Summary
Citing favorable inflation trends and good fiscal results in July, the Monetary Policy Committee cut the Selic overnight rate to 19% per annum on September 22. Since the middle of August, the Central Bank has increased its offer of dollar-linked bonds to provide a hedging instrument for the market to reduce pressure on the real/dollar exchange rate. While foreign exchange rates have fallen back from their August peaks, an anticipated interest rate hike by the FED could put further pressure on the currency in the last quarter. According to a private study, the banking system's net worth/assets ratio fell in the year to June 30, indicating an increased aversion to risk. Lower private bank bad debt and higher loan loss provision ratios also reflect greater conservatism on the part of both borrowers and lenders. Central Bank statistics confirm Citibank and BankBoston as the leading U.S. banks in Brazil in terms of assets. The stock market has been battered by drops in the New York market. August witnessed the largest monthly net outflow of foreign equities investment since January.
The current account deficit fell 9% during January-August on a year-over-year (YOY) basis. With both exports and imports in decline, the trade deficit was down 70% for the same period. Falling capital inflow contributed to a balance of payments deficit of US$2.3 billion in the first eight months of the year. The Central Bank estimates Brazil's external financing requirement in the remaining four months of the year at US$18.5 billion but private sector puts the total closer to US$20 billion. According to a Central Bank survey of financial institutions, at least 3% growth is expected for 2000 with the Selic rate averaging 16% for the year. Brazilian economist Luciano Coutinho has run a number of simulation studies that underscore the importance of export growth for the economy over the next few years. Consumer price inflation came in below expectations in August.
Two state enterprises set for privatization, the Brazil Reinsurance Institute and São Paulo state bank Banespa, have been hit by sizable bills for back taxes. The Banespa sale may well slip to the middle of 2000 if not later. The consolidated government primary surplus totaled R$20.7 billion for the first seven months of July, 68% of the annual target set in agreement with the fund. After four weeks of delay in the Lower House, the reform agenda is on the move again. Prospects for passage of further social security reform, the fiscal responsibility law, and implementation of the civil service reform by the end of the year are good.
Central Bank Policy
Monetary Policy
Selic Cut to 19%
Meeting in a scheduled "extraordinary" session on September 22, Brazil's Monetary Policy Committee (COPOM) acted within market expectations to cut the interbank reference rate (Selic) to 19% per annum from the former 19.5%. The "bias" continues to be neutral, signaling no intention to alter the rate prior to the next regular COPOM meeting on October 6. Commenting on the decision, Central Bank Director for Monetary Policy Luiz Fernando Figueiredo cited the lack of inflationary pressure and encouraging fiscal results as the main reasons behind the call. Some in the market opine that future reductions in the Selic rate will be constrained by an expected U.S. Federal reserve decision to raise U.S. rates at its October 5 meeting due to deterioration in our external accounts. COPOM also reduced the long term interest rate (TJLP) to 12.5% from 14.05% effective October 1. This is the rate charged by National Development Bank BNDES for long-term lending to the industrial sector.
Dollar-Linked Bonds
To Hedge Or Not To Hedge
According to data provided by the Central Bank of Brazil, the stock of Central Bank dollar-indexed bonds (NBC-E and NBC-F instruments) fell by R$2 billion from January to the end of July. With a surge in market nervousness at the beginning of August and a consequently increased appetite for hedge instruments on the part of the banking sector, the Central Bank acted on August 20 to prevent a further depreciation in the real versus the dollar by beginning a massive issue of such debt. The stock of the two Central Bank dollar-linked bonds rose by almost R$9 billion by the end of August (excluding coupon). After a week's hiatus at the beginning of September, the Central Bank resumed NBC-E auctions on September 10 but bank officials announced that further such auctions would take place on an occasional basis only to counter excessive oscillation in the foreign exchange market.
Further Pressure Seen
As debt sales mounted, market sources began to voice unease over the additional fiscal burden the bonds represent. (The stock of Government of Brazil dollar-linked debt (Central Bank plus Treasury) fell by R$17.4 billion from January to July as its share in overall federal bonds outstanding dropped six percentage points to 24.3%.) Market sources added that the price of the real also reflects the actual demand and supply of dollars in the foreign exchange market and that known private sector debt service needs to the end of October total some US$1 billion sans rollover. This demand will be countered to some extent by inflows of direct investment capital including a recent French acquisition of part of the Pão de Açúcar supermarket chain. Finally, an indication that demand for such hedging instruments has largely been satisfied is the increasing premium being demanded by the market to absorb dollar-linked debt.
Financial Markets
Banking System
Net Worth/Assets Ratio Down In 1999
A private study concludes that Brazilian banks have reduced their leverage significantly this past year. Based on a survey of 112 banks, the average net worth/assets ratio fell from 13.15% to 10.46% from June 1998 to June 1999. With aggregate net worth for the banks up 29% in the period, the decline reflects lagging growth in assets (up only 3%). The relative cutback in asset growth could reflect both a conservative lending policy and a reduction in risk assumed in options or futures contracts. Among major private banks, Unibanco is the most aggressive in terms of credit policy with a credit/assets ratio of almost 44%. In contrast, Bradesco has a ratio of only 34% and Itaú 30%.
Lower Bad Debt Ratio Reflects Lender, Borrower - Conservatism
Further evidence of a conservative banking sector lending posture is provided by the latest figures for banking sector bad debt and loan loss provisions. For the private sector, the bad debt ratio fell to 5.2% of outstanding credit in July from 5.3% in June and 5.4% in May. During a period of low growth and increased volatility in the first seven months of 1999, the average for this ratio actually fell to 5.1% this year from the 1998 average of 5.2%. These trends reflect both increased bank conservatism on the lending side and greater borrower reluctance to take on more debt at a time of increased uncertainty. Overall private bank lending to the private sector has been on the decline since January-February, although lending to some sectors such as industry has risen as domestic borrowing has become relatively more attractive for top Brazilian firms and banks remain willing to lend to such customers.
Loan Loss Provisions Up; Arbitrage Returns
The private sector loan loss ratio averaged 8.7% of outstanding credit for the first seven months of 1999 as compared with a 7.3% ratio for all of 1998. Media reports and discussions with market sources make it clear that the Selic rate, roughly equivalent to the bank cost of funds, and such factors as required reserve ratios have only limited influence on bank lending policies. Also important are risk (per type of borrower), the Bank's interest in cultivating long-term relationships with specific customers, and the continuing attractiveness of no-risk (at least in terms of bank capital adequacy ratios) and high return government bonds. We are also seeing an increase in arbitrage operations in which banks borrow abroad at around 10% per annum and invest in dollar-linked public debt at matching tenor for an assured rate of return several percentage points higher. In an effort to spread risk while providing longer term credit for Brazilian exporters, institutions are turning to "club deals" where several Banks participate in a syndicated loan, especially when larger amounts are involved.
Citi, BankBoston Assets Tops for U.S. Banks
According to Central Bank data on bank assets, two U.S. institutions, Citbank and BankBoston, are the 8th and 10th largest private banks in the country in terms of asset size. Chase Manhattan (32nd ) and American Express (minority U.S. interest, 49th) are among the top 50 banks, both private and public. Other U.S.-controlled banking institutions include Multibanco, General Motors, Liberal, Ford, and JP Morgan for a total of nine. Overall, five of the top ten banks in the country are public institutions. Banco do Brasil, BNDES, and the Federal Savings Bank are the first, second, and third ranking institutions in the country on this basis. The largest private banks are Bradesco, Itaú, and Unibanco. See table.
Top Brazilian Banks by Asset Size As of May 31, 1999
(US$ Billions)
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Name Type Assets
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Banco do Brasil Public 69.6
Federal Savings Bank Public 66.8
BNDES Public 44.0
Bradesco Private 28.2
Itaú Private 23.8
Unibanco Private 13.7
Banespa Public 12.8
Nossa Caixa Nosso Banco Public 8.7
Safra Private 8.3
Real Private 7.9
HSBC Bamerindus Private 7.7
BCN Private 6.4
Citibank Private 5.6
BBA-Creditanstalt Private 5.5
BankBoston Private 5.3
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Note: Values in domestic current converted to dollars at an average exchange rate of 180.7 reais to the dollar for the first three quarters of 1999.
Stock Market
Battered by NYSE
As of September 22, the São Paulo Stock Exchange Index (IBovespa) was up 9.2% for the month and 70% for the year in domestic currency terms. A lack of foreign investor interest and the negative effect of recent declines in the Dow Jones index have marked recent trading. The Annex IV account which includes foreign investment in Brazilian equities showed a net negative outflow of US$27 million in July and US$274 million in August.
External Sector
Balance of Payments
Current Account
Brazil's current account (CA) deficit totaled US$15.6 billion for the first eight months of 1999, a 9% improvement YOY. Nonetheless, the sharp drop in the dollar value of GDP due to devaluation resulted in a 12-month cumulative CA/GDP ratio of 5.02%, the highest since the early 1980's. Improving trade results and lower profit remittances relative to the huge outflow seen last September/October should contribute to a reduction in this ratio beginning in September. For the same 12-month period to August, the external financing requirement (CA deficit plus direct investment inflow) was only US$1.5 billion or 0.23% of GDP. Standouts in the CA were a 45% increase in net interest payments and a two-thirds drop in net spending on foreign travel. Inbound tourist spending was up only 2% for the January-August period in dollar terms while overseas spending by Brazilians dropped by almost 50%.
Trade Account
The merchandise deficit fell just over 70% to US$706 million for the eight-month period. Exports were down almost 12% and imports almost 16%. While the current Government of Brazil projection is for a US$1.5 billion surplus this year, the market consensus is for a balanced trade account. The value of basic goods exports fell 13% in the period, that of semi-manufactures 9% and manufactured product revenues were down 13%. On the import side, capital goods purchases fell the least at 10%. In contrast, consumer goods imports plunged 30%.
Balance of Payments Outcome
Balanced against a lower deficit in the CA was the almost three-fifths drop in capital inflow from January to August to US$13.3 billion. At almost US$21 billion, gross direct investment inflow was slightly above last year's pace while amortization payments almost doubled to almost US$37 billion. International reserves dropped US$2.3 billion in the period. Net foreign direct investment inflow for the period totaled US$19.9 billion, well ahead of the US$15.5 billion figure a year earlier. On a gross basis, investment inflow totaled US$23 billion through August, two-fifths of this related to privatization. The year-to-date privatization total of US$8.2 billion has already surpassed the 1998 full-year total by over US$2 billion. On a monthly basis, non-privatization direct investment is running 14% ahead of the pace set in the first eight months of 1998.
The Central Bank has issued revised projections for 1999 that imply that a further US$20 billion will be needed in the next four months to meet Brazil's external financing needs this year. While the official projection shows a gap of only US$18.5 billion, lower than projected trade performance will add to financing needs. See table.
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Uses of Funds 1-8, 1999 1999(projected)
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Total Uses 52,546 71,010
Current Acct 15,618 23,895
(Trade) 706 (1,500)
(Interest) 9,339 15,678
Amortizations 36,928 47,114
(Loans) 21,064 23,444
(Financing) 15,864 21,409
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Foreign Exchange
FED Could Undermine Recent Strength
After falling almost 9% against the dollar from the beginning of August to the 20th of that month, the real recovered some lost ground to close the month at 191.6, up 7%. With the increased sale of Central Bank dollar-linked bonds and an improved perspective on domestic developments in Brazil, the dollar retreated somewhat in the first three weeks of September to close at 189.1 by September 22 (Ptax basis). A rising trend in the São Paulo/Ptax ratio, which measures the gap between the parallel and official foreign exchange markets, is an indicator, however imperfect, of a greater degree of unease on the part of the Brazilian man in the street. The current expectation is that the prospect for higher interest rates in the U.S. could force the real above the 190 level in the next two weeks. To the end of the year, direct investment inflows and the Central Bank's demonstrated willingness to provide a dollar hedge to contain volatility are expected to keep the real/dollar exchange rate below the 2.0 level.
Macroeconomic Indicators
Central Bank Survey of Market Expectations
New Monthly Central Bank Survey
The Central Bank published on September 15 its first monthly survey of market expectations with respect to key economic variables. Responses were mainly (85%) from financial institutions, most (93%) operating in the domestic market and many (73%) abroad as well. Although the Central Bank would confirm only that "more than 30" responses were received, survey results imply that the actual number was at least 50. The survey was conducted at the end of August via e-mail questionnaires and responses collated until September 10.
3% Growth In 2000
According to the survey, GDP growth is expected to reach at least 3% in 2000 and to register positive results in the third and fourth quarters of 1999. Top factors expected to limit growth next year are the high cost of internal finance (59% of respondents), fiscal Policy (57%), and Brazil's internal political agenda (50%), i.e., the effect of nationwide municipal elections to be held in October 2000. Other negative factors cited include external economic uncertainties (36%) and inflationary pressures and international financial instability (16% each). Almost four-fifths of the respondents agreed that the fiscal deficit is the main obstacle of the improvement of Brazil's sovereign risk rating. The next two factors cited (by only 6% respondents) were macroeconomic perspectives and the current account deficit.
Selic Rate At 16%
The Selic rate is expected to remain in the 18-20% range for the remainder of this year and to fall to 16% on average in 2000 (note: this is above the Government's official figure of a 13.5% average rate in 2000). Exchange rate depreciation on the order of 8% is expected next year to produce an average R$ / US$ rate of 1.95 compared to this year's average of around 1.8. Respondents foresee declining open unemployment to just over 6% by December 2000 with real wages rising in the second half of the year in particular.
Barriers To Export Growth
Perceived barriers to export growth were divided into those affecting basic, semi-manufactured, and manufactured good exports. For basic goods, respondents were abut evenly divided in citing lack of export credit, legal non-trade barriers, and low demand for Brazilian products as the main inhibiting factors. For semi-manufactured products, weak demand was the most important factor. With respect to manufactured products, both weak external demand and poor export promotion were the problem areas most often identified. Non-tariff barriers were not considered a significant problem for this product category.
Economic Outlook
Export Performance Said Key
Brazilian economist Luciano Coutinho recently reported the results of a number of simulation studies that underline the importance of export growth for the economy over the next few years. The key variable in his analysis was the income elasticity of import demand, i.e., the degree to which increases in GDP affect demand for imported products. While Brazil clearly needs to grow at higher rates than in the recent past, the conundrum arises if this translates into higher imports and thus a rising current account deficit. According to Coutinho, "in the absence of export growth on the order of 10% per annum, GDP cannot grow more than 3%. This is the maximum growth rate if the current account is to fall relative to GDP." Under a low growth, low import elasticity scenario, the CA deficit / GDP ratio falls from 4.9% in 1999 to 2% in 2003. With high growth and high import elasticity, the ratio becomes explosive, rising to 6.8% by 2003.
Trade Account Seen In Balance This Year
Coutinho's simulation results have provoked a good deal of comment here, focusing as they do on the trade account whose performance has become increasingly worrying as the year has progressed. Lowered expectations can clearly be seen in the surveys of market forecasts that the Central Bank has published since April of this year. At the end of April, the consensus forecast for the 1999 trade balance was a US$6 billion surplus. As of today, the same readout indicates that Brazil will register no better than a rough balance between exports and imports. In the almost five months since the Central Bank first reported the consensus forecast, the decline in the expected trade surplus for 2000 has been less dramatic, falling from US$7.4 billion to US$5 billion.
Inflation
Consumer Inflation Below Expectations In August
The Central Bank's Target Consumer Price Index, the IPCA, rose 0.56% in August, below market expectations. In the first eight months of 1999, cumulative inflation as measured by the IPCA was 5.68%, practically the same as the cumulative 12-month figure. At present, the market consensus forecast for consumer inflation this year is 7.96%, a figure that may decline due to last month's favorable outcome. This favorable inflation news was an important factor underlying the 50 basis point rate cut at the September 22 COPOM meet.
Investment
Privatization
Privatizing Firms Hit By Back Taxes
In two recent cases, state enterprises near to being auctioned have been hit by substantial tax judgements. The Brazil Reinsurance Institute (IRB) recently paid R$200 million (US$ 111 million) in income taxes on outward remittances of premium payments and São Paulo state bank Banespa has been fined R$2.9 billion (US$ 1.6 billion) by the federal tax authorities for nonpayment of income taxes. IRB apparently chose to pay in view of its upcoming privatization, which could take place as early as January 2000. The government intends to reduce the applicable tax rate on these remittances from 25% to a 2% to 4% range more in keeping with international practice and will have to introduce legislation to this effect. In the second instance, Banespa President Eduardo Guimaraes reportedly told the São Paulo legislature that the bank's sale would not be delayed beyond the first half of 2000 despite the levy.
A Ministry of Finance Official admitted to Embassy Official that paying the fine could reduce the sales value of the institution but denied that the amount would be forgiven or negotiated, saying that this would be a violation of Brazilian law. He did acknowledge, however, that Banespa planned to "seek clarification" of the ruling and that it is entirely possible that lawsuits may be filed by minority shareholders such as the state of São Paulo. At any rate, any tax liability accruing to the bank's future owners will have to be clarified prior to the auction itself.
Public Finance
Primary Surplus
On-Track for IMF Target But It Will Be Close
The Government of Brazil has just released the combined public sector accounts through July and reports a 3.63% of GDP or R$20.7 billion primary surplus for the first seven months of the year. This cumulative nominal figure represents over 68% of the R$30.2 billion target for 1999 set in consultation with the IMF earlier this year. While the results benefited from extraordinary items such as a R$1 billion payment in July for telephone concessions, Central Bank Economic Research Director Altamir Lopes has stated publicly that the government will meet this year's fiscal targets, even if only by a narrow margin. Debt service payments amounted to R$95.1 billion (16.91% of GDP) through July, producing a nominal deficit of R$74.7 billion or 13.28% of GDP. With 59% of domestic federal debt instruments in floating rate bonds as of August 1999, the fiscal implication of the ongoing reduction in interest rates is also positive. Total public debt stood at R$ 495.3 billion or 49.5% of GDP by the end of July.
Political Developments
Reform Agenda Seen Advancing
Four weeks of delay in the Chamber of Deputies in approving important proposals ended September 15 when the executive and legislative branches unblocked the Lower House agenda and agreed to expedite the vote on tax reform. The administration also submitted to Congress its Pluriannual Investment Plan (PPA) and Year 2000 Budget. In addition to these two proposals, which must be approved in this calendar year, bills including further social security reform, the fiscal responsibility law, and implementing legislation for civil service reform are likely to be approved by the end of the year. Several more bills are likely to pass at least one house this year including tax reform, income tax changes, and omnibus financial sector regulation.
Internet Resources
US$ exchange rates and US$ Future Rates:
http://www.andima.com.br
Stock exchange:
http://www.www.quote.yahoo.com
Futures market index:
http://www.bmf.com.br
Interest rates:
http://www.agestado.com.br
Balance of payments (monthly):
http://www.bcb.gov.br
Trade balance (monthly):
http://www.mict.gov.br or
http://www.jb.com.br (Jornal do Brasil)
Monetary figures (monthly):
http://www.bcb.gov.br
Monetary targets (quarterly):
http://www.bcb.gov.br
Business information:
http://www.amcham.com.br
Agricultural Products:
http://www.fas.usda.gov
