Brazil’s powerful economic growth literally slammed to a halt during the third quarter. It was precisely zero. Of course, there were several obvious factors in the decline, such as the global economic slowdown, the debt crisis in Europe and Brazilian President Dilma’s Rousseff’s efforts earlier in the year to fight inflation with a combination of higher taxes and interest rates.
But beneath the headline numbers, the data also shed some light on another long-term factor in Brazil’s growth—the relative weakness of its capital spending, which fell 0.2 percent from the second quarter. Meanwhile, industrial spending fell 0.9 percent, far surpassing the 0.1 percent drop in the consumer sector. The temptation might be to blame all of those industrial setbacks on the relatively strong local currency, the real, which made Brazilian exports more expensive. But another reason is the country’s still underdeveloped debt capital markets, which have held back infrastructure development, both a source of jobs and a foundation for economic activity.
Brazil’s economy has evolved light years beyond the crisis era of the 1980s and early 1990s, when growth stalled and inflation peaked at 1000 percent. But it still lacks longer term debt instruments, which makes it difficult to fund major infrastructure projects. “Infrastructure investment is the handmaiden of long term growth,” says Eric Lascelles, global chief economist at RBC Asset Management. “Let’s not overstate the case—a country can get by for years without long-term debt. But it will be a brake on growth, as Brazil’s third quarter report shows.”
It might seem strange to talk about the lack of growth in Brazil, where 7.5 percent GDP gains in 2010 were among the few bright spots in the global economy. But that growth has turned out to be volatile, and even at its peak, it lagged the gains in other developing markets such as India and China. Infrastructure development has been a big factor in China’s world-leading growth. “Brazil lacks that sort of investment,” Lascelles says.
Why is that the case? The country has yet to fully escape the legacy of crisis. “Debt market allergies can last decades,” Lascelles says. Inflation in Brazil is down from the wild peaks of the 1980s and 1990s, but it is still relatively high, at just under 7 percent. That is well above the government target of 4.5 percent. That in itself is a disincentive to long-term fixed income investors.
Even worse, lending rates in Brazil are tied to inflation. Last month, the country’s Central Bank Monetary Policy Committee reduced its overnight lending rate to 11 percent from 11.5 percent. The rate is expected to remain at the 10 percent level next year, when inflation is expected to be in the 5 percent range. In that sort of lending environment, borrowing for 10 years, let alone 30, is all but impossible.
“What Brazil needs now is long-term money,” says Alexandre Aoude, global head of fixed income and derivatives at Itau BBA. “Credit in Brazil is very short term—five to seven years. You can’t borrow for 30 years. Inflation is still too high; people don’t want to lend that long,” says Aoude, a former CEO of Deutsche Bank’s business in Brazil.
To the extent that long-term financing exists in Brazil, it mostly takes the form of longer term bank loans. In most cases, banks hold those loans on their books, because securitization is limited, too, according to Aoude.
The local high-yield debt market is all but nonexistent, further limiting the pool of funds available for longer-term investment. “I don’t see a lot of money from the U.S. coming into Brazil, and the money that does get invested first goes to equities and the investment-grade debt market,” Aoude says.
The use of credit derivatives in Brazil has been scaled back in the wake of the credit crisis of 2008 and 2009. Derivatives are used mostly for “plain vanilla” purposes such as interest rate swaps or corporate hedging of commodity prices. “We don’t have the experience or demand to support other kinds of derivatives right now, although I expect that as liquidity returns, we will see more tools to enhance returns,” Aoude said. For now, though, local hedging products—which can be used to mitigate the risk of longer-tern investments—are highly regulated and expensive.
At just 17 percent of GDP, Brazilian infrastructure spending is way behind that of China (44 percent), India (38 percent) and Russia (24 percent), according to a report last year by Morgan Stanley. Brazil’s infrastructure spending lags on a regional basis, too—spending levels in Mexico and Peru are in the 20s, according to Morgan Stanley.
China, with its $3.2 trillion in foreign currency reserves, can afford to write a check for much of its development. That isn’t the case for most countries, including Brazil, which rely on debt capital markets. Until the country’s financial infrastructure gets to the next level, its physical infrastructure will lag as well.
Of course, Brazil’s economy can grow strongly without that infrastructure, thanks to its natural resources, a strong educational sector, and a solid governmental and legal framework. But lacking a fully developed financial and physical infrastructure, Brazil’s economic miracle might not be quite as spectacular as that of India or China.
