The mood at a conference on Brazil in Washington on the sidelines of the annual World Bank and International Monetary Fund meetings was dark last week.
Latin America`s largest economy and its capital markets are hostage to the same uncertainties over the eurozone that have pushed almost all emerging markets to lows in recent weeks and have weakened their currencies.
In spite of a 22 per cent fall in Brazil`s benchmark Bovespa index this year and a 13 per cent depreciation of the real against the dollar in the past month, only the bravest are willing to set foot back in a market that until last year was among the most favoured in the emerging world.
“No matter how oversold it may seem, I am not touching Brazilian stocks or the Brazilian real until Europe either blows up or the problems there are resolved,” says a US-based fund manager who attended the conference.
Among the large global emerging markets, few are as well-placed as Brazil to withstand a large external shock with its $352bn of foreign exchange reserves, sound financial system and significant capacity for counter-cyclical stimulus measures.
Yet Brazilian stocks are the among worst-performing in the emerging world. The reason for this goes beyond the uncertainty over the eurozone to domestic issues, most notably the unpredictable outlook for Brazilian inflation.
“In Brazil, clearly there is a prioritisation of growth over inflation in the short term,” says Oliver Leyland, of Mirae Asset Management in Sao Paulo. “The central bank has made a big bet that inflation will drop and the external scenario will be reflected in the local economy.”
Many economists do not disagree that at a macro-level Brazil is better placed than in 2008 to battle a slowdown. Goldman Sachs, in a stress test of the Brazilian economy in the event of a shock, concluded: “Brazil is capable of dealing with financial shocks because the fiscal and external accounts are in reasonable shape; the domestic banking system is strong and the stock of reserves is large.
The uncertainty for some investors is what will happen if an economic shock does not happen. The central bank has already taken a gamble on much lower global growth with its rate cut. But if growth proves better than expected, inflation in Brazil could stay high, forcing policymakers to begin tightening again.
At the conference in Washington, Fabio Kanczuk, a partner with Sao Paulo-based Reliance Asset Management, told the gathering that in the event of a slowdown in the global economy but not a Lehman Brothers-like shock, Brazilian inflation would be 7 per cent next year, above the official target.
Others argue that the government should use the eurozone crisis as an opportunity for Brazil to rebalance its policy mix to deliver steadier growth in the future. In the past, the Brazilian economy has been characterised by “one foot on the accelerator, one on the brake”, with loose fiscal policy from the government driving up inflation, forcing the central bank to react with tight monetary policy and high interest rates.
If the government can control fiscal spending during this slowdown and instead use monetary policy to counteract falling growth, Brazil could reduce its historically high real interest rates.
Copyright The Financial Times Limited 2011.