Is Brazil Overheating?
Given near universal austerity measures in Europe and thoughts of the same in the US, increasingly it looks like the emerging markets are expected to do the heavy lifting to sustain a global recovery. As I said recently, "for the global economy, it’s China or bust." But, of course, China is not the only major emerging market. With China, Brazil, India and Russia are the four largest economies outside the G-7. And right now the BRICs are doing well. In fact, they may be overheating.
Brown Brothers Harriman’s Win Thin wrote earlier today:
Markets have pared back tightening expectations in Brazil after the central bank hiked by only 50 bp last week. Weekly central bank survey now shows market looking for year-end rate of 11.75% vs. 12% last week and 12.13% earlier this month. Minutes from the July meeting due out July 29 should shed some light, as momentum in the economy remains strong, in our view. There are three meetings left (Sep 1, Oct 20, and Dec 8), and we expect two more 50 bp hikes this year that would take the policy rate to 11.75% by year-end. High interest rates remain attractive, but we expect market volatility to pick up as the Oct elections approach.
Some of the numbers are deteriorating sharply for Brazil, including the external accounts, and should help limit BRL upside. Exports remain robust, but imports are going through the roof and leading to worsening trade and current account balances. June current account gap was reported at a much higher than expected -$5.2 bln, and pushed the 12-month total to -$40.9 bln or -2.1% of GDP, the highest since Oct 2002. FDI flows have held up OK, but now only covers less than two thirds of the current account gap.
The accompanying chart makes the deteriorating macro balances picture plain.
Yet Brazil surprised the market with a 50bp hike instead of the widely anticipated 75bps. But, from my perspective, the foreign direct investment underpinning this current account deficit should be seen as extremely suspect. With interest rates at record lows all across the developed world, investors are taking a risk seeking return mentality and that attracts them to Brazil, with its high interest rates like moths to a flame.
This has to be worrying for policy makers in this volatile macro environment. It already has some Asian policy makers considering capital controls. Brazil, for its part, led the pack in this effort late last year by applying a tax on foreign money entering Brazil to buy shares and bonds as well as a tax on Brazilian ADRs traded in the US. Will this stem the tide of hot money flows? From the deteriorating current account, it doesn’t look like it.
Asian policy makers take note.