After the G20 finance ministers and the World Bank/IMF annual meetings in Washington last weekend, most Latin American ministers of finance returned to their countries with a somber outlook. As the global financial crisis continues to unfold, it was clear that developing countries may have to replace some market financing with lending from the multilaterals, and prepare for the recession in the U.S., which will inevitably occur as a result of the credit squeeze of the past months, and its impact on global markets.
This doom and gloom has not infected Brazil, however, where President Luiz Inácio Lula da Silva is showing unprecedented self-assurance. Speaking in Madrid, Lula said somewhat rhetorically that "this idea that markets can do everything is over,” and more fundamentally “The times in which emerging countries depended on the IMF are over.” This is not Hugo Chavez speaking, but the president of Latin America’s largest economy, who enjoys 80 percent popularity in his country. Lula also alluded to the fact that Basel rules have been applied to banks in Brazil but not in the U.S. “That has to end,” he said. Since 1995, banks in Brazil have complied with an 11 percent capital requirement—one of the highest in Latin America—and Lula wants new regulation of world financial markets, which would be stricter on banks from advanced countries.
Such a high level of confidence from Lula about Brazil’s economy reflects some underlying economic fundamentals that cannot be ignored. Brazil’s foreign reserves are now $205 billion, four times higher than in 2004. Financial intermediation, though low for developed country standards, is conducted primarily by domestic institutions. Only 30 percent of bank assets are foreign-owned, compared to over 80 percent in Mexico. To the extent that Brazilian banks also have very low foreign liabilities, the economy is somewhat protected from a major credit contraction in international financial markets.
However, nearly half of Brazil’s exports are commodities, which have benefited from historically high prices during the last four years. The world is still debating whether this is a permanent shift in commodity prices or whether prices will go back to their long-run levels. Demand from China, substitution of fossil fuels, and limited technological progress in agricultural production seem to be part of the explanation for higher prices (some economists would also add the effects of high liquidity in advanced countries). Although no one really knows what is going to happen with commodity prices in the future–with high food prices, research and development in agriculture is likely to surge—the simple fact is that during the last month alone soybean prices declined 20 percent. Prices of other commodities fell between 14 and 20 percent. This means that Brazil’s exports may indeed take a hit in the near future.
Brazil is expected to run a current account deficit of about 2 percent of GDP for 2008 and 2009 even under optimistic scenarios for export prices. Of course, with sharper declines in prices and lower demand abroad for its exports, the deficit could increase. Although this does not pose a major risk, it simply suggests that Brazil is not in the group of countries with large foreign exchange surpluses. Not surprisingly, as world financial markets collapsed during the last month, the real lost 31 percent and stock prices declined 20 percent, while spreads on Brazilian debt rose by more than 170 basis points. Under this new scenario, Petrobras, as well as other Brazilian flagship corporations, may have to cut somewhat their aggressive investment plans.
Looking at these fundamentals of the Brazilian economy, there are good reasons therefore to believe that Brazil’s economy is resilient to the global financial crisis. But that does not mean that Brazil is immune. As in China, the key to Brazil’s future depends heavily on the domestic market. With a growing middle class, and large infrastructure projects under way, private consumption and domestic investment are likely to become the major sources of growth in the years ahead. In fact, the government is launching a re-industrialization strategy, with high investment in steel, petrochemicals, and defense equipment (including construction of its first atomic submarine). Is this going to revive the white elephants of the 1960s and 70s? Probably not. This time around the development strategy in Brazil is carried out by the private sector, with limited support from the government, and much better governance structures than in the past. If these fundamentals can remain strong, Brazil may yet dodge the current global economic bullet.