demons from the past, but it has made a legitimate transition.”

Changes For The Better

The macroeconomic instability Brazil was known for is essentially a relic of the past, as new tax and interest rate policies have set the country on a trajectory of economic responsibility and international credibility.

Brazilian taxes are among the highest in developing countries, and certainly exceed those of its neighbors, as presidential candidate Jose Serra often pointed out during his campaign for office this year. But, despite tax-reform rhetoric, government officials seem well aware that high taxes mean solid revenue to fill national coffers.

At the same time, inflation has been brought largely under control, and is pegged at about 5 percent for 2010, a far cry from the double-digit levels seen less than a decade ago.

Part of the solution has come from a steady effort to lower foreign debt, often U.S. dollar denominated. That effort has come at a time of significant appreciation in the value of the Brazilian real: A real will buy about twice as many dollars as when Lula took office, partly because investor dollars have flowed into assets denominated in the Brazilian currency such as the iShares ETF, EWZ.

The booming middle class dovetails beautifully with a culture that’s always been consumption oriented. Credit is increasingly part of that consumer culture, though access to it remains limited—perhaps not such a bad thing considering the debt crisis the U.S. is still recovering from.

Global X, a New York-based ETF firm, has rolled three funds focused on Latin America’s biggest economy, including the Brazil Consumer ETF (NYSEArca: BRAQ), which it launched in July.

BRAQ has attracted $33 million, while the firm’s other two funds, the Brazil Mid Cap ETF (NYSEArca: BRAZ) and the Brazil Financials ETF (NYSEArca: BRAF), have gathered $28.3 million and $9.3 million, respectively.

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