The Trouble with Brazil: Credit Bubbles and Currency Wars- 17 November, 2010
Brazil has made significant strides toward economic prosperity over the last two decades. Economic progress has been built on the strong foundations of Luiz Inácio Lula da Silva and his predecessor, Fernando Henrique Cardoso, managing to forge strong relationships with major global trading partners and building a reputation for macroeconomic stability. A combination of sound economic policy, currency stability and sustained growth in commodity exports has brought about rising levels of employment, wage growth and more recently, an increase in the availability of consumer credit.
Strong economic growth has brought about the vast improvement in living standards for many Brazilians. Since 2003, over 24 million Brazilians have emerged from poverty, while over 31 million have transcended to middle class status according to recent government figures. Nominal wages have risen by more than 50% between 2003 and 2009 according to InterAmerican Development Bank. The amount of credit available to individuals has doubled as a percentage of GDP since 2005, with many households indulging in consumer goods that were inaccessible only a couple of years ago. Bank lending to individuals is estimated to be growing by 20% per annum.
The rise in level of employment has underpinned consumer and business confidence. Over 14 million jobs have been created in the last year alone and as wages have risen sharply, confidence about job security and economic prospects for the country have kept pace. As a result, households have been increasingly confident to buy goods on credit – but more importantly, the credit has been made available. The purchase of big-ticket household goods such as computers, washing machines and other relatively expensive products are now common place – purchased using credit supplied by banks. Although interest rates are some of the highest in the world, consumers are eager to own products that were previously unattainable. It is hard not to draw comparisons with the credit fuelled consumer boom in the West over the last 10 years – but this is consumer spending on steroids! Consumers are prepared to pay over twice the price of goods once interest repayments are taken into account. And now one of the biggest growth areas in the credit market is the provision of mortgages – still relatively underdeveloped in Brazil.
There are clear signs that Brazil’s economy is overheating and the phenomenal growth achieved over the last decade cannot continue on its current trajectory. Output grew at an annualised rate of 8.9% in the first half of 2010, almost double its 4% sustainable rate. Consumer demand rose 0.8 percent from the previous quarter in the three months to June, but much of this is credit fuelled. Strong economic growth has been coupled with rising living costs, with inflation currently above 5%. While tighter monetary policy has been implemented in an attempt to stifle inflationary pressures, (interest rates currently at over 10%, while both the UK and US are below 1%), this has led to volatile foreign exchange markets. Investment in Brazil has jumped by over 25% in the last 12 months. Capital inflows have pushed up the effective exchange rate (the Brazilian real measured against a basket of international currencies) by over 35% since January 2009. This will eventually damage Brazil’s competitiveness. Exports may have risen by 40% over the past five years, but imports have almost doubled – widening the current account deficit.
The situation is further complicated by the FED’s decision to embark on a second round of quantitative easing, QE2. The further “printing” of money will only act to push the US dollar even lower, thereby increasing its export competitiveness and diverting even more dollars into emerging economies. In the global “currency war”, Brazil has tended to align itself with China in criticising the US’s expansionary monetary policy, yet remaining noticeably quiet in public when it comes to China’s international policies. This is ultimately more politics than economics, with China now buying more than 12% of Brazil’s exports – now its biggest single market overtaking the US in 2009.
Brazil has enjoyed a sustained period of economic growth and its population has benefited from a massive increase in standards of living over the last 20 years. It is now the 8th largest economy in the world and it is entering a new era of economic and political change.
The immediate risk facing Brazil is the outlook for its currency and the implications of further quantitative easing in the West and capital inflows into the country. The real has appreciated sharply over the last 12 months and with so much of the economic development driven by foreign investment, which has increased employment levels and in turn, consumer spending – it has to remain competitive on the global stage if it is to avoid a sharp downturn in trade. In addition, banks are awash with cash from foreign investment and so credit availability has risen markedly to individuals, which is supporting consumer spending. The mortgage market is now gathering pace and this should be ringing alarm bells to Brazil’s policy makers.
There are formidable challenges ahead and the government has a delicate balancing act to perform. Only the most astute policy actions and proactive use of monetary and fiscal policy will be able to address the complex issues currently facing Brazil. This is not an enviable task for any economist!