The national currency, the ‘Real’ was introduced under the economic stabilization plan, Plano Real (Real Plan) on July 1, 1994. The Real Plan was designed to reign in inflation from hyperinflation levels of over 1000 percent down to single digit levels. Following floating of the currency in January 1999, the real experienced nominal depreciation of nearly 50 percent. In almost five years when the Real hit a low of 3.95 BRL to the US-dollar (USD) back in October 2002, the Real has since almost doubled in value to the 2 BRL level. Historically Brazil has had a history of vulnerability from periods of hyperinflation to international economic shocks as reflected with Mexico 1995, Asian financial crisis in 1997-98, Russia in August 98 were events that precipitated the January 1999 currency devaluation for the Brazilian Real. Fortunately today, many can consider Brazil a great story as the nation has achieved both economic growth and credit success.
POLITICS: functioning free market democracy. Please contact us at BankIntro.com for details.
ECONOMY: steady economic progress. Brazil is a major world market with a population of 190 million, it is now the 10th largest economy in the world and the largest in South America. The economy is diversified, rich in natural resources and is opening up to the world for foreign investment. Today, Brazil is home to more car manufacturers than any other country including the likes of foreign conglomerates such as Volkswagen, Fiat, Ford, etc. Brazil is advancing and modernizing, major credit rating agencies have now awarded long term sovereign credit ratings just below investment grade status. This is a significant achievement for Brazil particularly since the days of hyperinflation in the 1980’s.
President Silva’s (‘Lula’) government is presently managing the economy well with Brazilian companies now enjoying access to lower-cost foreign capital. Lula has put forward a platform that includes tight budget policies resulting in fiscal prudence. He is balancing a cautious economic approach and the need for social developments to tackle poverty. Accordingly, financial markets within Brazil have rallied to market highs with the stock market now surpassing a market capitalization of $1 trillion USD equivalent, the metals rally continue to drive Brazilian corporate profits. Over the last few years, sky high interest rates have declined, Brazilian corporations have prospered with many increasing their exports to foreign markets.
Unlike the past, debt default risk in Brazil is not an issue with strong capital inflows providing for appreciation into Brazilian bonds. Brazil has successfully raised monies on the international capital markets at favorable terms with bond spreads declining dramatically since year 2002. The national government debt burden still overhangs but debt within Brazil has either been refinanced, retired or shifted to a Real denominated debt profile and held domestically which is favorable. Domestic debt default risk is now very low. Since year 2003, debt to GDP has been declining with public debt now at 50 percent of GDP (2006). Hence, debt service ratios have fallen. The country’s reserve to short term debt ratio is healthy. External debt ratios are at 25 year lows while sovereign bond spreads are at all time lows. Of importance, Brazil now with record trade surpluses has paid its debt owing to both the IMF and Paris Club.
Of importance, Brazil is now energy self sufficient in thanks to a large part due to a dramatic increase in domestic production of ethanol from sugar production. In addition, new technology focus has taken place with respect to Brazil’s offshore deep oil exploration. Brazil’s huge agricultural heartland is now an important supplier for ethanol energy. Of significance, Brazil realized oil independence in April 2006 whereby domestic oil production equaled consumption.
Brazil is a player in the world aerospace industry today. Embraer, Brazil’s aircraft manufacturer is the country’s largest exporter for foreign exchange and now the world’s fourth largest civil aviation company, an active supplier of regional jets in the global market. The company is also active in providing military hardware as well. Brazil’s aerospace industry is thriving, the Alcantara satellite launch and missile development centre located near the equator is becoming a very cost-effective operation for the world market in satellite launches.
Higher commodity prices helping to fuel the economy: mining - aluminum/steel, energy, agriculture. This boost to national income with higher commodity prices helped to swing the Brazilian current account shortfall to surplus since year 2000 with increased foreign direct investment. Today, Brazil is the world’s largest exporter of sugar, coffee and orange juice.
Economic Statistics
Total GDP as measured by purchasing power parity stands at $1.6 trillion USD (2006) with corresponding GDP/Capita at $8,600 USD. GDP market prices stand at $943.6 billion USD (2006). Real GDP growth rates include year 2003 at 0.5 percent of GDP, 2005 GDP growth at 2.3 percent, 2006 at 3.8 percent, year 2007 estimated at 4.4 percent of GDP, year 2008 projected at 4.2 percent. Inflation quotes include year 2007 targeted at 4.5 percent, 2008 forecasted at 4.1 percent, year 2006 at 4.9 percent, 2004 at 7.3 percent, year 2003 at 14.8 percent, year 2002 at 12.5 percent, 2001 at 7.7 percent, 1999 at 9 percent and 1998 at 1.7 percent. The current account is in surplus at 1.1 percent of GDP (2006) with the trade component in surplus at $46 billion USD (2006). Year 2000 current account deficit came in at 4 percent of GDP. The turn around in the current account is attributed to the Real devaluation then the rise in commodity prices. The fiscal account is in an overall deficit position of 2.4 percent of GDP for 2006 when interest charges are taken into account. The primary fiscal account is in surplus. For comparison, year 2003 fiscal shortfall was 5.1 percent of GDP. External debt for 2002 at 45 percent of GDP, the figure for 2006 dropped dramatically to 18 percent. Unemployment came in at 9.6 percent (2006). Upwards of 30 percent live below the poverty line (2005).
POSITIVE: hydropower supplies 90 percent of Brazil’s electricity, improvement in education services, successful AIDS strategy. CONCERN: crime - kidnappings, wealth gap between rich and poor, poverty, labour & pension reform required, taxation is too high, over-regulated economy, infrastructure investment upgrade needed, overburdened pension system.
BANKING SYSTEM: the banking system is prepared, good condition. Brazilian banks are considered to be credit worthy, profitable, strong reserve coverage, low asset quality problems. Gross international reserves are strong at $122 billion USD (May 2, 2007). Brazilian Central Bank ‘Banco Central do Brasil’ has the central bank benchmark ‘Selic’ interest rate at 12.5 percent (April 2007), well down from 19.75 percent in August 2005.
REGIONAL ANALYSIS:
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KNOWLEDGE: Reforms, Biotechnology
In the 1980’s, Brazil experienced challenging financial times. It was then bailed out by the IMF resulting in a nasty recession and a lingering anti-IMF sentiment by various segments within the Brazilian population. Brazil economic policy tends to be inward thinking due to the large domestic market instead of an export culture such as Japan. Brazil has to address the issues of finding solutions of their limited export base, high levels of bureaucracy, inadequate infrastructure in area’s of ports & roads, etc. Future export markets for Brazil include Mexico, Russia, India and China. Industry privatization has taken place from telecommunications to the banking sector during the 1990’s. Tax reform is also required as taxes are too high particularly with a consumer that is in debt, pension reforms are also required. Private savings need to be stimulated, government spending needs to be monitored and/or reduced. The economy should continue to diversify, it is expected that services will be the next growth area.
There is tremendous wealth potential for Brazil in biotechnology with potential patents for products derived from the Brazilian rainforests & plants. Estimates have the size of this massive potential industry pegged at upwards of a $2 trillion USD market. Brazil is blessed with great natural resources as it is almost entirely self-sufficient in oil production, the second largest oil reserves in South America. Bio-diversity, Brazil is the ‘lungs’ of the earth with the world’s largest rainforest. Perhaps in the future, Brazil will receive environmental credits for oxygen production to trade with polluter nations, these credits may significantly increase in the years ahead. Brazil’s eco-tourism industry is growing quickly with the overall tourism industry valued at $30 billion USD/year, a number likely to increase. Of major concern however, reports of acceleration of the deforestation of the rainforest in light of economic progress, Brazil must find a balance.
CURRENCY: ISO Symbol ‘BRL’, Brazilian Real. At time of review on June 4, 2007, the Brazilian Real had an exchange valuation of 1.9157 BRL to 1 US-dollar (USD) and/or 2.5839BRL to 1 Euroland euro (EUR). Although Brazil has had a history of hyperinflations with several previous currencies being debased, the Real has performed very well providing Brazil with great currency stability. The currency regime follows that of a float within an inflation targeted framework. The float has served Brazil well particularly during times of weak commodity prices as the exchange regime reacts like a shock absorber. As measured by purchasing power parity, the Real is close to par to the USD (May 2007).
CURRENCY HISTORY: the original Brazilian real became official currency in year 1690, this currency unit lasted until 1942 until it was replaced by the ‘cruzeiro’. The Real (Real Plan) came into circulation on July 1, 1994 replacing the former cruzeiro real. From October 1994 to January 14, 1999, the Real was under a managed floating/pegged exchange rate regime. The Real was floated on January 15, 1999 after an 8 percent devaluation on January 13, 1999. The Real accordingly fell 40 percent in value over the next 12 months versus the USD.
Historical exchange quotes include: year 1995 at 0.918 BRL to the USD, 1996 at par to the USD, December 1998 at 1.2 BRL, January 1999 at 1.519, February 1999 after the devaluation the exchange was re-valued at 2.15 BRL to the USD, April 22, 2000 at 1.78, April 2002 at 2.32, August 2002 at 3.1, October 2002 at 3.95 BRL (low) during the election hype fears, April 2003 at 3.11, June 2004 at 3.128, November 2005 at 2.213, March 2007 at 2.089, May 16, 2007 breaching the 2 BRL level. Currency crisis dates include: January 1986, February 1986, February 1987, July 1989, January 1990, February 1990, December 1993, January 1994, March 1994, January 1999.
CURRENCY FORECAST: continued modest appreciation to the USD as the USD is expected to weaken further upwards of 15 to 25 percent to a trade weighted basket of currencies. Brazil’s economy is sound, lower interest rates, lower debt servicing, the country is in much stronger shape when compared to ten years ago. Currency risk: the BRL is vulnerable to quick change to investor sentiment , an up tick inflation risk remains and/or significant market correction in world commodity prices. The BRL has benefited from interest rate differentials boosting capital & portfolio inflows. However, now with rising US interest rates and potentially lower Brazilian rates, this may provide modest exchange pressure to the BRL valuation as the differential narrows. The Real has made great strides forward, Brazil warrants a stronger currency risk ranking. Indeed, there is light in the woods for Brazil.
