Brazil: Warning signs of a credit bubble being ignored

There is a flood of global investment rushing to Brazil, but the market has not really gone up in the past year; and the country’s new middle class is on a credit binge that’s larger than Russia, India and China. But the warnings signs are being studiously ignored

How do you know when a particular market is experiencing a credit bubble? One way is to look at two very different aspects of society, the top and the bottom. Certainly the indications in Brazil are beginning to signal a situation where credit is out of control.


One sure indication is when investment banks, hedge funds, private equity firms enter a market in epidemic proportions. Local hedge funds in Brazil have increased their assets under management by 23% since 2009. Two large US investment firms, Blackstone and JPMorgan Chase, have taken large stakes in local Brazilian firms. The competition is becoming intense and a Brazilian private equity firm complains about the “armies” of global investment firms flooding into the country. This wall of new investment money is pushing up demand and valuations for many local firms. The lure of a country, which is the largest exporter of commodities like sugar, coffee and meat, seems irresistible when those commodities are reaching record highs.


The other indication has to do with those on the bottom rung of the social hierarchy. The Financial Times reported on one. This particular individual worked as a maid. Although she lived in one of São Paulo’s most dangerous favelas, or slums, she was able to afford liposuction. The procedure was only possible, because the surgeon gave her credit. But it does not end there. The poor maid was able to finance not just elective surgery, but everything else, including clothes, sandals and school supplies for her daughter.


Certainly, Brazil seems to be the right place to invest money. While most developed countries were subjected to a decline of 2.7% of their GDP as a result of the crash, Brazil in fact grew almost 5% in 2008-2009 and 7.5% in 2010. Financial analysts resorting to historical averages, point out that Brazilian shares trade at only twice their book value, far below the five times book that the Japanese achieved before their market plummeted in 1989, or the seven times book value that dotcom shares reached in 2000.


But this analysis doesn’t exactly explain why the Brazilian market, the BOVESPA, has not really increased over the past year and has declined 6% in the past month. In contrast, the US market has increased 17%. They are committing the usual sin of assuming that financial yardsticks developed for mature markets can be exported to emerging markets.


Private equity firms, investment bankers and hedge funds only see the illusion of size and liquidity. The Brazilian exchange is now the fourth largest in the world by market value. It offers a playground for complicated financial strategies and an easy IPO exit for private equity.


But the Brazilian market, like other emerging markets, is quite different. While developed markets offer thousands of companies and diversification, Brazil’s market is limited. Only eight companies account for more than 50% of Brazil’s market capitalisation. Also, other mechanisms are not in place. Shorting stock is difficult and expensive. Accurate, timely and complete information may not be available from family or government-owned firms like the oil giant Petrobras. Watchdogs may be ineffective in a country that ranks 69th out of 178 countries in Transparency International’s annual ranking of perceived corruption.


But it is not just the equity market. Brazil’s new middle class has been on a five-year credit binge that has exceeded even the expansion in other emerging markets. Brazil’s credit has expanded 2.4 times the GDP compared with 2, 1.6 and 1.2 times for Russia, India and China, respectively.


The growth of credit in Brazil is all the more surprising because the interest rates are so high. The average rate for commercial loan is 29%. Consumer rates can be much higher, often in excess of 30%. Yet, despite interest that is punitively expensive, if not usurious, the lending goes on. According to bank Itaú-Unibanco, Brazil’s largest private sector bank, lending could surge as much as 20% this year. Like China, much of this lending is from the state bank BNDES.


Like in the US, the debt service burden for consumers has risen to unsustainable levels. It is now 24% of disposable income. The US consumer debt pyramid collapsed after it reached only 14% of disposable income. Can you say “subprime”?


While the warning signs are there, they are being studiously ignored. Bank Itaú dismissed the idea of a problem. A former central banker, Arminio Fraga, agrees that there might be some issues, but felt that it was not enough to evoke concern. “We may have traces of subprime in the system…I don’t think it has gone that far.” It reminds one of US Federal Reserve chairman, Ben Bernanke, who in 2007 said “that the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.” Not thinking about it does not make it go away.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected])



Nagesh KiniFCA

6 years ago

As a member of the BRICS club India should take this as an amber signal and not go the Brazil way. We've seen the East Asian bubble burst. Let's heed the warning from distant South America. We ignored the food inflation warning let us not be found wanting in a new front. Is the Planning Commission listening?

Alex Felipelli

6 years ago

Good article. I have written about a subprime equivalent in my blog as well when the government decided to increase the limit for Minha Casa Minha Vida, a program to subside popular houses.
However, I'd like to note that even though the disposable income is highly compromised as you described, the stock of debt in relation to GDP in the Brazilian economy is still way smaller than that of US (even after the de-leveraging that has been happening over there) so the disposable income (24% x 14%) is only part of the equation. Remember that it takes an over-leveraged economy to create a bubble.
In summary, my opinion is that while the risk is there, we are not in a bubble in Brazil yet.

Range-bound opening likely; budget eyed: Monday Market Preview

Extension of sops to exporters, infrastructure thrust and a hike in income tax limit are likely to find a mention in the budget
The market is likely to open range-bound ahead of the presentation of the Union Budget, which will be presented at noon today. On the global front, Wall Street closed higher on Friday on assurance by the International Energy Agency that it would step in if crude supplies were disrupted due to the ongoing turmoil in West Asia. Markets in Asia were mostly down in early trade on Monday on concerns that the West Asian crisis will derail economic growth in the region. The SGX Nifty was 4.50 points lower at 5,323.50 compared to its previous close of 5,328 on Friday.

Concerns about the implications of the rise in crude prices for the Indian economy, and interest rates in particular, pulled the market down sharply last week. While the indices ended in the green on the first and the last trading day of the week, they were in the red for three days in between. The market declined 3% for the week ended 25th February with the Sensex and Nifty falling 510.61 points and 155.40 points, respectively.

Although the market ended positive on Friday, the indicators have started finding some direction. The manner in which the market has lost in the past few days shows that the gains are very slow. This means that the bears are still in control of the market.

The market will get a clear direction after the close of trade on Monday, after the Union Budget is to be presented. However, all rallies are likely to be short-lived. With crude prices spiralling to two-year highs, finance minister Pranab Mukherjee will have a difficult balancing act to perform.

The US markets settled in the green on Friday aided by the easing in crude prices after the International Energy Agency asserted that the impact of Libyan crisis was less than estimated and that any shortfall could be easily made up by tapping oil reserves in other countries. However traders were worried that the fighting spread to other countries in the region. 

In economy news, the Commerce Department said the economy expanded at an annual rate of 2.8% in the October-December quarter, less than the previous estimate of 3.2%. Consumers spending rose at a rate of 4.1%, less than the initial estimate of 4.4%.

The Dow rose 61.95 points (0.51%) to end at 12,130.45. The S&P 500 Index gained 13.78 points (1.06%) at 1,319.88 and the Nasdaq advanced 43.15 points (1.58%) to settle at 2,781.05.

Markets in Asia were in the red in early trade on Monday on concerns that the ongoing political crisis in West Asia will slow down the economic recovery. Besides, threats by North Korea to attack South Korea and the US as the two allies prepare to conduct military drills, also played on investors’ minds. On the other hand, Japanese factory output rose in January for a third straight month, a sign that the economy is on track for a recovery. However, a rise in commodity costs triggered by unrest in the Middle East clouds the outlook.

The Shanghai Composite fell 0.06%, the Hang Seng declined 0.24%, the KLSE Composite was down 0.29%, the Nikkei 225 fell 0.62%, the Straits Times tanked 0.96% and the Seoul Composite tumbled 1.14%. On the flip side, the Jakarta Composite gained 0.08%. The Taiwanese market is closed for a local holiday.

Back home, finance minister Pranab Mukherjee is likely to extend the concessional credit scheme in his General Budget. In its pre-budget meeting, apex exporters body FIEO has also demanded that the income tax benefit available to export oriented units and software technology park units be extended for another three years.

He is also likely to announce steps to boost the infrastructure sector with a view to sustain over 9% growth in the coming years. The initiatives could include raising the limit for investment in tax saving infrastructure bonds and providing special thrust to plan expenditure for sectors like road, energy, ports, airports etc.

Tax experts are hopeful that the finance minister will increase the income tax exemption limit to Rs2 lakh per annum from Rs1.6 lakh to bring the rates in line with the Direct Taxes Code (DTC).


JSPL to set up world's biggest steel plant in Orissa, says Naveen Jindal

Company plans to commission first phase of six million tonnes per annum project by March next year; to expand capacity of plant to 20 mtpa in ten years

Bhubaneswar: Optimistic about commissioning the first phase of the proposed six million tonnes per annum steel project in Orissa by March next year, Jindal Steel and Power today said it would expand the capacity of the unit to make it the world’s biggest steel plant within a decade.

“The capacity of the proposed six mtpa steel plant will be expanded to 20 mtpa in the next 10 years. This will be the biggest steel plant in the world,” Naveen Jindal, executive vice-chairman and managing director, JSPL, told reporters after a meeting with Orissa chief minister Naveen Patnaik.

Mr Jindal said the company had already invested Rs10,000 crore and placed orders for another Rs5,000 crore for the Orissa project. The unit would start operation with the commissioning of two mtpa capacity in the first phase, reports PTI.

“We will be able to achieve the capacity of six mtpa steel plant by 2013,” he said, and added that the company was planning a big investment in the state. While JSPL would invest Rs45,000 crore to Rs50,000 crore in the steel sector, it would invest another Rs50,000 crore in the proposed coal-to-liquid (CTL) plant.

"The company is likely to invest Rs1,10,000 crore in the next 10 years,” Mr Jindal said. He also suggested that the environmental clearance for the project was not conditional.

To a question on the rehabilitation of people affected by the project, he said that the company had already demonstrated its intentions by its activities. “Both the chief minister and the company were concerned about the proper rehabilitation of the affected people,” he said.

The Congress member of Parliament also said, “I have never been ignored as an industrialist, even though I am an MP from the opposition party in this state,” he said.



surjeet kumar mishra

6 years ago


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