Thursday, November 6, 2008

The credit crunch reaches Brazil Inc - ECO

Nov 6th 2008 SÃO PAULO A big bank merger points to a tougher outlook for the private sector, but at least this time the public finances are not the problem JUST a few months ago, Brazil’s economy was growing at its fastest pace since the mid-1990s, driven by record commodity prices and record credit growth. The country’s president, Luiz Inácio Lula da Silva, declared confidently that “Bush’s crisis” in the United States would not affect Brazil. It all looks very different now. Credit is becoming scarcer and banks more suspicious of each other. Two of the largest, Itaú and Unibanco, announced a merger on November 3rd, creating a bank with combined assets of 575 billion reais ($263 billion). This will be the biggest bank in Latin America, the sixth-largest in the Americas and in the world’s top 20. The news pleased the merging banks’ shareholders but did not divert anyone else from the general gloom. In the free-trade zone around Manaus, in the Amazon, a dozen companies have told their staff to take unpaid leave, the first time this has happened in three decades. The problems began suddenly, with a sell-off last month of Brazilian shares and the currency as foreign investors rushed to cover losses elsewhere, or just went home. The sell-off triggered unexpected losses on foreign-exchange derivatives that were meant to limit the exposure of Brazilian companies to currency moves but have exacerbated it instead. “While the real was appreciating these contracts looked like a fairly safe one-way bet,” says Marcelo Carvalho of Morgan Stanley. “Companies got Lula-ed into a false sense of security.” The Brazilian press estimates that some 200 companies hold such contracts. For many, these instruments at best were peripheral to their business. Some have already acknowledged big losses. Jitters over how many more will follow, and confusion over how these contracts will be enforced in the clogged courts, has spread fear and caused banks to retract lending. To make matters worse, external funding has dried up. Figures from the central bank show that credit lines to finance trade, normally considered low-risk, are running at about half the level of mid-September. There are reports that farmers are finding it hard to find credit to buy fertilisers and pesticides, which could affect next year’s harvest. Furthermore, consumer credit is becoming scarcer as banks anticipate a rise in bad loans. The monthly payments demanded for everything from cars to football boots are rising. The government is no longer saying that Brazil will be untouched by the rich world’s recession. On October 30th Paulo Bernardo, the planning minister, confirmed that the government has reduced its target for the primary fiscal surplus (the difference between revenue and spending before debt payments) for 2009 from 4.3% to 3.8% of GDP. He said this was in order to maintain spending on infrastructure projects. But the change is unlikely to be sufficient for this purpose, particularly given that many of the government’s plans depend on private investors being able to raise credit. The Central Bank has put measures in place to make sure that those who need access to dollars can get them, while quietly indicating that it has enough dollars to prevent sudden moves in the value of the real. On October 29th the United States Federal Reserve announced a deal with Brazil, Singapore, South Korea and Mexico under which it will provide up to $30 billion to each of them. These steps seemed to bring some stability to the exchange rate. Officials have also moved to shore up the banking system. The government has reserved the right to take stakes in struggling banks, via two big state-owned ones, Banco do Brasil and Caixa Econômica Federal. Banco do Brasil is negotiating to buy several smaller banks owned by state governments. Itaú’s merger with Unibanco will probably trigger a new round of consolidation among private banks. Itaú, which will have a majority stake in the new bank, began to talk to Unibanco last year, when Spain’s Banco Santander bought Banco Real from ABN AMBRO, a Dutch bank, turning it into Brazil’s third-largest private lender. The financial turmoil “accelerated” the talks, according to Roberto Setúbal, Itaú’s chief executive, who will hold the same post in the merged bank. The deal may prompt acquisitions by Bradesco, previously the market leader. Although credit has been growing fast, it still amounts to only about 40% of GDP—a much lower figure than in developed economies. That is partly because reserve requirements and interest rates are the highest in the world. Because of past financial crises, most banks are conservatively run. “Brazil’s economy has been travelling with the brakes on,” says Eduardo Giannetti of IBMEC, a business school. “At times like this that can be an advantage.” Big bank failures seem unlikely at the moment. The government has used the favourable conditions of the last few years to improve its finances. The public sector’s debt has fallen to less than 40% of GDP, down from over 60% in 2002. At the same time, the government has retired most of its dollar-denominated debt. This means that at least currency depreciation does not trigger fiscal problems. But companies took advantage of Brazil’s new-found financial stability to raise dollar loans and issue bonds abroad, and to load up on derivatives (see chart). The result is a novelty for Brazil: a financial problem made entirely in the private rather than the public sector. That is progress of a sort. But it means that investment will slump. Analysts have slashed their forecast for growth next year to between 2% and 3%. Even so, many other big economies will fare worse.

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