8 July 2014

As World Cup fever is in full swing, Firstline will be zeroing in on the host country, Brazil, which has been a darling of the investment world over the last 8 to 10 years.

 Brazil team

‚ÄúBrazil is the country of the future, and always will be.‚ÄĚ

— Stefan Zweig

Brazil has constantly been spoken of as a place with ‚Äúpotential.‚ÄĚ This is not a recent phenomenon; the ironic quote above dates back to the post-World War II period.

In the 2000s and early 2010s, Brazil experienced explosive economic growth due to a commodities price boom, favourable demographics, and increased social mobility under President Luiz Inacio da Silva, better known as ‚ÄėLula.‚Äô This led many to believe that perhaps the old joke about Brazil could take on another meaning: that Brazil would become an economic superpower of the future.

While it is clear that Brazil indeed is a country to watch, some of the enthusiasm and appetite for that country’s risk have declined somewhat in recent years. However, for savvy investors, the country has made incredible strides and there are interesting opportunities available in both the bond and equity markets.



br gdp usd bn

brazil state gdp equivalents













The size of Brazil’s economy more than quadrupled in nominal terms between 2002 and 2013. Brazil’s GDP currently stands at a robust 2.24 trillion US Dollar equivalent as of December 2013, making it the 8th largest economy in the world.

Brazil’s GDP is around 90 times larger than Trinidad and Tobago’s, and many states in Brazil would be major economies in their own right if they were stand-alone countries. This map from the Economist, displays the size of the economy of various Brazilian states, and the closest country equivalent. For example, Rio de Janeiro state’s economy is as large as Singapore’s at USD 187 billion, while Sao Paulo state’s economy is the size of Poland’s, at USD 546 billion.



In real GDP growth terms, or growth adjusted for inflation, Brazil experienced high growth leading up to and immediately after the global financial crisis, but has faltered in recent years in large part due to policy fumbles and consequently a loss of domestic business confidence. A slowdown in China, which reduced demand for soy and iron ore, has also provided some headwinds.


Since 1960, Services have increasingly come to dominate the Brazilian economy, and this trend is likely to continue as the country continues to develop.

As seen in the GDP components, Industry has been a major contributor to GDP for some time. Everything from cars to planes are made in Brazil, and Foxconn, Apple’s contract manufacturer, has begun building a massive manufacturing complex in Brazil over the next few years to produce iPhones, iPads and other devices.


Industrial Production has almost doubled since 1990 and has been one of the drivers of Brazilian growth over the years. However, production has been on a slight downtrend in the last two to three years.

Investment from the private sector, another major driver to the economy, has waned in recent years as the business community loses confidence in President Dilma Rousseff’s economic policies. In fact, from April going into May, industrial sector business confidence declined 4.6%, the largest decrease since the onset of the global financial crisis in 2008, and the 5th monthly decline in a row.

Federal government spending and revenue are large relative to overall GDP. Brazil has a notoriously convoluted and onerous tax code, which has been the bane of local as well as foreign businesses doing business in the country. Government expenditure has increased substantially, and while the ROI on this expenditure was substantial in the past due to the social programs that enabled class mobility, many observers are now concerned that the current levels of spending are unsustainable. Before you ask: the World Cup expenditures have been only USD 11 billion dollars spread out over several years, out of hundreds of billions spent by the government on various programs.


Consumption has increased tremendously, alongside GDP per capita. This also coincides with the reduction in poverty levels as 40 million moved from poverty into the Brazilian middle class over the last decade, which represented over 57% of the population as of February 2013. The Brazilian census and statistical authorities classify households as middle class if they make between USD 700 and 3,000 per month. However, there are concerns that much of this increase in consumption was due to expanded access to consumer credit, where private debt is now equivalent to 70% of GDP, the highest in Latin America.


The federal government debt to GDP ratio is quite subdued at 22.54%, however this number is as high as 60% when regional government and other ancillary debts are considered. The number has crept higher in recent years and has begun to spook many investors.

Economic strength and growth, and the resulting bullish sentiment on Brazil, have reduced spreads between U.S. Treasuries and Brazil sovereign debt.



Nevertheless, Brazil suffered a downgrade from BBB- from BBB by Standard and Poors earlier this year.

According to S&P, ‚ÄúThe downgrade reflects the combination of fiscal slippage, the prospect that fiscal execution will remain weak amid subdued growth in the coming years, a constrained ability to adjust policy ahead of the October presidential elections, and some weakening in Brazil’s external accounts. Low growth prospects reflect both cyclical and structural factors, including investment as a share of GDP of only 18% in 2013 and a slowdown in growth in the labour force. Combined, these factors underscore the government’s diminished room for manoeuvre in the face of external shocks.‚ÄĚ

However, Moody‚Äôs did not downgrade Brazil‚ÄĒwith the caveat that their current Baa2 / Stable rating is based on the ‚Äúimplicit assumption that something will have to change next year.‚ÄĚ Also helping Brazil, according to Moody‚Äôs, is the ‚Äúdiversified economic and export bases, high levels of international reserves and capital ratios in the banking system, and a government debt profile associated with limited foreign currency exposure and a relatively low share of non-resident holdings.‚ÄĚ

On the other hand, Moody’s cites weaknesses in debt to GDP levels, large refinancing needs, and recurring large-scale lending from the Treasury to state-owned banks, as well as low investment and low GDP growth.

While there are elections in Brazil later this year, current President Dilma Rousseff is widely expected to win and most investors are not overly concerned with political risk. President Rousseff has been seen by investors, both domestic and foreign, as willing to ‚Äėinterfere‚Äô or be more assertive in the economy. Nevertheless, there are signs that she is beginning to realize the impact of policy actions (or inactions) on the investment environment and take a more Lula-like pragmatic approach. Investors, however, are waiting until after the election to gauge how much things have actually changed.

Perhaps due to some of this investor dissatisfaction, there is a very compelling opportunity to invest in Brazil 2018 bonds, which currently sport a yield to maturity of around 4% and a current yield of 7%. Brazil 2017 are also an attractive option; while their yield to maturity is low at 1.5%, their current yield of 5.4% stands out.

In conclusion, Brazil sovereigns, corporate credits and equities may present attractive pockets of opportunity for value-oriented investors with a medium to long term horizon, and moderate risk tolerance. By reaching out to Firstline Securities at or at 868.628.1175, we can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.

Michael John Cooper


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