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Re: ANALYSIS FOR COMMENT - Brazil's recession

Released on 2012-08-02 04:00 GMT

Email-ID 1393779
Date 2009-06-04 17:09:50
"Brazil's financial system has proven one of the world's more robust in
stressed times. Tier 1 capital ratios are high (12%-13% for major banks),
as are reserve requirements (30% pre-crisis). Domestic sources provide 96%
of bank funding." --second bullet on pg 4 of Goldman's "Brazil vs.
Russia: Resilience vs. Valuation" April 7th, 2009. attached.

Robert Reinfrank
Austin, Texas
P: + 1-310-614-1156

Karen Hooper wrote:

Do you have a source for that 95 percent number? That would surprise me
if it were true since foreign companies control 30 percent of Brazil's
bank deposits.

Robert Reinfrank wrote:

Nice work and an interesting read. You may want to touch on the fact
that Brazilian banks are also forbidden from lending in foreign
currency, a practice which has trashed other emerging markets, and
that domestic banks also account for ~95% of lending and therefore
don't have to deal with capital flight that have completely enervated
economies like Russia's.

Robert Reinfrank
Austin, Texas
P: + 1-310-614-1156

Karen Hooper wrote:

Please let me know if you see places that are particularly wonky. I
will make sure this gets a heavy vetting for understandability by
the average reader before this goes to edit.

As the financial crisis takes its toll, STRATFOR continues to watch
the impact of the global economic downturn on Latin America, a
region that has a history of relatively regular economic crises.
Perhaps uniquely for Latin America, the origins of this crisis have
nothing to do with the Latin American policies this time around, and
everything to do with instability in developed nations. This is cold
comfort, however, as many developing states -- in Latin America and
abroad -- have been shaken to the core by shrinking capital markets
and plunging commodity prices. In this addition to STRATFOR's
Recession Revisited series, we consider the impact of the crisis on
Brazil, a developing country that is perhaps uniquely well suited to
weathering the storm.
The Geopolitics of Economics in Latin America
>From the very beginning, Latin American states have been hampered
in development by their own geography. With enormous geographical
barriers to economic expansion, integration and trade, Latin
American states started off at a disadvantage from the moment of
independence. Without major river systems [LINK to weekly] to
facilitate exploration, settlement, development and trade, Latin
American governments had to attempt to forge transportation links
throughout their countries using expensive foreign capital to build
railways and roads. The reliance on international capital put Latin
American countries at an immediate disadvantage, and the region's
early history is characterized by numerous debt defaults to former
colonizing nations. Without the ability to build reliable
transportation networks, it has been extremely difficult for Latin
American countries to accumulate domestic pools of capital, thus
reinforcing the cycle of underdevelopment.

The one river system that could potentially foster the kind of
development that has characterized the United States is the Rio
Plata. But the Rio Plata system is split among four countries --
Brazil, Argentina, Paraguay and Uruguay -- and no one country has
succeeded at utilizing the river's transportation potential as a
stepping-stone towards development. Indeed, the perennial (if rather
anti-climactic) struggle between Brazil and Argentina to exert
maximum influence in the politics of the states that buffer the two
South American giants (Uruguay, Paraguay and Bolivia) exemplifies
the slow-rolling competition for control over the river drainage

At the moment, Brazil appears to be winning the struggle [LINK] for
influence in South America, but it has been a long road for the
Amazonian nation.

Since independence in 1822, Brazil has bounced among many different
economic management models. Much of Brazil's history was
characterized by cycles of boom and bust related to oscillation in
the price of key Brazilian commodity exports -- primarily coffee and
sugar in the country's early history. In the 20th century, Brazil
has gone through periodic spasms of industrial development and
growth, punctuated by severe economic downturns, which culminated in
an economic crisis in the late 1980's and early 1990's that was
characterized by inflation of more than 2,400 percent per year.

Plano Real, which finally solved Brazil's hyperinflation problem,
was spearheaded by then-finance minister Fernando Henrique Cardoso
in 1994 and established the currency Brazil uses today, the real.
Aimed at cutting to the heart of the inflation problem -- massive
and persistent government deficit spending -- Cardoso and his team
drew up a balanced budget, and started a sustained public relations
campaign to convince weary Brazilians that this anti-inflation plan
would work (with an understanding that public acceptance of a new
currency is key to maintaining its value). The real succeeded in
maintaining a stable value, and Cardoso rode this success to the
top, becoming president in 1995. Once in office, Cardoso pushed
through a series of reforms. Many of these reforms necessitated a
turnaround in Brazilian economic policy. Brazil abandoned the ideas
of export-led growth and import substitution industrialization
[LINK] and turned its sights towards cultivating liberal
institutions and encouraging foreign direct investment. Cardoso's
successor, Brazilian President Luiz Inacio Lula da Silva, continued
the country's policies of fiscal prudence.
Brazilian Banks
Included in the reforms pursued in the late 1990's was the complete
reorganization of the Brazilian banking industry. In the days of
hyperinflation, banks were able to turn a quick buck by exploiting
fluctuating currency value, and the whole enterprise was at once
very profitable, highly corrupt and run by a unique set of rules.
Once the currency was stabilized, many Brazilian banks that had poor
accounting standards (something they could sustain with high profits
from the hyperinflation) were unable to carry on. Several bank
failures (in some cases of major banks) required a government
bailout, led by the Brazilian Central Bank. Once involved in bailing
out the banking sector, the Cardoso government was able to lift
restrictions preventing foreign investment in banking and establish
very conservative regulations on the sector.

These regulations include some of the highest (if not the highest)
reserve to deposit ratios in the world, at about 50 percent (prior
to the crisis)***. Inspired in part because of fears that too much
liquidity could endanger the stability of the real, this essentially
means that for every real put into a Brazilian bank, the bank can
lend half, but must keep the other half in a vault. For the sake of
comparison, the United States maintains a reserve ratio of about 6.5
percent (depending on the size of the bank and type of deposit).
China's reserve ratio is about 15 percent.

This does two notable things for Brazil: It slows growth because the
banks have to maintain a tight grip on their capital, and makes the
banks incredibly capital rich compared to other banks.

Brazil has not been able to achieve the kind of growth it has
yearned for, despite a relatively stable decade. Where China and
India have seen growth rates soar, Brazil has had to be satisfied
with a growth rate that has hovered around 5 percent in recent
years. Though there are many reasons for this, part of Brazil's
plodding growth rates can be linked to the reserve ratio. By
reducing the amount of loans that can be made from bank deposits,
Brazil permanently limits the amount of credit available to
Brazilians. This stifles growth by restricting economic activity --
capital is simply not as available for start-up companies to get
loans, or existing companies to pursue innovation -- more, at least,
than would a lower reserve ratio. This is exacerbated by a culture
of extreme caution among Brazilian banks, which generally refrain
from uncertain investments in order to maintain a high ratio of
capital to risk.

Ultimately, however, the reserve ratio also serves as a very
effective insurance policy. Not only does it mean that banks have a
harder time failing (if some loans go bad they still have plenty of
cash on hand, whereas if the banks only maintained a 3 percent
reserve ratio, it wouldn't take many bad loans to make the banks
technically bankrupt). This also means that in a time of scarce
capital resources the world `round, Brazil has the resources it
needs to create liquidity. Though the Brazilian government has been
cautious in loosening the reserves, it did let about $50 billion
worth of reserves go in the first months after the crisis hit.

As a result of Brazil's fiscal prudence over the past 14 or so
years, the central bank has managed to store away $190.5 billion in
official reserve assets***. Before the financial crisis, these
reserves were even higher, at almost $207 billion. The government
has another $24 billion in assets controlled by the Brazilian
Development Bank (BNDES). In the private sector, capital
accumulation is uniquely high, among Latin American countries.
Because of extremely high reserve ratios on banking deposits --
which is the percentage of each deposit that each bank has to hold
onto, and cannot loan out -- the domestic banking sector boasts an
impressive $100 billion in bank deposit reserves -- down 38.5
percent from pre-crisis levels as the government has worked to
increase credit throughout the country. Furthermore, Brazil's
relative economic stability has earned the country the confidence of
investors, who have responded with substantial foreign direct
The External Sector
With domestic capital markets secure from the international turmoil,
Brazil's biggest worry in the economic crisis is its external
sector. Compared to many industrialized nations, Brazil has a
relatively small export sector, which comprises about 13 percent of
economic output. Of Brazil's exports, about 45 percent are
manufactured goods, 30 percent are in raw commodities (such as oil,
iron and soy), and the remainder is comprised mainly of
semi-manufactured goods.

Of Brazil's raw commodity exports, the energy sector is a
particularly strong and promising area. Although Brazil will have to
wait several more years before its recently discovered massive oil
and natural gas deposits can be tapped [LINK], the country has an
enormous amount of natural wealth that has clearly helped already --
in Brazil's strong relationship with China -- and will continue to
be a source of capital. Furthermore, Brazil's potential as an energy
exporter is enhanced by the fact that it is the leading producer of
ethanol, which means that Brazil can exploit the growing interest in
integrating biofuels into national energy mixes. It also means that
as soon as its oil wells do come online, they can translate much
more quickly into exports and revenue generation. If Brazil follows
through on plans currently under discussion to construct a
petrochemical industry around its oil extraction, the country will
find itself with a value-added industry that will further contribute
to development.

This commitment to value-added industry can be seen throughout
Brazil's economy, which is characterized by relatively broad
sectoral diversification. Brazil also has a substantial
manufacturing sector. Brazil exports a number of industrial products
that range from cars to petrochemicals to aircraft. Much of the
industrial sector is led by a set of very able national champions.
From Petroleos Brasilieros (Petrobras) [LINK] to Empresa Brasileira
de Aeronautica (Embraer) [LINK], Brazil has a number of both
publicly and privately owned companies that are extremely
competitive in international markets, and operate with the full
backing of the government. This well of strength is both economic
and political. Brazil's ability to extend investment [LINK] and
financing [LINK] -- a product of its substantial capital resources
-- to partner countries all over the world means that Brazil has a
growing number of opportunities even at a time of shrinking global

However, Brazil's manufacturing sector has been hit the hardest by
the downturn. While commodity exports were up just over 1 percent in
the first quarter of 2009 as compared to the first quarter of 2008,
manufacturing exports are down by 29.2 percent.

In part, the impact on the external sector was caused by instability
in the real. The financial crisis sparked immediate turmoil in the
Brazilian currency, and the real's value tumbled almost 40 percent
from highs in August to lows in December. The fall of the real
sparked a trade crisis with Argentina [LINK], in which Argentina
increased its non-tariff barriers to Brazilian goods (in order to
protect its industries from suddenly much cheaper Brazilian
imports), and exports to Argentina fell 49 percent from July to
March. Over the same time period, total U.S. imports fell 34
percent, triggering a 58 percent in Brazil's exports to the United
States. The fall in exports came as a particularly harsh blow
because the United States and Argentina tend to import higher
value-added goods from Brazil. Overall, exports have dropped almost
40 percent from highs in June -- due in part to the changing seasons
and the fall in commodity prices -- although they have rebounded 20
percent since January.

Contributing to this, have been Brazilian exports to China, which
have risen quite a bit in the wake of the crisis (after a sharp fall
during the lead up to the U.S. financial sector's meltdown [LINK]).
China's bid to secure access to natural resources all over the world
has led the country to utilize its substantial capital reserves to
cement business partnerships while prices are low, with an eye on
securing access to the resources of the future. This has led China
to stockpile some commodities, and seek partnerships with major
natural resource producers, such as Brazil. Although China's
increased imports from Brazil have been instrumental in spurring a
current account surplus [LINK], because China's demand is primarily
for commodities and unprocessed goods, increased trade with China
cannot fix the damage to Brazil's manufacturing sector caused by
collapsed trade with Argentina and the United States.

There do appear to be some signs of recovery in the external sector
already. After dropping by 17 percent in January, year-on-year,
industrial production has increased for four straight months. Trade
is recovering with some partners, including the United States. The
Brazilian real has also begun to appreciate, although it is too
early to say if the rally in markets around the world is here to
stay. However, this is a mixed blessing, as the lower value for the
real is a boon to Brazil's manufactured goods exports (commodities
are all dollar-denominated). Brazilian Central Bank officials have
sought to keep the Brazil at its devalued rate in order to hold on
to the advantage.

Unlike its southern neighbor, Argentina, which must keep its
currency from devaluing or risk the rapid inflation of its foreign
debt, Brazil's foreign debt profile is actually in pretty good
shape. Brazil's foreign debt has held steady for the past several
years, but GDP growth has brought foreign debt as a percentage of
GDP down from 42 percent in 2002 to 12 percent in 2008. This is not
to say that Brazil's debt structure is entirely rosy, as Brazil's
total net public debt remains at 37 percent of GDP. With most of the
debt held in domestic hands, it gives Brazil more flexibility to
adjust its monetary policy vis-`a-vis its external markets, and it
is an indication of the substantial capacity of the domestic capital
Although Brazil has experienced a number of very serious challenges
in relation to the international economic crisis, Brazil is
remarkably well positioned to handle the crisis -- something that
distinguishes Brazil from its Latin American fellows, and from
developing nations all over the world.

Although Brazil's first quarter GDP measurements have not yet been
released, the country appears to be well positioned to weather the
storm. Official government estimates put Brazilian growth at about 1
percent in 2009 -- which would make it one of the few states to grow
in the coming year. Even if Brazil's economy does shrink this year,
it will be slight. And following the recession, Brazil may well be
one of the countries best positioned to come out of the crisis
stronger than it went into it.

Karen Hooper
Latin America Analyst

Karen Hooper
Latin America Analyst

Attached Files

118818118818_Brazil vs. Russia.pdf343.4KiB