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Can New Finance Minister Turn Brazil Around?

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There’s no question that Brazil is an important economy in the emerging markets universe with considerable growth potential ahead, but it’s also been one of the most out-of-favor markets for a considerable period of time. Which is why investors are hoping that the recent appointment of Joaquim Levy as Brazil’s new minister of finance could turn things around.

Levy, a Ph.D. from the University of Chicago and a market-friendly reformer who previously served as Treasury secretary, could well help Brazil get back onto a more positive path that would in turn lead to better things after a long period of slow growth, high inflation and falling markets, said Jim Barrineau, co-head of emerging markets debt relative at Schroders.

“We are pretty optimistic about Brazil right now and I think that Levy is off to as good a start as any investor could possibly hope for,” Barrineau said. “Obviously, the scope for change in Brazil will be limited by the political system and the political capital of President Dilma Rousseff, but within what is possible, Levy is doing the right thing.”

Levy, who spoke last week at the annual meeting of the World Economic Forum in Davos, Switzerland, has set in motion an agenda that will curb excessive government spending and help shore up Brazil’s finances. He has introduced a series of important tax hikes and, among others, made some changes to Brazil’s social welfare program, in such areas as unemployment benefits. It’s likely, too, that Levy will cut government subsidies in key areas like fuel.

“We’re looking for these kinds of spending cuts and Levy has signaled that they will come,” Barrineau said. “All of these fiscal measures will have a positive impact on Brazil, especially in the context of a central bank that looks like it is close to or done with the tightening cycle.”

At the same time, though, Brazil’s macro problems still present a huge challenge for the country and investors remain wary overall about Brazil’s future. The consistently high inflation growth in Brazil (some economists believe that inflation could continue to rise this year) has led to higher interest rates and increased borrowing expenses for many companies and this has led to some corporate defaults. Although Brazil is not as dependent on commodity exports as other emerging market countries, the sharp decline in global commodity prices has also taken a toll on the economy, and Brazil still sorely lags in terms of key infrastructure spending and development.  

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But while Brazil still faces a number of challenges, the country also has a number of key strengths on its side, said Lauren van Biljon, emerging markets debt analyst at First International Advisors, a part of Wells Capital Management, in London. Brazil runs a modest current deficit, for example, but that is almost all covered by foreign direct investment, she said, “and with elections out of the way and a more market friendly team in place, there is space to rein in fiscal spending and let monetary policy power the economy.”

A tighter fiscal stance will also reduce the amount by which Brazil’s central bank has to still hike rates by, and that should bode well for the local currency debt instruments that van Biljon invests in. Currently, there is a huge yield gap between local and foreign currency bonds in Brazil, she said, and although local currency sovereign debt has been a good place to be, “yields of 11.5% can cover some ills, so we have to be cautious.”

Investors like Barrineau believe there’s good opportunity right now in Brazilian dollar-denominated sovereign debt.

“We are staying away from the Brazilian corporate sector because there have been a number of defaults there, but the sovereign’s dollar-dollar-denominated debt is very attractive compared to similarly rated dollar-denominated sovereign debt throughout the globe,” he said.

Barrineau is also keen on the short-duration bonds of Petrobras, Brazil’s state-owned oil company, despite recent news of a bribery and money laundering scandal that has tainted Petrobras’s image worldwide. In December, the yield on 10-year Petrobras bonds rose sharply from 6% to 8%.