Decoupling or recoupling? Contagion or resilience? If you want a stage where to observe those opposite trends at play in Latin America, the evolution of capital flows to Brazil might serve.
First, look at the recent short-term capital flow moves as the global financial crisis went through a second wave in November. The new round of discoveries of big losses at large banks in core economies sparked a new bout of fever in risky assets, as manifested in the rise of risk aversion, the global EMBI, and EMBI Brazil (roughly 20% of the former) (Chart 1). A similar evolution can be found in the other Latin American markets, with Ecuador as a glaring exception, with its EMBI descending from higher levels (Table A)
There has been a retreat of short-term capital flows to Brazil, although gradually, after a tremendously high inflow in the first half of the year. But even this retrenchment has happened by waves. Short dollar positions at BM&F by foreign institutional investors, for instance, reversed to slightly long in July and August, recovered partially in September and October, and have returned close to zero. There is a widely held perception that the crisis in money markets abroad has provoked a retrenchment of arbitrage-related inflows.
Source: IADB Research Department
Now, look at the other capital accounts and you will see another picture. As revealed by the Brazilian Central Bank (BCB) last week, Foreign Direct Investment has reached US$36 billion over the last 12 months, including US$3.2 billion in October and at least US$2.2 billion in November. That is a neck-breaking record, superior even to the high times of the privatization years. It is worth noting that most of the conservative projections by pundits for 2008, taking into account their assessment of the credit crunch abroad next year, are currently above US$ 24 billion.
The same benign scenario applies in the case of portfolio capital inflows, which have surpassed US$46 billion over the last 12 months until October. Two remarkable bouts of equity investment took place in July and October, whereas fixed income investments have stabilized. Consistent with the optimism reflected in equity flows, the Bovespa index has exhibited the behavior displayed in Chart 2, one in which, after feeling the heat of the first wave of financial shock from abroad, stock prices also underwent some pressure along the second wave, but not devolving entirely the gains accrued from mid-August onwards. As of now, the huge amount of IPOs in the pipeline for 2008 appears to reflect a favorable growth outlook for the economy and stock markets next year.
Source: IADB Research Department
Bottom line: so far, neither gloom, nor boom. It will all hinge upon the unfolding of two opposing chains of events. On the one hand, the global financial crisis will start to show its transmission to the real side, passing by some credit crunch inflicting the leverage of long-term corporate investments. On the other, benign domestic growth factors and stabilization dividends coming to fruition in Brazil. Choose between a Hollywood and a French-film type of ending as your bet…
8 Responses to “Capital Flows to Brazil as a Moving Contradiction”
FBO,Did Colombia’s EMBI reall go down to 16 in October? Wowsers…seems like that Uribe/Chávez spat really hurt :-)Typo (and my flippancy) apart, the message here seems to be whether Brazil will continue to act as a first port of call for EM risk exposure (aka hot money in, hot money out), or whether the macro can make the significant progress most expect it to make in the MT to LT. Personally I’ll bet on the happy ending (that will come despite hitting a few rocks in the road along the way). ‘American Beauty’ beats ‘Un Bout de Souffle’ in my book.
Fellow (Blogger) MarkThe typing correction is done. But the charts are still missing!My “moving contradiction” is upward bended (less hot money might not be bad at the end of the day)
Now everything is OK! The blog and Brazil (hopefully!)
“Bottom line: so far, neither gloom, nor boom.”Which way are you leaning? Gloom or Boom?
Dear GuestI lean toward the “boom” side, although one tempered by a “gloomy” downward cycle turn abroad. Some degree of retrenchment of short-term money-market-related capital inflows might even mitigate local currency over-valuation. As I’ve been doing here, I intend to keep on highlighting reasons for my cautious optimism. Credit “boom” comes next…
Otaviano, very interesting piece! Actually, your pieces are great stuff.Two questions1) I wonder if credit default swap data (CDS) on Brazilian govt bonds is picking up some the EMBI-FDI contradiction. 2) Investment banks sell BRICS a lot (or used to at least, pardon my ignorance here). To the extent that balance-sheet adjustment of big IB is still to come, don’t you think the real correction on EM is pending?
Otaviano: Ceteris Paribus – I also take a positive view on FDI for next year. Nonetheless, it remains to be seen whether Brazil’s financial system –particularly larger banks — does not suffer any contagion from the subprime disaster.
Guest1. I think you are right, and that’s why I believe keeping the eyes exclusively on EMBI spreads may have become misleading.2. A fire sale of EM assets by IBs if these are compelled to adjust further downwards may certanly generate further spikes in EMBI spreads. But, first, such spikes would tend to reverse – at least partially – after critical sale moments, and secondly FDI decisions would be affected only to the extent that investors can not rely primarily on internal sources of funding.UzielI don’t think Brazilian large banks are currently much exposed either directly to deteriorating assets abroad or indirectly through connections with banks abroad. The domestic funding basis – and the same applies to other large LA banking systems – might work out as a buffer. I’d be more concerned with the cases of local banking systems in small economies that have gone through a process of full internationalization.