Brazil looks cheap, but foreigners stay away from domestic assets, economists say

RIO DE JANEIRO, BRAZIL – Although the prices in U.S. dollars of Brazilian assets now seem attractive, the willingness for foreign capital to invest in the stock market or fixed income here is low.

After the widespread stress with the declared hole in the spending cap last week, the balance between risk and return discourages the evaluation of local opportunities, according to specialists who participated in the panel “Inside the mind of foreign investors: what they think of Brazil and emerging markets”, at the Anbima Summit.

According to Cassiana Fernandez, chief economist at J.P. Morgan in Brazil, for the first time since 2016, investors have again asked questions about the solvency of Brazilian debt. “What’s going to happen with debt/GDP if you don’t have fiscal anchoring, are you going to pay or not?”

With no adjustment in sight on the expenditure side, it is feared that Brazil will have to cope with an even higher tax burden. “Am I going to look at the value of the companies or put the risk of the government not honoring all the commitments and being forced to have higher inflation? Inflate and have the adjustment of the nominal debt.”

In local assets and derivatives, the level reached by implicit inflation already shows that this is a concern that local and, especially, foreign investors already see today, said Fernandez. She added that those looking at the country from outside recognize they have a less competitive advantage in analyzing Brazilian economic policy. Hence, the preference is to stick to the markets they know best.

“If you want to bring back foreigners to Brazil, the word you need, more than talking about reforms, is a little more predictability,” she commented. “Bringing, at least in the next few weeks, confidence about what decisions you make and being able to guarantee that you’re going to honor the commitments brought in. On the investor side, on the businessman side, it’s the businessman, that’s the most important part of attracting investment back in the short term.”

Foreign investors are usually very pragmatic, look at risk and return, and want predictability in the fiscal model, said Marcela Rocha, chief economist at Claritas. “The spending cap has already been changed and may go through new highs. There may be some risk throughout the electoral process next year,” she said.

In rebuilding this confidence, there is not a single factor, but the “political articulation has to show coherence and that the new fiscal regime is not the one of irresponsibility. Tax burden increases and creative fiscal accounting? Can these be the way out?” he questioned. “It may even be a worse balance than before, but you need to know what level you are going to work at. It’s a huge cost for inflation.”

The international scenario also does not look very constructive for emerging economies, mainly due to the Chinese slowdown. With revisions to next year’s growth for China below 5 percent and potential GDP also falling over time, Fernandez said this would have repercussions for Brazil. This means that the dynamism for emerging markets, the leading commodities producers, will be much weaker than in the early 2000s.

Another conclusion is that the economic growth cycle tends to be more uneven, differentiating countries that can afford to wait longer to withdraw monetary stimulus and those emerging economies. Brazil stands out, that will have to remove more aggressively, sacrificing short-term economic growth, Fernandez said.

In this scenario, a combination of economic recovery, amid the advance of vaccination, mismatches in supply chains, and still loose fiscal and monetary policies, has caused inflation to surprise, above the central banks’ target.

One of the main issues in this scenario is how temporary the inflationary effects tend to be in the post-pandemic, said Rocha. “Whether it is transitory or permanent that is a debate that has no answer in the short term, it is going to be a discussion for the coming months.”

One of the doubts that persist is how far the Federal Reserve’s willingness to tolerate inflation away from its target will go, which could unanchor expectations with the shocks that are already being observed.

In this negative balance for the coming months, Rocha says he is already working with inflation between 4% and 4.5% in the United States for a long time. “That monetary policy response may be faster than imagined.”

Even if the Fed’s communication is better than in the post-2008 stimulus reduction, “telegraphing the next steps with transparency,” the Claritas expert points out that the process occurs at a time when emerging countries present a more challenging environment. “It’s a time when emerging Central Banks have to raise interest rates to fight inflation, they have no room to react.”

Fernandez, of J.P. Morgan, added that some countries could live with higher inflation numbers without compromising the credibility of economic policy in the medium term. “Others are going to have to cut their demand, even more, that’s what’s in investors’ minds.”