Subject
In the first part of this piece of research we analysed the performance of the Brazilian economy in 2003 and the key role assigned to fiscal policy in winning back the confidence of the financial markets and stabilising prices. In Part II we look at the state of the economy from an international standpoint, the difficulties encountered in reducing international vulnerability and Brazil’s complex insertion in the process of international globalisation in order to determine the possibilities of strengthening the balance of payments, Brazil’s ability to attract foreign investment and ways of improving the country’s liquidity and solvency ratios.
Summary
Exports were the only variable to record an outstanding performance, allowing Brazil to obtain a surplus on its trade balance of US$ 25.0 billion and a net current account surplus of US$ 4.0 billion, equivalent to 0.9% of GDP; all this, just two years after having run up a trade deficit of around 5.0% of GDP. The success of the foreign sector is due as much to the exports themselves as to the adjustments made to the domestic economy. The fiscal target of 4.25% was achieved, the exchange rate was held steady at between BRL 2.90 and BRL 3.00 per US$ 1.00 and inflation was cut to 9.3%. Brazil’s new foreign trade position was accompanied by an inflow of direct and portfolio foreign capital investment which, coupled with its agreements with the IMF, allowed the country to raise its ratings from B to B+, meet all its international financial commitments and improve its liquidity and solvency ratios. Even so, Brazil’s approach to its insertion in the process of international globalisation has given rise to some uncertainty as regards the economy’s external direction and whether the target is primarily current- or capital-account insertion.
Analysis
The first steps in shoring up international defences
The excellent performance in 2003 of the trade balance was the main factor in providing a positive current-account balance. This occurred in July, thus reversing the habitual negative balance of the last few years. The full-year balance showed a surplus of US$ 24.8 billion, together with a net gain on current-account transactions of US$ 4.1 billion, equivalent to 0.8% of GDP, in stark contrast to the trade deficits of the preceding two years, at 1.7% and 4.6%, respectively. Such progress bears witness to the major external adjustment carried out by the Brazilian economy, moving from a current-account deficit of US$ 23.1 billion in 2001 to a surplus of US$ 4.1 billion in 2003, a US$ 27.2 billion turnaround in just two years.
It is important to highlight that the 2003 trade surplus was mostly due to the major improvement in exports, as opposed to 2002 and 2001 where attempts to control the deficit focused on controlling imports. 2003 imports held practically the same level as in 2002, thanks to the relative slowdown of the domestic market, whereas exports boomed by over 20%.
Export growth was aided by: the effective depreciation of the real (despite the appreciation in the first half against the level of September 2002), the growth in the volume of goods sold abroad (+15%) and the rise in international prices paid both for farm produce, one of Brazil’s main export commodities, and semi-manufactured goods. Low import growth, except in the last few months of the year, reflected the slowdown in the purchase of both consumer durables and non-durables, along with industrial goods. The only imports to increase were fuel –as a consequence of high international market prices up to May due to the Iraq war– and, to a lesser extent, raw materials and other inputs required for exports, although capital goods are still recording negative rates.
Brazil’s main export markets are: the European Union (25%, mostly Germany and the Netherlands); the US (23.5%); the countries of the Latin-American Integration Association or ALADI (17.5%, mostly Argentina and Mexico); and Asia (17.5%, mainly China, Japan and South Korea). Its imports come largely from the same areas and countries, in more or less the same order of importance, with a growing shift towards Asia: EU (26%); US (20%); Asia (19.0%) and ALADI (17%).
The current account, which started the year with a moderately negative balance, only to become positive in all the months of the second half of the year, was accompanied by an uneven picture as regards capital movements. Capital inflows to the Brazilian economy have long been symptomatic of the ‘feast or famine’ syndrome (see Institute of International Finance; and Daniela Magalhaes Prates, Política Economica em Foco, nº 2, Unicamp, on the website www.eco.unicamp.br), typical of the approach by international financial markets to emerging economies. The gradual reduction of the country risk attaching to Brazil, after the giddy heights it achieved in the second half of 2002, combined with the fact that both Mexico and Russia regained their investment-grade ratings, brought investor attention back to Brazil.
The economic policies of the Lula administration, the attractive yields obtainable on the Brazilian economy and the prospects of Brazil becoming the next country to see a rating upgrade –which occurred last November following the agreement with the IMF, when its sovereign debt was upgraded from B to B+– confirmed the attractiveness of Brazilian investments. As measured by the rating of its C-bond, Brazilian country risk moved from 2,350 basis points at the height of the crisis of confidence in the summer of 2002 to less than 500 points in December 2003. Thus, the new phase of ‘feasting’ in the international liquidity cycle –verified by the fact that private capital flows to emerging economies moved from US$ 124.0 billion in 2002 to US$ 188.0 billion in 2003 (Institute of International Finance)– and the search for high yield on reasonable risk set the tone for capital inflows to Brazil in 2003.
Capital began to reappear after the first few months of the year, but the highest figures coincided with the months of April, June and September in which the IMF disbursed the different tranches of its loan. By types of capital, direct investment continued to improve, reaching US$ 10.1 billion for the year, less than the amount invested in 2002 and 2001 but significant in the sense that it revealed the interest Brazil holds for foreign companies in a year of zero growth. Other than direct investment, inflows were obtained on more volatile securities such as fixed-interest instruments issued overseas (notes and commercial paper) and portfolio investments in local stocks and ADRs. Foreign bank lending to Brazil diminished.
Direct investment, though reasonably strong, was still some way off the figures of a few years back, mainly as a result of the position international investors currently find themselves in and the remaining uncertainties over the Brazilian economy. US and EU companies (particularly Spanish investors) appear to be steering clear of Brazil until the international scene unfolds further. Domestic investment was hit by the freeze on privatisations and the need to keep a close eye on domestic economic indicators, as well as on the regulatory environments for telecommunications, natural gas, infrastructures and the oil industry. In the first nine months direct investment was very cautious, reaching no more than US$ 5.8 billion. However, it began to speed up in the last three months of the year, reaching what was considered to be an optimistic estimate of US$ 10.1 billion.
Investment in stocks and shares, despite periods of high volatility, eventually succeeded in achieving net positive inflows. Events moved in various phases. In the months from the crisis to the end of 2002, punters disinvested. In the first few months of the new government, there was a mild recovery. Then, in the summer, disposals continued only to reverse be followed in the autumn by another wave of investment to take the full-year figure to a positive net inflow of portfolio investment worth US$ 5.1 billion. In the third type of capital movements, ‘Other investments’, net borrowings moved into a negative balance and the situation began to cause concern, particularly when international interbank facilities started to falter. However, the position stabilised in the last four months of the year and is now positive to the tune of US$ 13.5 billion.
The improvement evident from September in terms of attracting international financial resources also improved the rate of rotation, ie, the ratio of borrowed to repaid funds. Prior to this, it had dropped to 70%, far below what is considered an acceptable level: 82%. However, in the four following months, taking into consideration the broad count of financial liabilities, the rotation ratio surpassed 100%, a sure sign that international financiers were less worried than they had been about the maturity profile of Brazil’s foreign debt, particularly that of the private sector which, although it amounts to only half the government debt, is largely short-term.
Combined repayments in 2003 of US$ 27.4 billion were covered by medium- and long-term funding (including the resources provided by multilateral agencies), direct investment and a net positive balance on current account. However, the bill in 2004 is for US$ 39.7 billion, meaning that the government will have to achieve a positive trade balance not far off that obtained in 2003 in order to keep the current-account balance in the black also and, at the same time, obtain a significant increase in external capital inflows if it wants to meet these substantial repayments while maintaining a high volume of reserves.
By the end of December, Brazil’s international reserves, measured as its international liquidity, stood at US$ 49.3 billion. That was after having repaid the IMF US$ 6.2 billion in the last month of the year. However, reserves to be used in market intervention are not total but net adjusted reserves, which at the end of December amounted to US$ 17.4 billion, considerably higher than the floor of US$ 5.1 billion agreed with the IMF. Under the latest IMF agreement, signed in November, repayment to the IMF of US$ 8.1 billion under the previous agreement was superseded by a new loan of US$ 14.0 billion (what amounts, in fact, to an extension of the loan by US$ 5.9 billion, on top of the unused US$ 8.1 billion), which will be paid out only if the country faces adverse conditions such as the turbulence derived from the international money markets. In addition, the agreement establishes a staggered scale of repayments for 2005 (repayment of only US$ 6.0 billion), 2006, and 2007.
The export performance of the Brazilian economy achieved excellent results, thus contributing in no small measure to temporary abeyance of its exposure to external factors. Nonetheless, its outstanding trade balance, current-account surplus, the significant inflow of foreign direct investment, increased access to the international money markets and sharp reduction in Brazil’s country risk must be complemented by additional measurements in order to gain a better idea of the economy’s external vulnerability. In this respect, its vulnerability can best be measured by time categories: the short, medium and long terms.
In the short term, vulnerability is measured as a function of liquidity, whereas in the medium and long term, what is important is the solvency of its economy. The most popular indicators of external liquidity are: a) the ratio of short-term overseas liabilities to net adjusted reserves; b) the ratio of gross foreign funding requirements to net adjusted reserves; and c) the ratio of gross foreign fund requirements, plus foreign portfolio investments, to net adjusted reserves. The results of all three indicators up to November indicate a steady decline and, therefore, a gradual improvement in external liquidity and, hence, a fall in overseas vulnerability. If, at the same time, we look at solvency, the most important element of which is the ability to generate foreign currency earnings (in Brazil’s case, its ability to obtain and keep a positive trade balance with which to generate a current-account surplus), the most widely-used indicator is the ratio between the amount of external public and private debt on the one hand, and exports on the other. At present the ratio between total foreign debt and exports stands at 306, its lowest point for the past eight years.
Thus, all the signs are that Brazil has managed to reduce the overseas vulnerability of its economy in the short term, as witnessed by the fact that the warning lights for liquidity and solvency have ceased to flash. What Brazil must do is maintain the current level of exports and the consequent trading surplus to permit a positive current-account balance with which to bring the level of foreign debt into line with the volume of exports, while maintaining a healthy level of reserves. The fact that the greatest effort falls on the trade balance, ie, exports, however, means that overseas vulnerability in the longer term remains in doubt.
The variable exchange-rate system adopted in 1999 failed to guarantee a regular positive trade balance, which only occurred, briefly, in the wake of the two major devaluations (L.G Belluzzo and R Carneiro, Política Economica em Foco, nº 2, Unicamp, available on the website www.eco.unicamp.br). At other times, the rate has lurched, ie, the real has tended to rise in value, by the increasing influx of foreign capital, hampering exports and exacerbating vulnerability to external factors by both weakening the trade balance and increasing external liabilities. The strategy of reducing overseas vulnerability requires an exchange rate in accordance with the sustainable development of the country’s export capacity and with the definition of a new type of insertion in the process of international globalisation. Only then will the necessary trade surpluses and foreign direct investments be obtained which, like ‘good’ as opposed to ‘bad’ cholesterol, will provide the required financial inflows and contribute to strengthen exports and reduce outflows for factor services. Otherwise, external vulnerability will continue to cast a shadow over economic stability and growth.
Can the Brazilian economy insert itself differently in a global world?
In the 1990s, using the rate of exchange to swell current-account and capital inflows was the well-worn method of controlling inflation. It prompted several Latin American countries to embark, unwittingly, on ‘a process of abandoning productive processes due to the strength of imports (…), starving export projects of funds (…) and allowing foreign capital to control not only the production of goods but also, and in particular, the provision of services for the domestic market which, thenceforth, ceased to contribute to the nation’s foreign earnings capacity’ (Belluzzo and Carneiro, op. cit.). To make matters worse, the influx of foreign capital favoured, above all, the entrance of portfolio investments and short-term borrowing, thus deteriorating currency liquidity and solvency indicators and undermining exchange-rate stability by fuelling just those speculative onslaughts which, sooner or later, were bound to tip the whole economy into crisis.
Dooley, Folkerts-Landau and Garber (in An Essay on the Revisited Bretton Woods System, NBER, WP 9971, available on the web at www.nber.org) note that ‘American globalisation’ in the 80s and 90s fostered two kinds of regions (incidentally, this view is the same as that taken by Belluzzo and Carneiro, op. cit., in analysing the structural dimensions of integration of the Brazilian economy): those for which international insertion is achieved by means of trade and the influx of direct investment into what the authors call ‘trade account regions’, ie, the path followed by European countries after the Second World War and, later, by the Asian economies; and, secondly, regions which achieve insertion by means of the capital account (‘capital account regions’). They include most Latin American countries and, in particular, Brazil, in which there is an imbalance between the overhang of foreign debt and export capacity or, worse still, between foreign reserves and short-term foreign liabilities.
In the former regions, exchange-rate policies are crucial in guaranteeing export competitiveness on a medium- to long-term view and, thus, the ongoing technological advance of their production structures. In the latter regions, newly arrived capital keeps a close eye on interest-rate differences and takes stock market positions, resulting in rapid shifts of capital back and forth which generate huge swings in the exchange rate, play havoc with host country exports and impede the development of a healthy export sector which, to make matters worse still, has also to compete with the incoming waves of imports facilitated by lower tariffs and higher exchange rates.
This bad mix of capital inflows initiates, from the outset, a continuous drain of resources in the shape of interest and principal repayments, dividends, repatriation of capital, etc, which, in turn, exacerbate the negative balance on the services account. The host country thus becomes enmeshed in a vicious circle in which it has to continually increase its exports to enable it to meet its overseas obligations and retain foreign investor confidence. However, as the influx of capital also pushes up the exchange rate, it helps to create a chronic current-account deficit, which has then to be funded by yet more supplies of foreign capital. By this means, those economies that opted for insertion via the capital account end up with strong linkage between foreign capital funding and currency liquidity.
The linkage between the international liquidity cycle and external funding works in response to investor confidence and a country’s credibility. When the international liquidity cycle is high, resources are eager to enter and you end up with a ‘feast’; when the cycle turns and liquidity is short, you face a ‘famine’. A famine typically sends the value of the currency spiralling downwards, imposing painful adjustments on precisely those agents carrying the largest proportion of foreign debt.
Once those adjustments are made and investors recover their confidence thanks, also, to the application of orthodox macroeconomic policies, the liquidity cycle sends capital scurrying back to the host country in search of higher returns in a stable exchange-rate environment and of stock market opportunities. Exchange rates start to climb once again and if the economy starts to recover, interest rates are likely to remain high as they must continue to attract foreign capital and keep inflation under control. Unless the country has managed to promote and diversify its export sector, the currency’s appreciation in a context of economic recovery will erode the trade balance, generating a fresh current-account deficit, throwing the economy back into the arms of foreign investors and increasing its level of external vulnerability.
In Latin America, as Dooley, Folkerts-Laundau and Garber point out, Chile and Mexico (the latter as from the tequila crisis) are cases of ‘trade-account insertion’ in American globalisation, while Brazil and Argentina are cases of ‘financial insertion’. This type of insertion has favoured the following cycle: a growing current-account deficit – capital inflow/foreign debt – high interest rate monetary policies – currency appreciation – contracting export sector production – increasing imports and a burgeoning surplus for factor services – modest growth rates fuelled by expanding consumption – lower-than-normal rates of investment – higher current-account deficits – an increasing need for foreign capital – increasing foreign vulnerability – an exchange-rate crisis and external adjustments – a search for lost credibility by means of orthodox macroeconomic policies and dependence on the foreign liquidity cycle. Seen in the medium term, escaping from this cycle –of scant and periodic growth and exchange rate crises– requires a new model for international insertion drawing more from the trade-account version wherein investment, export recovery and the influx of foreign direct investments should focus in the main on goods and services suitable for foreign markets. ‘Financial insertion’, the alternative, entails too much instability and inadequate growth; it does not foster development.
Conclusions
In 2003 the Lula government succeeded in pulling Brazil back from the brink of default and restoring the confidence the country deserves among international investors. However, the price paid was very high, as stability and credibility were bought at the cost of growth. The indicators in the last few months of 2003 suggest that the hoped-for recovery could be on the way. 2004 began well, setting a new record for exports, with a chance that the sector may achieve the planned targets. GDP growth of 3.6% is expected, based on a recovery in investment, along with consumer spending and exports. Investment should rise by around 6.5%, given that the financial position of companies has improved by dint of the appreciation of the real in 2003; employment of installed capacity has increased, and interest rates should continue to decline to around 13%, with inflation steady at around 5.5%. Consumer spending should grow at a rate of 5% based on a recovery in real earnings, declining inflation, lower interest rates and renewed borrowing. The government will continue to keep debt at bay by means of a trade surplus in primary goods and services equivalent to 4.25% of GDP. An outlook for 2004 which combines real growth of 3.25%, a primary surplus of 4.25% and a Selic rate of 15%, should reduce the public debt from its present level of around 58% to 54.9% by year end and, if similar conditions prevail, to 41.8% by 2007. This appears to be the strategy of the Lula administration. The idea is to use fiscal policy to achieve a dual objective: price stability by means of stable exchange rates and create elbow room for public policy through a first stage of debt reduction accompanied by institutional reform of the tax and social security systems.
The moderate increase in domestic demand, accompanied by good export performance, exchange-rate stability and the continued presence of idle capacity in consumer goods are the key elements to guarantee a year of stable growth. That said, consolidation of medium-term growth at levels above 3.5% of GDP will require investment to extend its current share of GDP from 17.5% to over 21.0%, meaning it will need the full support of monetary policy and the adoption of an international insertion strategy with the emphasis primarily on exports and direct foreign investment from firms focused on the domestic market but, above all, on exports. This would explain the new industrial and trade policies being pushed by the government, given that the rate of investment of domestic and foreign firms, together with exports, is the key to economic development in Brazil. Spanish companies investing in Brazil since the end of the 90s previously focused, in the main, on financial services, telecommunications, utilities and, only to a minor degree, on the production of industrial goods. Brazil is a strategic bid for these investments in the region, so all the indications are that Spanish companies will increase their direct investments in Brazil, helping to raise the inflow to over US$ 15 bn.
Alfredo Arahuetes García
Lecturer in International Economy and, currently, Vice-Dean of the Faculty of Economic and Business Science (ICADE) of the Comillas Pontifical University of Madrid and freelance researcher in International Economy for the Royal Elcano Institute.