Girish Gupta



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The Debate Over Brazil's Credit Bubble
Jul. 14, 2011

Published by Minyanville

Brazil’s credit bubble has been the subject of much debate this past week, adding to concerns about one of the world’s biggest emerging markets. The debate has largely taken place in the pages of London’s Financial Times, with Paul Marshall and Amit Rajpal of hedge fund Marshall Wace writing last week that Brazil’s “cash flow burden is astronomical and rising.”

May’s average rate of interest was at 47%, up from 41% in 2010. “This rise from an already elevated level reflects the cumulative effect of tightening by the Brazilian central bank in order to contain inflation,” the pair said before suggesting that the debt service burden for Brazil’s growing middle class is now greater than 50% of disposable income.

Smaller banks, Marshall and Rajpal write, are struggling to access funding while defaults in excess of 15 days were at 9.1% of total loans in May, from 7.8% in December. “Ultimately,” the pair conclude, “Brazil needs to restructure the way it dispenses credit to consumers. More of the lending needs to be collateralized.”

However, the economists were joined in the debate not only by Brazil’s finance minister Guido Mantega, but also Tony Volpon of Nomura who believes that while investors are right to worry, there should be no fear of a credit bubble, but rather “an overstretched consumer and under-appreciated downside risks to future economic growth.”

Volpon points out that most credit growth is in so-called “earmarked” loans, those that mostly consist of corporate lending from the state-owned BNDES development bank. These loans, suggests Volpon, are much safer than consumer loans.

Speaking to the paper, Mantega said that there was nothing to worry about. Jonathan Wheatley writes, in conclusion, that Marshall and Rajpal may have overstated their case, however, Mantega is at the other extreme.

“Brazil is not on the verge of a credit crisis,” said Wheatley. “Its banking system is well regulated and conservative. Debt securitization is in its infancy. More and more lending is collateralized. But as banks lend more they will make more mistakes. The lack of a positive credit registry makes it doubly hard for them to gauge risk. There may be no cause for panic but there is certainly no cause for complacency.”

Back on the ground, the Associated Press illustrates the debate with a taxi driver, Silas Xavier, 24, whose vehicle is full of credit card bills. He has defaulted three times in four years, struggling to provide for his family, having been led into temptation by the consumption that is taking over his home city of São Paulo. The interest rate in São Paulo is at an average of 238%, according to Fecomercio, while the central bank maintains its interest rate rises in order to curb growing inflation.

Central bank president Alexandre Tombini said this week that the effects of recent economic policy are likely to be seen in the second half of 2011, as authorities hope inflation slows. The 12 months up to June saw inflation at 6.71%, compared to 6.55% in May. This is the highest level since 2005. Interest rates have risen four times this year and currently sit at 12.25%

One major factor for inflation is the rapid rise of the real. Local banks are now being forced to put 60% of their short dollar positions above $1 billion in non-interest bearing deposits with the central bank. The real traded at 1.5801 to the US dollar on Monday, weaker than Friday’s figure of 1.5615. However, analysts are cynical that this short term bounce will continue. The real was at 1.5524 last week, its highest level since 1999.

It is a difficult tightrope to be walking for President Dilma Rousseff, who has had to tighten her grip on an over-whelming economy. However, the Wall Street Journal points out that political infighting and scandals will also be pummelling at Rousseff as she attempts to maintain momentum after her landslide victory.

Two cabinet ministers have been forced to resign on corruption charges in a month. Transport minister Alfredo Nascimento quit as it emerged his agency took in 5% kickbacks on contracts it awarded. He has denied illegal activity. Chief of staff Antonio Palocci was unable to explain a vast rise in wealth while also failing to name corporate clients of a consulting business he ran while in office.

The Journal suggests that this is all adding to worries within Rousseff’s “unruly” coalition, with some suggesting that she is a “political novice." Quite naturally, though perhaps annoyingly for her, Rousseff is being compared to Brazil’s immensely popular former president Luiz Inácio Lula da Silva. “Her political upbringing is about giving orders and having people follow them, and she always had Lula around to make things work,” Roberto Romano, a professor of ethics and politics at Brazil's Unicamp University, told the paper. “Now she's finding out that Congress isn't there to take orders, they are there to grab funds."


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© Girish Gupta