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Brazil gets the vote for value

Emerging economies Helen Pow looks at the prospects for Brazil after president Lula finally prevailed in the election

Brazil is a contender for the top performer among emerging economies in recent years.

The Brazilian market was unaffected by the second- round election in late October which reinstated Luiz Inacio Lula da Silva as president of the country for a second term.

Brazilian stocks and currency rose on Tuesday of last week after Lula said he would maintain key economic policies to keep inflation and spending under control in his next term.

The second round of elections was scheduled after Lula failed to secure 50 per cent of votes necessary for an outright win, by 1 per cent, in the first-round election on October 6.

First State Investments deputy head of global markets Alan Nesbit says the first round’s result was a surprise but the whole industry was expecting Lula’s victory in round two.

But Nesbit adds that Brazil’s strong performance of late has little to do with who is in the top job.

He says: “It is about economics rather than politics. It would take a really mad politician to screw up what is going on in Brazil right now.”

Bestinvest head of communications Justin Modray agrees: “The fundamentals driving the market is so much bigger than the political picture. Politics does matter of course but unless there is a significant change, it will not have that much of an impact.”

What are the fundamentals making Brazil so attractive?

Nesbit believes export is a big factor, saying Brazil has $1bn a week flooding in from trade.

According to Modray, the key is that Brazil is dominated by commodities and natural resources which are performing well.

He says: “The general consensus in most areas is that demand will keep up and supply cannot come in fast enough. Historically, commodity prices are still quite low. It has been good for four to five years years but most people believe are still plenty of gains to come. If there is a big production and continued shortage, then you are in a good position because supply cannot catch up overnight so it should stay fairly robust.”

But he warns that if commodities go pear- shaped, Brazil would be in a vulnerable position.

Threadneedle Latin America deputy fund manager Katy Dobson says strong exports are making the market more buoyant and the stable currency and impressively low inflation are also attracting investors.

But she adds that hefty interest rates and a high tax burden on the economy have been stifling investment, keeping the GDP low and holding Brazil back although this is starting to change.

Dobson says: “If they reduce the tax burden and interest rates the GDP would grow faster. We are quite positive that if interest rates drop, investment will rise and GDP will increase.”

Nesbit believes that high interest rates give Brazil room to move and suggests that, after dropping by 5 per cent already, rates will continue to decline.

He says interest rates should be around three or four basis points above inflation. Currently, interest rates are just under 14 per cent, much higher than the 5 per cent inflation rate and Nesbit says this is a sign they will keep falling.

Opposition leader Geraldo Alckmin was the more market-friendly of the two contenders as fund managers believe he would have been more proactive in pushing the economy.

Dobson says: “Sentiment shows that Alckmin was more likely to do the reforms needed for the economy. Social security reforms, fiscal reforms and a number of others needed to boost the economy and improve growth. Lula is not a risk, just not as strong as it could be. We see it as a continuation of the status quo. If Alckmin had won, we would have expected a stronger market performance.”

Modray considers there is a lot of pressure on Lula to bring in reforms which will help Brazil secure a degree of longer-term fiscal stability and grow the economy.

Nesbit says Lula’s victory agrees investors can expect more of the same in Lula’s second term as president – slow but steady progression.

He also points out that sometimes what the market wants is not the best thing for a country.

Seven Investment director Justin Urquhart-Stewart says investors would have preferred an Alckmin victory but it would have caused unrest in the streets. He is confident that Lula can improve the economy.

He says: “The election has given us a bit more confidence. Lula’s reform process is steady and his social welfare schemes are encouraging. The openness for investment and transparency of company reporting is improving.”

He believes that Brazil is a crucial market but is waiting to see the direction of the US economy before investing in the area.

He says: “As the US economy slows, it will have an impact on demand for commodities around the world, not least in China. A slowdown in the US economy would slow China’s economy as well.”

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