A worsening terms-of-trade, reduced capital inflows and diminishing domestic credit availability will generate major headwinds for the Brazilian economy in the months ahead.
T he outlook for the Brazilian economy remains dim despite monetary easing. Brazil’s terms-of-trade has already rolled over and there is potential for a further slide in the country’s export prices. In addition, foreign funding is set to dry up as European bank deleveraging limits funding available for developing nations.
Brazil, in particular, would feel the pinch since European banks hold $350 billion in claims out of a total of $540 billion in foreign claims. Apart from funding difficulties, a deterioration of credit portfolios warns of severe constraints to private bank lending. Consumer delinquency rates are rising even though the unemployment rate is at a record low and income growth has been solid. The main reason for increasing defaults is that debt-servicing costs in Brazil have risen sharply and remain high relative to income.
As the potential credit crunch and deteriorating external environment weigh on growth and corporate profitability, the employment situation and wage growth will worsen and household delinquency rates will likely rise even further. Even the ongoing currency depreciation may fail to boost growth. Exports account for only 12% of Brazilian GDP so the positive impact from currency depreciation is limited, especially if commodity prices drop further. Also, the ongoing currency depreciation coupled with falling share prices could discourage capital inflows.
Bottom line: Our Emerging Markets Strategy service continues to recommend underweight positions in Brazilian equities within EM portfolios.