Will Government Intervention Rescue Brazilian Growth?
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The Brazilian government has intervened aggressively in the economy this year, slashing the benchmark interest rate from 12.5% to 9% in six months, the most of any government. The administration of President Dilma Rousseff aims to restart growth, which slowed from 7.5% in 2010 to 2.7% in 2011. As a result, Brazilian interest rates are nearing historic lows and expected to drop further, but what effects is this likely to have?
Slowdown and Intervention
After several years of runaway growth – which the previous administration intervened to slow – Brazil cooled in 2011 due to weak exports and weak demand from its largest trading partner, China. The Rousseff administration, which has widely criticized the U.S. and China’s currency practices, is taking a very conventional approach to stimulating growth by lowering the benchmark rate, pressuring banks to lower commercial rates, and abolishing the constitutionally enshrined guaranteed 6% return on savings accounts, which had previously been a floor for the benchmark rate.
As you may remember from macroeconomics, lowering the interest rate devalues currency. Since hitting a multiyear high of 1.55 per dollar last July, the Brazilian real (plural: reais) has declined to around 2. For tourism, manufacturers, other export-oriented businesses and the federal government, this is great news; last year’s unimpressive growth stemmed in part from a high currency valuation, which burned exporters and many domestic consumer goods producers, as Brazilian consumers bought massive amounts of imports and Brazilian exports became uncompetitive.
The currency devaluation brings mixed results for publicly traded Brazilian companies, however. Across the board, the dropping real made mixed and low earnings reports look even more dismal when translated into dollars and shareholders with dollar-denominated accounts have seen their real-denominated dividends decrease, dropping yields. Additionally, Brazilian multinationals usually have dollar-denominated debt from international lending institutions, which takes more reais to service as the currency falls.
The biggest Brazilian companies are commodity firms Vale (NYSE: VALE) and Petrobras (NYSE: PBR), brewer Ambev (NYSE: ABV), and banks Banco Itau (NYSE: ITUB) and Banco Bradesco (NYSE: BBD). The majority of Petrobras’ operations and revenues are domestic and are thus less affected by currency fluctuations. However, Petrobras’ $80 million long-term debt is in dollars, and those payments now take more reais.
Vale, on the other hand, is set to profit from the fall of the real; most of Vale’s revenue is in dollars from sales on the international market while its operating costs are in reais. AmBev has suffered from higher costs on the materials it sources from international markets, but has had little trouble passing the costs onto consumers through price increases.
On the other hand, as I discussed recently, lower interest rates have slammed Brazilian banks including Itau and Bradesco, whose profits have relied on sky-high interest rates for over a decade.
Brazil’s economy has picked up only a little this year; the most recent Central Bank report estimates that it will reach a mere 2.9% this year. Lower interest rates have propped up the economy in the first half of 2012, but have not kick-started growth as intended.
Additionally, economists have pinpointed high interest rates as a hindrance to a smoothly functioning and competitive market. By nearly all accounts, lowered rates should promote domestic business growth and development while reducing the growth of onerous household debt, thus buoying domestic demand. However, the same economists point to low firm productivity, high taxes, poor infrastructure and excessive regulations and bureaucratic delays as other growth bottlenecks and the federal government has done much less to address those issues. Additionally, cutting interest rates slows the growth of Brazilian household debt payments but a quarter of Brazilian households are already too overleveraged to spend more, according to the economic consulting firm MB Associados.
A recent report from Columbia University economist Marcos Troyjo and the BBC, as well as a recent feature article in The Economist, suggests that Brazil’s economy is settling into a sustainable, if boring, annual growth rate of 3% to 4%. If Brazil achieves a steady growth rate, Ambev and Petrobras will see sales rise steadily as well. Itau and Bradesco could stand to gain from a healthy and stable economy in the long run, but their business models and share prices will suffer from lost interest income in the short to medium terms. However, Brazil’s economy rose with commodity prices and is now slowing with them as well. Central bank intervention may not be enough to reverse that trend and escape Brazil’s 500-year history as a cyclical commodity exporter.
CallaMarie owns shares of Companhia Vale Ads and Petroleo Brasileiro S.A. (ADR). The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Petroleo Brasileiro S.A. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.