Sunday, 4 May 2008

“Passamos A Ser Donos Do Nosso Nariz”

At last we are masters of our own nose

The international rating agency Standard & Poor's announced on 30 April the upgrading of Brazil from BB to BBB- (BBB-(minus): is the lowest rating above non-investment grade BB) with which the country joins the group of "reasonably secure countries for investments". On the stock market in São Paulo (Bovespa) the value of shares rose dramatically after the news broke, while the shares of Brazilian companies listed on the stock exchange in New York joined the euphoria.

President Luiz Inácio Lula da Silva commemorated the promotion to "investment grade" with the words:
"I don’t know how to pronounce the word, nor what it means, but if it is translated into a language Brazilians understand, then it seems, that Brazil is classified as a serious country … .. It is a victory for the Brazilian people, which waited for this moment for years. With this new classification, there is no doubt that Brazil is now a serious country." Clearly alluding to the infamous words of Charles de Gaulle.
According to Lula, the upgrading is of great importance. "It is the guarantee that we are now master of our own nose, and can decide on a policy which we deem suitable for Brazil."

Of course the national press was full of praise and positive analysis and even the international press could not remain at the sideline to extol Brazil to the skies.

The British "The Independent" suggested that the Brazilian economy undergoes a "carnivalesque experience.”
The "Financial Times", meanwhile, put Brazil “among the first countries on the investment list", although it warned that the prevailing high interest rates could impede economic growth.
The French newspaper "Les Echos" wrote that the country "is bathing in sweet euphoria" referring to the absurd stock market rise of 6% in São Paulo within one day.
The Spanish "El País" pointed out that the addition of Brazil to the list of "secure countries" will encourage investors to switch from the speculative markets to a secure investment in this country."
Economists expect that some 1,000 billion USdollar will enter the country.

The essential advantage of the change to investment grade is that large institutional investors, who according to their statutes only can invest in low risk assets, are now allowed to invest in Brazil, as the classification is an instrument that reflects the risk of a country being capable of complying with its obligations. The higher the classification, the lower the risk, and with it the likelihood that investment capital will enter the country.

The president of the Central Bank, Henrique Meirelles (see photo), called the S&P decision "very significant." For him, it shows that Brazil has sufficient immunity against external shocks.

But if everything is so positively judged by everyone, why do I feel so worried about it.
Fortunately I am not the only one as a few critical comments appear on various blogs. Just let’s take one. A résumé of the blog of Jose Paulo Kupfer, a renowned Brazilian journalist.

Résumé: By upgrading Brazil, S&P has completely ignored its own fundamental parameters. Where are the tax reforms, the redesign of the labour legislation and the reconstruction of the social security? And what about the correlation between government debt and GDP, which should be 30%, but actually is more than 40%. And Jose ends by saying: "It looks like, that Brazil has given some "grant" to the "dilapidated" reputation of S&P."

I conclude with my own vision.
Across the board the new classification by S&P has induced euphoria. However, it is questionable whether that is based on real grounds. I admit that the elevated standards for Brazil - to investment grade - will cause an influx of foreign capital. As a consequence, many Brazilian companies can negotiate loans against better conditions abroad, but at the same time, many smaller and medium-sized Brazilian production companies will be pushed even harder to keep up their export due to the USdollar falling further against the real. Although the volume of Brazilian exports measured in USdollars will not diminish, as the overwhelming part consists of commodities (not enriched raw materials and agricultural products), which prices are determined by the market in Chicago, many companies with manufactured products are forced to discontinue their exports. It is obvious, that it will not be beneficial to the country as all manufacturing companies have to concentrate exclusively on the home market. Without doubt the home market will grow, but never to the extent that it will benefit from the S&P classification. Exports of manufactured products will decrease, while the imports increase, both due to the declining value of the USdollar. The trade balance will, as a consequence, entirely rely on the export of commodities whose price is determined by Chicago in which Brazil merely is the direct object. No significant exports in manufactured products with added value almost always lead to a fatal blow to a country.

But there is yet another side to the new upgrading of S&P, which is much more dangerous and could even be disastrous. With the crisis in the U.S. housing market, S&P (and other financial graduators) demonstrated its absolute ignorance, or its involvement in the manipulation of the banking system. It would not be the first time that S & P and its peers manipulate an economy of a country, after firstly praising it into the sky, and then opening the door to hell for the mere benefit of the big money guys.
What is more, we live in a special time cycle. The valuation of the real is only partly due to the performance of Brazil itself and for the other part to the fact that the U.S. is ruled by the worst president of all time and that in an election year the economic cycle of a free fall of the currency always can be observed. That means that after the U.S. presidential elections have given certainty about the successor, the dollar will rise worldwide, as the financial institutions "suddenly" discover new confidence in the economy of the country. This will certainly happen if Barack Obama is elected as president. In the unlikely event that John McCain will be president, I believe, the dollar will probably continue its free fall.

This means that in 2009 another ratio will be seen between the dollar and the real. But beginning in 2009 Brazil seriously starts thinking about the succession of Lula. Herewith we enter the next time cycle of elections, which will have a negative impact on the position of (in this case) the real. We have also seen this during the presidential election to replace the predecessor of Lula, during which the real grossly was manipulated (not to use the word speculated) by the financial institutions with the ABN / AMRO as the frontrunner. If we run in a situation that the U.S. economy shows an improvement, as a result of the appointment of a new president and the period before the Brazilian presidential elections shows no absolute clarity about Lula's successor, the value of the real against the dollar will deteriorate.
That is also the moment the international financial world will withdraw its investments from Brazil to profit in the short term.

I shall illustrate this danger. I read in ValorOnLine, the following:
"The private sector has been hopeful about reducing the financial costs due to the upgrading.
For Renato Vale, president of CCR, one of the largest transport companies in the country, Labor Day was one big party. The CCR, which in March won a concession for a piece of the Rodoanel in São Paulo, is currently negotiating abroad a loan of 1.6 billion reais to be paid to the government of São Paulo. The upgrading of Brazil means a savings of several million USdollars in drawing expenditures on foreign funds."

Ok, let’s assume that CCR indeed attracts BRR 1.6 billion (the rate is now USD = 1.60 BRR, thus USD 1 billion) with an interest rate of 5% from the international market. The investor pays in USdollars and both interest and principal have to be paid back in USdollars. 5% interest means an annual interest charge of USD 50 million or 80 million BRR. Suppose he has a payback period of 10 years. That represents is an annual redemption of 100 million USD or 160 million BRR. Total = 150 million USD = 240 million BRR.
I believe the USdollar will return at a rate of around 2.25 BRR, as a result of two presidential elections, restoration of the US economy, the future expectations of the Chicago commodities market, rising imports and the lack of Brazilian exports of products with added value.
This leads for CCR in a rise in annual payments of 240 million to 337 million BRR. It is of no importance whether the dollar changes +5% +10% or in any other different value. The fact remains that a Brazilian company suddenly is facing much higher operating costs and a much higher debt.

We have seen this before. In Pará during the government of Fernando Henrique Cardoso, shipping companies in the Amazônia region could arrange loans from the BNDES (National Development Bank) to build ships for the expansion of the transport capacity in the region. The loans were in USdollars (rate 1:1), although the revenues of the companies were in BRR. We do not have to detail here (see above) what happened during the election year of FHC/Lula (picture right). Suddenly, but insurmountably, the companies faced payments, which were 2 to 3 times higher, than they were accustomed to. It took many on the verge of bankruptcy.
Brazil is not (yet) in a position to withstand foreign manipulation or speculation as the country’s economic cushion is (still) too fragile.
History repeats itself. Always.

I'm afraid that's Lula’s: “Passamos a ser donos do nosso nariz”, will end up with people getting their nose pinched.

80469 - cartoons courtesy of J. Bosco/O Liberal

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