Emerging markets: The Brazilian play

Canadian Business
March 30, 2009

Should Brazilians be doing a samba? After all, the country’s closed economy has bolstered its immunity against the global downturn. Although it contracted in the last quarter of 2008, analysts expect it to accomplish over the course of this year a seemingly rare feat: growth. True, the projected growth rate by the International Monetary Fund is a modest 1.8%. But that’s a much better prospect than shrinking western economies face.

David Creighton, president and chief executive of Cordiant Capital, a fund manager based in Montreal, has been investing in Brazil since 2001 and has about $85 million invested there. It’s his top pick among the BRIC markets because of its good regulatory environment, which he says has reduced the effects of the economic storm. For institutional investors, Creighton figures the best way to get Brazilian exposure is through private equity and debt instruments, which offer direct access to management. And he might be on to something. Brazil is the most popular destination in Latin America for private equity: almost two-thirds of all Latin America PE dollars went to the world’s 11th-largest economy between 2002 and 2008, according to the Washington, D.C-based Emerging Markets Private Equity Association.

One attractive feature of Brazil is that the domestic market consumes more than the country exports. There’s also the growing middle class. Last year, nearly 52% of Brazilians earned the middle range of the average income, between 1,064 reals and 4,561 reals (about $575 to $2,500) a year. That’s in part thanks to government efforts to curb inflation (now at just more than 5.8%) and its focus on increasing the number of jobs with health and pension benefits. Middle-class growth has also coincided with political stability, which will likely endure beyond next year’s election and the departure of popular President Luiz Inácio Lula da Silva.

For retail investors looking to cash in, Creighton suggests looking at Brazilian blue-chips – especially Petrobras Energia (NYSE: PBR), which has just signed an agreement with China to export 60,000 to 100,000 barrels of oil every day.

Oscar S_nchez, Scotiabank’s Latin America senior economist, chooses Brazil as one of his two top emerging-market picks – in part because two other BRIC countries are under such intense pressure. Russia has faded because of its heavy dependency on the quickly collapsing oil price; India, Sánchez thinks, will be slow to pull together a strategy to deal with the global recession. But Brazil deserves top marks in its own right. “The Brazilian economy is more closed than the rest of Latin America,” explains Sánchez. “Trade is just one-quarter of GDP, and the domestic economy is slowing, but not as much as the foreign sector.”

Those factors, combined with its strong fiscal stimulus plan and independence from the U.S. economy, make it attractive for foreign investment. Moreover, early in 2008, Brazil improved its debt rating to investment grade. The nation’s popularity with investors can be seen in the recent performance of its São Paulo stock exchange, Bovespa, which has grown in tandem with the Shanghai exchange this year, says Sánchez. For retail investors, Sánchez says the energy, auto, commodity and agricultural sectors all have potential.

Not everyone is so keen. Walter Molano, head of research at BCP Securities LLP in Connecticut, noted in February’s Latin Business Chronicle that for the first time in more than seven years, Brazil posted a trade deficit; exports dropped 29% year over year in January, resulting in a shortfall of US$518 million. Molano still expects the economy to grow 2% this year, but he questions whether the country’s loose policies around automobile loans could be its version of the sub-prime meltdown. And Marcelo Carvalho, Latin America economist for Morgan Stanley, argues that the commodities boom spurred the growth in Brazil’s middle class, which might stall now that commodity prices have slumped. Adding some weight to his argument: on March 3, Vale Inco Ltd., the subsidiary of Brazilian mining giant Vale (NYSE: RIO), announced it would cut 900 jobs, 350 of them in Canada.

It might be too early to strike up the band just yet.