The Idle Strategist

The Policy Risks to Brazil's Banks, Cont.

I think the Brazilian government’s policy response to the global financial and economic crisis over the past several months generally has been admirable. But I’ve also argued that it raises several risks for equity investors, and that chief among these risks is that government-controlled banks would be compelled to let the quality of their loan portfolios suffer in pursuit of public policy goals.  

Last week came news that President Lula had replaced the president of Banco do Brasil because he believed that interest rates and fees were too high. Today Folha has an article reporting (via anonymous sources) that Lula has ordered government-controlled banks – including Banco do Brasil – to offer new credit lines to large Brazilian retailers, presumably so that they can offer more financing to for consumer purchases of durable goods.  

As an investor, I would continue to look for pair trades in the banking sector – buying private banks that may be better-able to manage their loan book risk and selling government-controlled banks that may be more subject to these risks.

Another View of the Obama-Chavez Meeting

This new video of Chavez and Obama talking at the Summit of the Americas in Trinidad appears to show a far more intense encounter than previously reported. On several occassions, Obama seems to be forcefully arguing a point, giving a very different impression of the meeting than that of the lone New York Times photo that appeared over the weekend. Hopefully this quiets the ridiculous cable TV and talk radio chatter today about Obama's "shameful" handshake with Hugo.    

Many thanks to Bill Bamber for the pointer.

Chavez Obama
by noticias24

Chavez’s Gift

I was fascinated – and frankly perplexed – to read that Hugo Chavez gave President Obama the book The Open Veins of Latin America by Eduardo Galeano. It’s a book I – and most people with more than a passing academic familiarity with Latin America – know well. Indeed, in the late 1990s, it was an occasional topic of discussion among my graduate school classmates at Georgetown, but our ultimate conclusions about the book were generally critical. (The New Yorker has a nice summary of the book here).

I’m no fan of the policies or practices of Hugo Chavez. But if I were a sympathizer, and if I had to choose one book to try to influence the thinking of the new president of the US, it certainly wouldn’t be this one. (And I’d make sure to give him an English-language version).

For one, it’s perhaps the most clichéd book on US-Latin American relations, and these days is more likely to be discussed by beer-fueled grad students than foreign policy practitioners. Second, although it is considered part of the dependency-theory literature, it’s not the most representative or even the most orthodox work of the genre – and it’s one of the least sophisticated and nuanced. Unlike most dependency theorists, who rightly argue that domestic elites have been complicit in Latin America’s historic underdevelopment, Galeano lays the blame exclusively at the feet of the US. Finally, it’s an overtly defensive work – concerned above all about Latin America being the victim of US cultural hegemony.

I’ve always thought that Chavez was a true cynic – going after the US and advocating radicalism because it suits his domestic political aims, not because of any one consistent ideology. I’ve thought the same regarding his volatile relationship with the more pragmatic left in the region (Lula in Brazil and Bachelet in Chile, for example). But his choice of reading material for Obama reveals a man still very much influenced by old and failed ideologies.

Automakers Pushing Ethanol in Brazil

SugarcaneBlog has an interesting post on how global automakers with operations in Brazil are actually advocating for more use of ethanol -- more evidence of how successful Brazil has been in quickly shifting its auto fleet from gasoline-only to alternative-fuel equipped. The highlights: 

"While in the U.S. the automakers are fighting the use of higher blends, the major automakers in Brazil have joined forces with ethanol producers in a campaign aimed at expanding the use of ethanol in flex-fuel vehicles.

Local subsidiaries of General Motors, Ford Motor, Fiat and Volkswagen will distribute 2 million free booklets (pictured on the right) explaining the benefits of ethanol for consumers who buy their flex-fuel cars in Brazil. These four automakers account for 80% of the Brazilian auto market.

The initiative is part of the Brazilian Sugarcane Industry Association (UNICA)’s efforts to change consumers’ view on the fuel. Most flex-fuel car owners decide whether to use pure ethanol or gasoline (which in Brazil is already blended with 25% ethanol) based solely on which is selling at the cheapest price in the filling station. Even though gasoline is now the alternative fuel in Brazil since last year, UNICA believes that a bigger awareness of ethanol’s environmental benefits would give demand a boost. Recently, UNICA managed to get the government to use the word “etanol” instead of “ethyl alcohol” at the fueling stations. The move was seen as a way to standarize the product naming in Brazil and abroad."

Signs of Life in Brazil’s Labor Market

The Brazilian Labor Ministry reported yesterday that on a net basis, 34,818 formal sector jobs were created in Brazil in March. The labor market is still quite weak: Since October 2008, the economy has lost 754,000 formal sector jobs, and on a twelve-month trailing basis, the steep job losses persisted through March. But March was the second consecutive month of positive net job creation, and saw an improvement over the 9,179 jobs created in February.

Many of the job gains appear to have been directly or indirectly generated by the public sector – civil construction and public administration saw the largest gains during the month. The retail sector and manufacturing continued to lose jobs, but for the first time since October there was job stability in the mining industry.

I expect the general weakness in the labor market to persist over the next several months. While I remain cautious, the labor market appears to have stabilized, and any further deterioration may be limited to a few sectors of the economy.

Net Formal Registered Jobs (Jan. 2007-Mar. 2009)

Brazil Cuts Primary Surplus Target

Earlier today Brazilian Finance Minister Guido Mantega confirmed long-held expectations that Brazil will reduce its primary surplus targets for the next several years – from 3.8% of GDP previously to 2.5% of GDP for 2009 and 3.3% for each year from 2010-2012. Moreover, state oil company Petrobras – which generally has accounted for about 0.5 pp of the primary surplus – will be separated from the normal federal budget, so that increased spending under its US$174 billion five-year investment plan will not count against the surplus target.

I continue to be impressed by how successfully Brazil’s policymakers have credibly pushed the boundaries of counter-cyclical fiscal and monetary policy. It wasn’t that long ago that the mere hint of a decrease in the primary surplus target would push sovereign spreads higher and lead the currency to sell off – even the economy was growing. But following today’s announcement (which was not unexpected) the currency actually rallied, as growth concerns continue to trump any potential worries about inflation or external financing risks.

Poland Joins Mexico in New IMF Facility

The IMF has just announced that Poland will seek a US$20.5 billion credit line from the Fund’s new Flexible Credit Line. The new facility allows quick access to emergency financing for countries that have been “pre-approved” because the IMF considers their economic policy frameworks to be fundamentally sound.

When the FCL was first announced I thought countries would be reluctant to sign up for the facility. But each additional country that signs up reduces the “stigma risk” for others and raises the probability that the new program is a success. 

No Cuts in Transfers to Brazil’s Cities

Planning Minister Paulo Bernardo said earlier today that the federal government will transfer R$51.3 billion to municipalities in 2009 – unchanged from 2008, despite a decrease in the tax revenues that fund the Municipal Participation Fund ( a form of revenue-sharing with Brazil’s smaller cities). President Lula also will apparently sign an executive order on Tuesday to immediately release R$1 billion to smaller cities. Tax revenues are being hit not only by the slowdown in economic activity, but also by recent tax cuts (such as the IPI exemption on car sales) intended to spur household consumption.

Mexico: Formal Job Creation Remains Weak in March

The Mexican government reported that there were 13.88 million formal-sector jobs in Mexico in March – essentially flat from the previous month, but 2.61% lower compared to March 2008. Jobs were added on a net basis in March in construction, and lost in manufacturing, retail, and transportation and communication. 

While a breakdown between private and public sector jobs was not provided, my guess is that most of the new jobs in construction came from publicly-funded civil construction projects. The private sector appears to have continued to shed jobs in March.

Recession, Poverty, and Inequality in Latin America

The Wall Street Journal previews this week’s Latin America regional World Economic Forum meeting in Rio (in addition to its annual meeting in Davos, the WEF hosts regular regional meetings throughout the year):

“For the economic elite gathering in Rio de Janeiro on Tuesday at a regional meeting of the World Economic Forum, the city's hillside slums may loom even closer than usual.

Recent boom years eased inequalities between the rich and poor. But now Latin America has plunged into a recession. That has leaders facing two tasks: boosting economic growth and improving the plight of the region's poor.

Some answers are starting to emerge. Governments that can afford to are talking up huge public-works programs in an effort to create jobs while improving roads and ports. In Brazil, the government of President Luiz Inácio Lula da Silva recently unveiled a plan to build one million low-income homes. In nearby Chile, major spending programs are also under way.

This recession hasn't plunged Latin countries into unrest. But social conditions remain a worry. According to the Inter-American Development Bank, sluggish economic growth in Latin America and the Caribbean could send 2.8 million to 12.7 million people into poverty in the next two years.”

These concerns are more than justified by the historical record. Global recessions or external shocks often have been associated with increases in poverty and income inequality in Latin America (I contributed to some academic research on this topic in the late 1990s, and have written about it recently). Poorer households tend to bear the brunt of economic shocks and lack the mechanisms available to more wealthy households to insure against them. The region’s governments historically have not had the resources, the will, or the appropriate policies to protect poorer households from these shocks; instead, they often have been forced (by budget and external constraints) to revert to pro-cyclical fiscal and monetary policies that ended up exacerbating and deepening the adverse impact on poor households.

So far, we’ve seen some signs that this may be a different type of recession for much (but not all) of Latin America. Many of the region’s governments are credibly testing the limits of counter-cyclical fiscal and economic policies by reducing policy interest rates, expanding (or not reducing) overall public spending, and by quickly putting into place specific targeted policies to minimize the adverse impact on less-wealthy households.

I continue to believe that this will be a painful recession for the region – job losses likely will persist for many more months, and most of the region will experience a large contraction in GDP in 2009. Moreover, the trend toward a growing consumer middle class that we’ve seen in Brazil in recent years likely will suffer a setback. But for much of the region – and especially for Brazil – this recession may be the region’s first “normal” recession – i.e, it won’t lead to a full-blown economic and political crisis, and it may not be associated with a large increase in poverty and inequality. Besides Brazil, I would consider Chile, Peru, and Colombia (in order of confidence) as the region’s major economies best-poised to effectively manage the crisis.

This group of countries best-prepared to manage their way through this recession all used the boom years from 2004-2007 to build foreign currency reserves, reduce or eliminate external and foreign currency-denominated debt, and (to a lesser extent) accumulate some fiscal savings. (Ironically, although the term as fallen way out of favor in the region, those Latin countries that followed the broad outlines of the so-called “Washington Consensus” of economic policies are generally in the best shape today.)

On the other hand, countries like Venezuela and Argentina appear more vulnerable to a severe crisis emerging in late 2009 or 2010 – they face relatively more severe external constraints, lack the credibility to tap global capital markets to borrow, and have had a contentious relationship with the official lending community (the IMF and other IFIs). Although their government’s populist rhetoric have favored the poor, if a serious crisis emerges the poorest households likely will suffer the most. And because the popularity of these governments is based primarily on their ability to deliver real income gains to their constituents, any serious domestic economic cris may quickly become a political crisis. 

I’m more on the fence about Mexico – among the region’s largest economies, in my view it faces the most daunting longer-term structural challenges. But the Calderon administration – and the last several governments – have hewed to sensible macro-economic policies, and Mexico’s economic institutions have accumulated quite a bit of credibility over the years. Mexico’s recent decision to tap the IMF’s new credit facility underscores that Mexico – unlike Argentina and Venezuela – will have as much multi- and bi-lateral support as they desire in the months and years ahead.