Last year when I visited Brazil I was cautiously optimistic, and returning again this year, I remain so. We were expecting problems, but we were encouraged to see some signs of change taking place and are hopeful that as host of the 2016 Summer Olympic Games this year, Brazil will have the opportunity to shine. People find it difficult to believe the situation will turn around in a downtrodden market like Brazil, but we have found that, in general, the time of maximum pessimism marks the time when a bottom is near, and that’s the time we want to be investing. Given all the dire headlines swirling around Brazil over the past year—including corruption scandals, ratings agency downgrades, a severe recession and the Zika virus—it may seem surprising that Brazil’s stock market is actually up more than 10% year-to-date.1 While the market seems to be reflecting some of the optimism we see, it may take some time for Brazil’s economy to recover. My recent travels there confirmed the potential we see as investors in Brazil, and that opportunities still exist there. An Economic Quagmire As my team and I took off from Buenos Aires, Argentina, for the two-hour flight to São Paulo, we wondered what the mood of the Brazilian people would be. Brazil has been mired in a terrible economic situation. Gross domestic product (GDP) sank 3.8% in 2015—the worst in 25 years—and is expected to remain negative in 2016. The Central Bank of Brazil’s key short-term interest rate, the Selic rate, is above 14%, inflation has been running above 10% and the unemployment rate was about 7%–8% at the end of 2015.2 Brazil’s currency (the real) has devalued significantly against the US dollar, and gross government debt as a percentage of GDP has risen above 60%.3 In the wake of a credit rating agency downgrades to below investment-grade status by two of the three major credit agencies, in September of last year the government proposed an austerity plan that included spending cuts and tax increases totaling about US$17 billion.4 The plan included cuts in tax incentives granted to the chemicals industry and manufactured exports, elimination of 10 government ministries from the current 37, a freeze on public employee salaries, a reduction in health care and low-income housing budgets, a new tax on financial transactions and an increase in the capital gains tax, from 15% to 30%. However, given the weak political position of President Dilma Rousseff, it was questionable whether the National Congress would support the proposed fiscal retrenchment. With her approval rating in opinion polls at a mere 7%, Rousseff probably figured she didn’t have much to lose if the measures were unpopular. Even Vice President Michel Temer opposed the financial transactions tax. Nevertheless, commentators said that even if the measures were passed, a further downgrade probably could not be avoided, and that’s exactly what happened. In February 2016, Moody’s was the last of the big three rating agencies to downgrade Brazilian debt to junk status. In its decision, Moody’s cited the combination of a low-growth environment, the likelihood that the government’s debt would exceed 80% of GDP within three years—annual interest payments account for more than 20% of government revenues—and the challenging political environment complicating the government’s ability to pass fiscal reforms.5 It is important to note that in late 2015, the Tribunal de Contas da União (TCU), Brazil’s federal audit court upholding the Fiscal Responsibility Law,6 voted to reject the government’s 2014 fiscal accounts, the first time this had been done since 1937. The TCU said Rousseff had manipulated the fiscal accounts in the run-up to the presidential election (making the accounts appear more attractive than they really were) with irregularities totaling about US$26 billion. Government expenditures were much higher than the government reported at the time, which led to a damaging fiscal situation creating high inflation and a deep recession. This led for calls for the impeachment of Rousseff, but a Supreme Court injunction in favor of Rousseff reduced this risk. Demonstrations that spread throughout Brazil this month were the biggest in history, with widespread support for the ongoing crackdown on corruption cases. The pressure has increased on the president and her position seems to have weakened further. While demonstrators continue to clamor for her removal or resignation, in my view, reform is what’s really needed in many areas, including labor, taxes and the retirement system, even if she remains in charge. Austerity measures in Brazil have had an impact on many sectors of the economy. A Brazilian airplane manufacturer we visited reported that the government’s austerity measures have forced it to delay the first deliveries of its much-anticipated cargo jets until the first half of 2018 from an original deadline of end-2016. The delays will affect not only the Brazilian company and other countries it has contracted with to deliver planes, but also the suppliers of the parts that they import from all over the world, particularly the United States. Exports a Bright Spot One bright spot for Brazil last year was a trade surplus. Due to lower imports and better-than-expected exports because of the weak currency, we think Brazil could maintain a good trade position but that remains to be seen. For example, automobile exports were up 37% in January 2016 on a year-over-year basis.7 As far as the domestic market is concerned, however, Brazil’s numbers for various industries have told a more depressing story. Retail sales, sales of automobiles and other durable goods, and industrial production have dropped and are not expected to see much, if any, improvement in the near term. Consumers’ purchasing power has been weakened by high inflation, while unemployment is hurting household income. Tax increases on a wide range of products, including cigarettes, chocolate and ice cream, haven’t helped consumer confidence, and companies have been delaying capital expenditures. Brazil has been in a difficult position due to a combination of government economic policy mismanagement, a major corruption scandal and very low commodity prices (Brazil’s is a major...
Investment Adventures in Emerging Markets - Notes from Mark Mobius
Mark Mobius, Ph.D., executive chairman of Templeton Emerging Markets Group, joined Templeton in 1987. Currently, he directs the Templeton research team based in 15 global emerging markets offices and manages emerging markets portfolios. As he spans the globe in search of investment opportunities, his “Investment Adventures in Emerging Markets” blog gives readers a taste for what he does, when, where, why and how. Dr. Mobius has written several books, including “Trading with China,” “The Investor’s Guide to Emerging Markets,” “Mobius on Emerging Markets,” “Passport to Profits,” “Equities—An Introduction to the Core Concepts,” “Mutual Funds—An Introduction to the Core Concepts,” ”The Little Book of Emerging Markets,” and “Mark Mobius: An Illustrated Biography."
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