For nearly three centuries, Brazilians have been flocking to the streets adorned in colorful costumes for their annual Carnival. There’s no shortage of whimsy here, and it’s a time-tested tradition that attracts visitors from across the globe.
But there’s more to Brazil than just a big party. While its economy may not be prime for celebration right now, it did take years for Carnival to get internationally noticed. Why shouldn’t an emerging country also receive adequate time to build itself?
Last year, Brazil was slighted by investors as one of the “Fragile Five” emerging market economies because it was deemed as being over-dependent on foreign investment. Brazil was also one of the market economies hit hardest by capital flight after the US Federal Reserve announced plans to reduce stimulus policies that initially encouraged international investors to allocate money to so-called riskier assets.
We believe the lackluster image that has been given to Brazil may be unwarranted. Brazil maintains a strong fundamental growth story. The country has an ample supply of quality companies. Many of our holdings are market leaders in their respective industries and have strong businesses that are well-equipped to weather any economic or political swings.
The country has now grown to become the world’s seventh largest economy with a population of more than 200 million people. It is also South America’s largest country and abundant in natural resources.
Of course, these strengths do not mean Brazil is without obstacles. Corruption concerns and excessive government intervention in its economy are also driving up costs that make the country among the harder countries to conduct business in.
Brazil’s historical emphasis on supporting domestic industries also created a slew of taxes and tariffs that limited imports. With such a protected domestic market, companies had little reason to become efficient, and the prices of goods rose to an unfavorably higher price.
The country’s stock market is also hitting a bump on recent news of President Dilma Rousseff’s re-election in October 2014. Investors worried that her continued leadership would prevent policy changes. But we believe Brazil is learning from past outcomes, and we foresee Rousseff being more open to alliances with political counterparts who are more market-focused and business-friendly. We’re already seeing some shifts in motion.
Joaquim Levy was recently named finance minister, which signals that more market-friendly policies are likely to be adopted. His announced plan is to bring the primary surplus before interest payments down to 1.2% of gross domestic product (GDP) this year. He then plans to raise it back up to 2% moving forward after that. The whole point of doing this is to restore credibility, in hopes that greater certainty will boost private investment.
Former Treasury Secretary Nelson Barbosa is transitioning to planning minister, in charge of major infrastructure projects. This is vital to the development of Brazil’s rich natural resources industry. Often, the issue with having abundant resources is having the proper infrastructure upgrades (which require substantial funding) in place to keep up with growing demand.
The Brazilian government’s declining popularity under Rousseff is adding pressure on the country to address all the economic problems it’s facing, and we expect to see more discipline in the fiscal and economic policies that it rolls out. For Brazil to continuing growing on the world stage, it needs to focus on exports, which currently account for only 10% of the nation’s GDP.
Over the long-term, increased exports would support the Brazilian currency and help reduce imported inflation. In turn, this would lower domestic interest rates and debt servicing costs, potentially supporting consumer demand.
We expect that Brazil’s growing young population will also help foster demand by driving urbanization, industrialization and domestic consumption. As purchasing power rises, there will be potentially many new investment categories that service this population, including shopping mall developers, retailers, financial services providers and consumer goods companies. This will foster a stronger economy.
In short, what Brazil needs more of right now is liberalization – the freedom to change, adapt and grow – much in the unobstructed way that Carnival has been able to evolve these past centuries. Because Brazil cannot afford another restrained economy or “lost decade” like the one it experienced in the 1980s. That is one party we wouldn’t want to attend.
By Nick Robinson, Director - Head of Brazilian Equities at Aberdeen Asset Management