Brazil: Flying

With GDP growth set to crest over 7% y/y in 2010, Brazil is showing tiger-like tendencies. The level of economic activity surged 9% y/y during the first quarter of this year, the fastest rate of expansion in 15 years. A close look at the data showed an even more impressive picture. The industrial sector grew 14.6% y/y, while services expanded 5.9% y/y. Gross Fixed Capital Formation was 26.0%. This was highest level recorded since IBGE started its time series. Brazil’s savings rate also reached 15.8% of GDP. Although consumption is strong, the main engine of growth is investment. With the World Cup and Olympics on the horizon, the country is busily improving its infrastructure to become the next global showcase.

Likewise, the government’s Program to Accelerate Growth (PAC) is expected to kick into gear during the next four years. The program, which was launched in 2007, promised to invest R$504 billion on housing, electricity generation, highways and other infrastructure projects. However, only R$257 billion was spent. Regulatory and bureaucratic impediments were part of the reasons for the delay. Nevertheless, Brasilia intends to expand the program to R$959 billion over the course of the next four years. Almost a third of the new PAC funds will be directed to oil and natural gas. This will include the construction of new petrochemical plants for Petrobras. The former state-owned oil company is becoming a major engine of growth, as it develops its deep water hydrocarbon basins. Brazil is now becoming a full-fledged energy giant, with oil production exceeding 2 million barrels per day. A universe of drilling equipment and service providers are sprouting across Rio de Janeiro and the surrounding areas. Leagues of newly-minted engineers from Brazil’s top universities are being employed by the growing oil industry. As a result, the country’s unemployment rate is on the decline and millions of lower-class Brazilians are being pushed into the middle class.

The investment boom is also fuelling a consumption boom. Brazil is becoming the fourth largest automobile market in the world, overtaking Germany. This is creating spill over effects for surrounding countries, such as Argentina and Uruguay, as they rush to attend the surge in Brazilian domestic demand.

With consumer credit expanding at an annual rate of 26% to 30% y/y, banks are providing Brazilian households with the funds needed to keep up with their consumption needs. Interestingly, inflation remains under control.

It’s true that consumer prices rose significantly during the first part of the year, reaching the upper end of the central bank’s target band. However, the inflation rate began to moderate sharply in June-falling to 4.8%. This is a significant development, particularly given the torrential rate of economic growth that was posted during the first quarter. Brazil has a long history of overheating whenever GDP growth exceeds 4% y/y. However, GDP growth was more than twice as high during the first quarter, yet the inflation rate began to ebb. Part of the reason was the COPOM’s proactive monetary tightening. It was also explained by the ongoing PAC investment in infrastructure-particularly investment in the electricity sector.

Previously, bottlenecks would lead to imbalances between supply and demand, thus giving producers greater ability to raise prices. Further investment into infrastructure, especially in transportation and logistics, will remove more of the bottlenecks. As a result, Brazil will be able to achieve Asian-styled rates of GDP growth, without fuelling inflationary pressures.

The booming economy is boosting the prospects for Dilma Rousseff, the PT’s official candidate. Rousseff was groomed for the position, having been appointed by President Lula da Silva to head the PAC initiative as soon as it was launched. Although she initially trailed in the polls, she is now tied with PSDB candidate Jose Serra. The smart money says that she will pull ahead at the end and sweep past the uncharismatic former-Governor of Sao Paulo. Under Rousseff, the Brazilian state will continue to take a more assertive stance on the domestic and international fronts. Through the vehicles of BNDES and Caixa Economica, the Brazilian government will play a bigger role in private sector activity. Likewise, we will continue to see Brazil taking a more independent direction in its foreign policy. Brazil was heavily criticized for the deal it brokered along with Turkey to enrich Iranian uranium. However, the country was acting in its own economic interest. Iran is a major trading partner for Brazil, importing vast quantities of beef and sugar. It is time to recognize the obvious. Brazil is flying, and it will be so for the foreseeable future.