Brazilian GDP growth has been on a downward curve since 2010; how severe and sustained will this slowdown be?
Will Landers: Clearly we are in an adjustment phase that is lasting longer than the government expected. This is reflected in the cuts made to the primary surplus goals established at the beginning of the year, and highlighted further by the disastrous 2016 budget originally put forward with a primary deficit. The fact is that the weaker economic performance is leading to lower tax collections; in addition, unemployment is growing fast – albeit from a record-low levels – and it will grow by 1 to 2 million people over this slowdown period which will last well into 2016.
But it’s not all bad. One positive is that the new finance minister is focused on improving the economy. The fact is that the bad growth coincides with Dilma Rousseff’s term in government. Like all politicians she only makes the tough decisions when she has to and now there are signs that she is taking them. Also Brazil still has ample reserves and liquidity, gross debt won’t be above 70% of GDP by 2016 while net debt is still below 40% of GDP, so the country is in a much better position than it was 15 years ago.
The S&P downgrade came sooner than most analysts expected; is this more bad news for the economy or is it a sign that we are nearing the end of the crisis?
The S&P downgrade reflected the political difficulties of approving the fiscal reforms being proposed and the deterioration of the accounts, if nothing changes, as reflected in the initial budget proposal for 2016. Hopefully it highlighted to Brazil’s political class, the gravity of continuing with loose fiscal policies. It is tough to make a call that this will mark the bottom for Brazil’s markets.
So should investors steer clear of Brazil at the moment?
WL: It’s all about timeframe. I mean in terms of drivers for the economy, it doesn’t look positive in the short term. The Petrobras scandal is paralysing the infrastructure sector, so you won’t get growth from there. Meanwhile the consumer sector, which was based on cheap access to credit, is suffering because rates are going up and that credit is much less available. But if you look further forward, we will get to a better place when the government can stabilise debt and inflation comes down.
“There are good companies in Brazil. Whether their shares will provide a positive return in dollars over the next six months is a different question…”
In the meantime there are good Brazilian companies, with solid management teams that are adjusting their cost structure to reflect their new revenue reality. On the corporate side we don’t see balance sheet issues as a larger majority of companies don’t have a mismatch of currencies. For local investors the Bovespa hasn’t fallen as much. It’s a weak environment but not disastrous. The real problem for international investors has been the FX losses as the real has fallen against the dollar, recently breaking through 4 reais per dollar for the first time.
There are good companies in Brazil. Whether their shares will provide a positive return in dollars over the next six months is a different question. But yes, there are lots of areas where Brazil offers potential for investors. It’s a large economy with a big middle class, globally competitive in areas like commodities and agribusiness, and gaining competitiveness in other export markets with the FX devaluation.
The Petrobras scandal created a wave of negative headlines around the world; how much impact is it having on the wider economy?
WL: A lot. For one thing Petrobras is the biggest infrastructure investor in Brazil and now it is having to revisit its entire capital expenditure program. All the old contracts are being revised, some projects have been stopped or in some cases a partner is under suspicion. Moreover it’s not just Petrobras. The scandal has created a climate where firms don’t want to sign contracts for new projects given that so many of the major construction companies are being investigated.
From a global investor point of view if you see that Petrobras, the biggest company in the country, is being investigated, it makes you less keen to invest in the Brazil. That is another reason (along with the weak economy) that most large global funds are underweight Brazil right now. On the plus side this means that there’s not much more money to leave the country if the scandal continues while there is the potential for a lot to come back when things improve.
Mexico’s first energy auction was widely branded a failure; what’s your take on it?
WL: Mexico has had to deal with the unfortunate reality that when energy reform was passed in 2013 we lived in a world of triple-digit oil prices. Since then, oil has halved, making all industry participants more cautious about the amount of projects they are willing to consider and the price they are willing to pay. But there are also some technical factors. The first phase was all shallow water projects, not attracting the international oil majors. The companies involved were the medium-sized independents, many of whom have their own balance sheet issues given the fall in oil prices, therefore reducing their appetite to bid.
So yes it was disappointing but that doesn’t mean we are pessimistic. The next phase involves mature fields and will hopefully attract more bids. Once you get to deepwater fields in the Gulf of Mexico there will be a lot of synergies for those on the US side of the border to add acreage. I think the shale will probably get delayed because of the low oil price right now.
It’s true that the investment we’re going to see in this part of the energy reform is less than had been hoped for but ultimately its investment that you wouldn’t have had otherwise. If the energy reform really gets going then it should lift the rest of the economy and we would see the Mexican peso strengthen. We have already started to see some positive effects from the other reforms feed into the results of companies in the consumer sector.