Brazil‘s currency, the real, is strengthening again. It’s now around R$1.98 to the dollar. It was a weaker R$2.10 in December.
Once the government starts raising interest rates, the currency will strengthen further. More demand for the real will come on the heals of global demand for yield.
The carry-trade will pick up steam, where investors from low-yielding countries (U.S., Europe and Japan) will buy local currency bonds in Brazil that will yield over 8% by June if Barclays Capital’s rate hike forecast is correct.
More money will flow into Brazil. The real will get stronger. The Central Bank will turn on its dollar vacuum machine and suck them out of the market every day at dollar auctions, building reserves. Companies will complain again about the forex.
They might not invest, which was what slowed the economy to a halt in 2012.Brazil is in a conundrum. The economy grew at 0.9% last year, yet inflation rose over 6% (suggesting demand for everything from private schools to gasoline to Sadia chicken remained high).
Incomes rose. Interest rates fell to historic lows of 7.25%. Brazil’s economy should have expanded.
But it didn’t. It’s losing the competition war. Brazil is too expensive for everyone involved. Investment firms that thought the fair value for the Brazilian real was R$1.65 to R$1.70 just a short year ago are now rethinking that assessment. Brazil is getting richer.
Those that are getting richest quickest are the poor and lower income. Most of them do not have a good education, because Brazil’s public school system leaves little to be desired.
Educated in public schools, most of them are not prepared to pass the entrance exams to get into Brazil’s free state colleges and universities.
That puts them at the mercy of private colleges, which they cannot afford. So despite higher incomes and more spending power, few of them are equipped to help Cosan develop better technologies at its ethanol processing plants. Few have the background in oil and gas engineering to help Petrobras expand its operations in deep sea drilling off the Atlantic.
So those guys already employed are commanding a premium. Labor costs are rising down market, and up market. Meanwhile, the real is pulling the rug out from under many Brazilian firms from shoe makers to soy farmers.
It might be better for Brazil if the real was closer to R$2.30 than R$1.90, which is where it is heading once interest rates rise. A weaker real would be a good start, says Tony Volpon, head of emerging markets Americas at Nomura Securities. Volpon says labor is the elephant in Brazil’s “sala de estar”. That’s living room, people.
Unit labor costs in Brazil from January 2010 to December 2012 rose by 44%, Volpon estimates. In many ways Brazil has ended up after a long credit/consumption boom in similar conditions to southern European economies though, fortunately, with a big boost to its terms of trade to keep its current account deficit under control.
It will be very hard — and very costly — to reduce other cost competitiveness barriers significantly enough to compensate for this stratospheric rise in unit labor costs, even as every move in this direction is worth taking.
“There is a solution and it’s right from the IMF’s playbook,” says Volpon. “Let the currency do the dirty work.”
Ah, yes, the currency war. Let the currency do the dirty work, in this case, means lowering domestic wages in foreign currency terms. This restores competitiveness. It is cheaper to pay a worker in dollars in Brazil than it is in Mexico.
Right now, of course, it is not. The peso is around 12 to one. The real: two to one, on a weak day. It’s getting stronger. The exchange rate was devalued last year, gradually weakening from R$1.60 in August 2011 to R$2.10 by the end of 2012.
But, Volpon points out, internal demand was boosted by easy monetary and fiscal policy. The end result, of course, was higher inflation with little to no positive impact on growth.
Only by tightening internal liquidity and allowing the real exchange rate to fall will competitiveness be restored as the economy will shift resources to the tradable sector.
Labor markets will weaken at first, but unemployed resources will over time migrate toward the manufacturing and industrial sectors most damaged by current policies that sustain such high labor costs.
This is pretty much what happened in the 2002-2003 period that set the basis for the subsequent economic boom in Brazil.
Investors, scared by the prospects of a left wing Lula government, massively devalued the real by a measure of four to one. (Man, was I filthy rich in Brazil at that time!) The Central Bank tightened monetary policy to fight inflation.
The end result was a massive gain in competitiveness, with Brazil actually running a balance of payment surplus. Something similar is needed. What are the odds of this happening? Volpon answers his own question in a five page report to clients, published Friday.
“ A far-sighted government could ‘look through’ the transition period in which labor markets need to weaken before resources are reallocated from non-tradable to tradable sectors (exports).
This is much more likely at the beginning of a new term in office, as hopefully by the time the next elections come around a good part of the transition has already taken place and labor markets are strong again. Since we are close to the 2014 election cycle, more muddle-through is likely.
But there is little doubt that at some point in time an adjustment of this type will likely have to happen if there is any hope to rebalance this economy.” — Tony Volpon, Managing Director, Nomura Securities, “Brazil: Want To Return To Growth? Call The IMF”, March 8, 2013.
forbes.com
Once the government starts raising interest rates, the currency will strengthen further. More demand for the real will come on the heals of global demand for yield.
The carry-trade will pick up steam, where investors from low-yielding countries (U.S., Europe and Japan) will buy local currency bonds in Brazil that will yield over 8% by June if Barclays Capital’s rate hike forecast is correct.
More money will flow into Brazil. The real will get stronger. The Central Bank will turn on its dollar vacuum machine and suck them out of the market every day at dollar auctions, building reserves. Companies will complain again about the forex.
They might not invest, which was what slowed the economy to a halt in 2012.Brazil is in a conundrum. The economy grew at 0.9% last year, yet inflation rose over 6% (suggesting demand for everything from private schools to gasoline to Sadia chicken remained high).
Incomes rose. Interest rates fell to historic lows of 7.25%. Brazil’s economy should have expanded.
But it didn’t. It’s losing the competition war. Brazil is too expensive for everyone involved. Investment firms that thought the fair value for the Brazilian real was R$1.65 to R$1.70 just a short year ago are now rethinking that assessment. Brazil is getting richer.
Those that are getting richest quickest are the poor and lower income. Most of them do not have a good education, because Brazil’s public school system leaves little to be desired.
Educated in public schools, most of them are not prepared to pass the entrance exams to get into Brazil’s free state colleges and universities.
That puts them at the mercy of private colleges, which they cannot afford. So despite higher incomes and more spending power, few of them are equipped to help Cosan develop better technologies at its ethanol processing plants. Few have the background in oil and gas engineering to help Petrobras expand its operations in deep sea drilling off the Atlantic.
So those guys already employed are commanding a premium. Labor costs are rising down market, and up market. Meanwhile, the real is pulling the rug out from under many Brazilian firms from shoe makers to soy farmers.
It might be better for Brazil if the real was closer to R$2.30 than R$1.90, which is where it is heading once interest rates rise. A weaker real would be a good start, says Tony Volpon, head of emerging markets Americas at Nomura Securities. Volpon says labor is the elephant in Brazil’s “sala de estar”. That’s living room, people.
Unit labor costs in Brazil from January 2010 to December 2012 rose by 44%, Volpon estimates. In many ways Brazil has ended up after a long credit/consumption boom in similar conditions to southern European economies though, fortunately, with a big boost to its terms of trade to keep its current account deficit under control.
It will be very hard — and very costly — to reduce other cost competitiveness barriers significantly enough to compensate for this stratospheric rise in unit labor costs, even as every move in this direction is worth taking.
“There is a solution and it’s right from the IMF’s playbook,” says Volpon. “Let the currency do the dirty work.”
Ah, yes, the currency war. Let the currency do the dirty work, in this case, means lowering domestic wages in foreign currency terms. This restores competitiveness. It is cheaper to pay a worker in dollars in Brazil than it is in Mexico.
Right now, of course, it is not. The peso is around 12 to one. The real: two to one, on a weak day. It’s getting stronger. The exchange rate was devalued last year, gradually weakening from R$1.60 in August 2011 to R$2.10 by the end of 2012.
But, Volpon points out, internal demand was boosted by easy monetary and fiscal policy. The end result, of course, was higher inflation with little to no positive impact on growth.
Only by tightening internal liquidity and allowing the real exchange rate to fall will competitiveness be restored as the economy will shift resources to the tradable sector.
Labor markets will weaken at first, but unemployed resources will over time migrate toward the manufacturing and industrial sectors most damaged by current policies that sustain such high labor costs.
This is pretty much what happened in the 2002-2003 period that set the basis for the subsequent economic boom in Brazil.
Investors, scared by the prospects of a left wing Lula government, massively devalued the real by a measure of four to one. (Man, was I filthy rich in Brazil at that time!) The Central Bank tightened monetary policy to fight inflation.
The end result was a massive gain in competitiveness, with Brazil actually running a balance of payment surplus. Something similar is needed. What are the odds of this happening? Volpon answers his own question in a five page report to clients, published Friday.
“ A far-sighted government could ‘look through’ the transition period in which labor markets need to weaken before resources are reallocated from non-tradable to tradable sectors (exports).
This is much more likely at the beginning of a new term in office, as hopefully by the time the next elections come around a good part of the transition has already taken place and labor markets are strong again. Since we are close to the 2014 election cycle, more muddle-through is likely.
But there is little doubt that at some point in time an adjustment of this type will likely have to happen if there is any hope to rebalance this economy.” — Tony Volpon, Managing Director, Nomura Securities, “Brazil: Want To Return To Growth? Call The IMF”, March 8, 2013.
forbes.com
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