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A closer look at Brazil’s new year prospects

Developing markets have undergone a major turnaround in performance following a challenging 2015, emerging as one of the strongest equity plays last year. Conditions for emerging markets improved as Federal Reserve kept rates lower than anticipated, and commodity prices stabilised. Big emerging economies such as Brazil and China saw better-than-expected growth, while other countries benefited from concerns over potentially destabilising geopolitical events in developed markets.

Now the key issue for investors is to determine which emerging nations may have already fulfilled their short-term potential and have a more subdued 2017, and which countries might still have the capacity for strong and continued growth during the next 12 months and beyond.

One of the biggest improvements among emerging markets has been Brazil, which saw a number of developments during 2016. Brazilian equities were one of the stand-out performers last year, up over 80% at year end. Under president Dilma Rousseff, the country had failed to live up to its potential and lagged well behind other developing markets. However, her impeachment and replacement by Michel Termer has signalled a positive change for the economy. Temer, who had already released his manifesto called ‘Bridge to the Future’ in October 2015, has begun to tackle some of the key issues, including government debt, pension reforms and government spending. Now some analysts believe Brazil could surprise investors again in 2017.

Perhaps the largest worry with Brazil at the start of last year was the sustainability of the government debt ratio, and the sharp increase from 50% to 70% of GDP in just the two previous years. Some had forecast a rise to 100% as early as 2020, so it was evident that the model had become unsustainable. In addition, the primary surplus which had been running for over a decade had collapsed, and the country was now running a primary deficit for the first time in recent memory. So, Temer’s first job was to stabilise government finances and to continue to attract capital and stimulate investment in the Brazilian economy.

Indeed, many feel the new president has done an excellent job in enacting some of the policies announced in his aforementioned ‘Bridge to the Future’ manifesto, and the country’s current account deficit has already been largely reduced. The IMF believe that an emerging market can run a sustainable current account deficit of around 2%, and Brazil is now less than that figure, meaning its vulnerability to external shocks has been massively reduced.

There are, of course, still numerous corruption issues and government scandals to be dealt with, but if the president can get fiscal accounts under control, the country can turn its attention to key issues such as the nation’s pension deficit, as well as other, more orthodox economic policies, and the hope is Brazil will finally start to emerge from its recent recession.

But it is important to note that, while Brazil has certainly outperformed this year, and in spite of all the positive economic developments, it remains a long way off the highs seen earlier this decade. Indeed, the market remains more than 30% lower than it was in 2011, which surely means investors with a long-term horizon potentially still have a good entry point to the market, as many valuations are seen as relatively cheap and still with large upside potential. The expectation is that 2017 should see a continued recovery in oil prices and commodities in general, meaning that it could be a very good year indeed, for those choosing to invest in Brazil.

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