As has happened to other Emerging Countries (and not only), the history of Brazil is also studded with successes and failures. Decades of military dictatorship, high levels of inflation, high widespread poverty and high inequalities have been followed by democratic governments that have also been able to improve Brazil's financial condition.
To understand the risks to which Brazil is exposed and the possible reactions of the financial markets, it is advisable to briefly analyze the economic, social and political evolution that has characterized the country since the beginning of the new millennium.
PERIOD 2000-2010: LULA
During the Lula government, in the decade 2000-2010, the Brazilian economy grew by 4% a year. Social measures and the favorable economic situation help to bring tens of millions of Brazilians out of the state of poverty and increase the level of employment. Furthermore, the expansion of the banking system contributes to improving conditions in the country. According to the World Bank, between 2004 and 2012 Brazil would have reduced the country's state of "chronic" poverty by three quarters. At the end of the decade the economic situation is as follows:
– higher employment and low levels of inflation;
– easy access to credit;
– low taxation;
– low public deficit;
– expanding markets for goods and services.
PERIOD 2011-2015: ROUSSEFF
The country changes face. Dilma Rousseff takes the government, then reconfirmed at the elections in 2014:
– the level of development is much more disappointing;
– foreign investments are reduced;
– the labor market threatens to freeze;
– the public deficit is increasing;
– the consumer price index according to the latest IMF estimates is around 7,8%.
Various criticisms came from economic and financial circles, who accused the government of excessive public interventionism and called for a reduction of the role of the state in the economy. The Government, for its part, defends itself by attributing the blame mainly to the bad performance of the international economy. If the beneficial public interventions in the economy in the past had been financed with the growth of foreign demand for raw materials (especially Chinese) and food products, today the collapse of raw materials also linked to the slowdown of the Chinese economy is negatively influencing the economy of the country.
WHAT RISKS IS BRAZIL RUNNING?
In short: a fiscal and political crisis. According to the IMF, Brazil has a structural fiscal deficit due to tight spending that prevents a balance between spending cuts and tax increases. Social and pension expenditures are linked to the minimum wage indexed to GDP. Consequently, the fiscal adjustment is strongly linked to budget revenues, penalized by the contraction of economic activity and demographic deterioration.
The top left chart shows the IMF's structural fiscal deficit estimates and projections for a 15-year period. However, government officials deny the risk of a fiscal crisis. Finance Minister Levy announced an ambitious fiscal program for the next 7 years: a primary surplus target of 1,2% of GDP in 2015, followed by fiscal surpluses of 2% over the medium term.
But the works are late and the results have not been seen much. Bureaucratic inefficiencies and corruption also do not help (the Petrobras case on the eve of the elections is an example). Brazil appears to have entered a dangerous and unpredictable phase of political turmoil with the risk of a sovereign rating downgrade and political crisis (possible by the end of the year).
INVESTING IN BRAZIL?
According to our analysis, the Brazilian stock market has the worst valuations among the BRIC countries. Since 2011, the Brazilian stock index has lost about 23%. Earnings in the last quarter are flat. If we look at the Graham and Dodd P/E ratio (the ratio between quotations and the average of the profits generated over 5 years) it is higher than the long-term average, albeit decreasing.
Given the uninspiring valuations of emerging markets, we have already consciously reduced our exposure to emerging markets for some months (June).
