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Look on the bright side of the Brazilian real

Brazilian economy

Look on the bright side of the Brazilian real

Rate cuts hurt the currency but should buoy local markets

A shopper counts Brazilian real banknotes. Investors have good reason to be positive about Brazil, not least because of a rate cut. © Bloomberg

Is it time to buy the dip in Brazil? Local assets have been tanking. The currency has dropped 7 per cent this year to a record low. São Paulo stocks have slumped by a similar degree.

Investors were spooked last week when December’s industrial production data disappointed. The nervous mood certainly has not been helped by the coronavirus outbreak. Brazil is far from the centre of that storm but its large commodities exports and relatively liquid markets make it an easy target when jitters hit.

Last week, the central bank cut its policy interest rate to an all-time low of 4.25 per cent a year — a classic trigger for currency weakness.

But investors have good reason to be positive about Brazil, not least because of that rate cut.

The significance of Brazil’s new, low interest-rate environment is hard to overstate. Real rates, after inflation, are close to zero. This is not what Brazilians are used to. For decades, they have been able to get real annual returns in double digits just by buying risk-free debt linked to the overnight rate. As recently as 2017, these instruments were delivering 8 per cent a year on top of inflation. The sudden slide to zero, for many savers, has meant a painful adjustment.

This helps to explain why, since 2016, stocks have been on a tear. Either directly or through mutual funds, retail investors have been piling in. At the end of last year, the value of stocks held by locals in São Paulo overtook that held by foreigners for the first time since early 2014.

Locals have also been buying riskier fixed-income instruments, especially corporate bonds. This has been great news for companies, most of whom have been starved of credit for decades unless they were big enough to borrow overseas or, until recently, lucky enough to be singled out for taxpayer-subsidised loans. Many companies have retired foreign debt early to borrow at home instead — a previously unthinkable proposition.

This can only be good for the economy, and more such changes, including a long-delayed tax reform, are in the pipeline.

Yet foreign portfolio investors appear to be unimpressed. For the past two years they have been big net sellers of stocks in São Paulo, for the first time since the global financial crisis. Preliminary data suggest they are still selling strongly this year.

Perhaps they feel they have seen it all before. The state of Brazilian politics, to be sure, leaves plenty of reason to think reform efforts might be delayed. Even if progress continues, Brazil’s fiscal problems are far from solved.

Nevertheless, over the past four years Brazilian stocks have almost trebled in value in local currency terms. Cautious foreigners risk missing out.


jonathan.wheatley@ft.com

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