Brazil

Brazil’s decision to rush through a sovereign wealth fund at the end of last year has been greeted with some derision among economists. The fund has none of the characteristics of a typical fund of its kind and is more oriented to shoring up spending for next year than long-term investments. It underlines the increasing concern of the government at the rapidly-deteriorating economic situation.

Sovereign wealth funds were all the rage three years ago. A sign of having made it as obvious and flashy as a Chanel bag, a slew of emerging markets set such funds up or expanded them. China’s wealth fund which stands at some $200 billion and Singapore’s Temasek of some $135 billion are the fruits of consistent balance of trade surpluses. Commodity-rich countries have been particularly visible in the field, ranging from the oil and gas-funded Government Pension Fund of Norway, the world’s second largest such fund at $306 billion, and the less transparent fund managed by the government of Abu Dhabi, the world’s largest with an estimated $328 billion.

Performance of such funds over the last year has been admittedly poor, but longer-term track records are typically enviable. Norway’s fund saw growth of over 50% annually for the three years starting 2003.

While heterogeneous in many aspects from the source of funding to transparency and management, these wealth funds have many features in common. They are typically heavily weighted in US dollars with a smattering of other foreign currencies. They are almost exclusively run by governments that have overall budget surpluses, funded by weighty international reserves generated from exporting manufactured goods or commodities. The idea is to ramp up returns on these reserves and diversify away from US Treasuries with higher risk-adjusted returns through investing in global equities and long-term projects.

Brazil’s odd-man-out fund

That’s what makes Brazil’s decision to set up a sovereign wealth fund, seeded with R$14.2 billion, all the more surprising. The country has almost none of these requisites. Although it has been building up its exports of soft and hard commodities, think agriculture and mining, it continues to run a total budget deficit even if it has recently managed a primary budget surplus.

Moreover, the timing of the new fund, just as commodity prices were slumping and Brazil’s balance of payments was deteriorating rapidly, seems particularly clumsy. Last year, Brazil posted the worst result since 2003 in its balance of trade, with a surplus of $24.7 billion or 38.2% less than in 2007. Not only that but the country’s terms of trade are rapidly deteriorating still further thanks to the drop in commodities prices. Indeed, in the third week in January, the balance of trade showed a deficit of $378 million, according to government numbers.

That may well be why the government decided to push ahead with an idea whose time seems already to have passed. The idea to launch such a fund is by no means a new one. The Brazilian government has been debating the uses and scope of such a fund for well over a year. But the final product has little to do with a long-term savings fund and looks more like a short-term fiscal stimulus package for spending in 2009 in recognition that the year is going to be particularly tough.

Senior economists were quick to dismiss the ham-fisted attempt by the government to retain the sovereign wealth fund tag. They say that the mechanism to create the fund has ended up being little more than a clever ruse to transfer unspent budget monies from last year to this one.

They point to the numerous discrepancies between Brazil’s fund and those of the rest of the world. Brazil’s fund is denominated in local currency, the seed money comes from an issue of government debt, and proceeds are set to be spent on local projects, with a keen eye on longer-term infrastructure projects and the growth acceleration programme (PAC).

“With the beak of the central bank and the plumage of the national development bank, the creature being created by the government, just like the platypus, seems to have parts from various animals and a poorly-defined identity,” says Dr Eduardo Felipe Matias, the author of a book on such funds that collected on the Jabuti prize, Brazil’s highest literary honour, in 2006.

Edmar Bacha, a central figure in the economic team that instituted the Real Plan that brought hyperinflation under control in 1994, concurs. He sees the fund as little more than an accounting wheeze that will allow the government to transfer unspent budget monies from one year to the next, something forbidden by Brazilian budget law. When the government enjoys a surplus, it should pay down public debt, he says. The ratio of Brazil’s net public debt to GDP is still relatively high at some 35%.

Despite its unorthodox provenance, economists see the fund as having some advantages this year. With Brazil’s economy in sharp deterioration, a boost early in the year will prove salutary, economists admit. Ilan Goldfajn, a former deputy governor of the central bank and founder of Ciano Consulting in Rio de Janeiro, argues that the government pushed through the creation of the fund as it recognised that tax collection will be crimped on all sides due to slow economic growth, weaker corporate profits and a comatose stock market.

The problem is that it remains unclear just how well-managed and transparent the fund will be. The solution may be simply to use the funds to boost the budget of the National Development Bank or offer outside scrutiny of the fund’s investments, economists agree. It may also garner money from other sources and risks becoming a source of off-budget financing for the government, they add.

Brazilian economic woes

The sovereign wealth fund is just one measure to combat what is turning out to be much faster-than-expected economic weakening in Latin America’s largest economy. Brazil’s economic situation has been deteriorating much faster and more steeply than anyone was predicting. “Industrial production numbers released in November and December were awful,” says Goldfajn, who points out that even if such production is maintained at current levels, thanks to growth through most of 2008 year-on-year figures would show a slump of 4.7% throughout the year.

Brazilian industrial production enjoyed a heady 2007 on the back of easy credit and strong economic growth, which boosted consumer spending. The suddenness and steepness of the reversal took economists by surprise. Production fell 5.2% month-over-month in November after a 2.8% fall in October. Worse still, two of the leading lights of the economy last year, automobile and machine production, were down a whopping 22.6% and 11.9%, respectively.

Recent actions by manufacturers suggest that there will be no turn around soon. Renault put 1,000 workers on five months leave on reduced pay towards the end of last year, following other car manufacturers who granted a month’s leave in December, and there is a significant risk that consumers will also stop spending on big ticket items, spreading the contagion out further, says David Fleischer, Professor of Political Science at the University of Brasilia.

Fleischer is watching credit card spending, which had been growing at a clip of 30% annually, fearing: “The crunch has not hit credit cards yet, but the nightmare is that this is coming, just as it has in the United States”. Consumer and manufacturer surveys show a continued build up in negative sentiment, he adds. Consumer confidence in São Paulo has hit the lowest levels since November 2005, according to a recent survey.

Commodities across the board are suffering with the supply chain of iron ore mines and steel makers caught up in the global auto recession and mothballing projects as fast as they were launching new ones this time last year. Vale’s shares are down close to 40% over the last 12 months and steelmaker Gerdau’s down close to 30% over the same time period. The agro boom is over too, for now.

That drop in profits from such companies has hit Brazil’s trade deficit and the monthly budget deficit widened in November thanks to slower tax collection. Federal, local government and state companies posted a deficit of BRL 8.92 billion, compared with a surplus of BRL5.22 billion the previous month.

The government has been casting around for ways to soften the impact of the slow down. In addition to the sovereign wealth fund, measures to stimulate bank lending have been initiated and the Central Bank reduced required reserve amounts for privately-held banks while the government twisted their arms to both increase lending and snap up the portfolios of smaller, less capitalised banks.

State-owned banks, which include giants such as Banco do Brasil and Caixa Economica Federal, have stepped up lending under government pressure and have been engaging in outright purchases of smaller banks, such as Banco do Brasil’s decision to buy 50% of Banco Votorantim for BRL4.2 billion.

Brazil still has plenty of ammunition left and has pledged to carry out a plan that would result in BRL500 billion in public and private spending by 2010. There is plenty of scope for monetary policy loosening with rates reduced by a full 1% on January 21 to a still hefty 12.75%.

But as the developed world has shown even giant programmes may not be enough this time round. The latest survey of economists by the Central Bank highlights the gloom. Results showed the average forecast for growth is 2.4% this year. Others are more pessimistic. The big surprise of the crisis in Brazil has been the speed at which it has arrived, says Marcelo Salomon, Chief Economist, Unibanco. The bank was revising its GDP forecasts for Brazil down from 2% to just over 1% at the end of January. Some are even predicting an outright recession.

The sovereign wealth fund may be unorthodox and have little to do with the rainy day funds its names suggests. What it does imply is that the Brazilian government is nothing if not pragmatic as it confronts a situation which will call for major government support. It’s a pity that Brazil was not able to pay into the fund in the boom times of 2006-07 rather than wait for today’s crunch to fund what looks more like an emergency than a wealth fund.

This entry was posted in Articles, Emerging Markets. Bookmark the permalink.

Comments are closed.