Driving through the streets of Sao Paulo, one often sees street vendors walking through the cars queued up at a light or stuck in traffic. The vendors are selling a range of things, and are generating what must be, at best, a subsistence level of income through their efforts. On my last visit to Sao Paulo, I watched as a vendor, selling children’s toy racquets and balls, slowly retreated to the curb as traffic began to move and he reached into his pocket to pull out his smartphone which he began intently examining as he waited for the next stop in traffic.
Brazil’s future is poignantly captured in that passing snapshot. On one hand, the country has good reason to be confident in the durability of its achievements – the past decade of stellar export-led economic performances has created a viable middle class in Latin America’s biggest economy. These newly empowered consumers have been responsible for 50% of the gross domestic product (GDP) growth Brazil has experienced across the past decade.
At the same time, the country is beset by inflation (which is eroding consumer’s purchasing power), is facing a slowing economy, and the country as a whole is labouring under public debt of 66% of GDP – the highest of the BRIC countries.
The Macroeconomic Bottom Line
When looking at the fundamentals, the Brazilian economy is facing a number of challenges: weak GDP growth (growth has averaged only 1.3% over the past four years and Fitch has forecast 1% for 2015), high inflation and a currency devaluation (the real is down 12.5% in 2014). In addition, the entire economy is suffering because of the corruption scandals centring on Brazilian energy giant Petrobras. The net effect of the Petrobras crisis is likely to shave nearly 1% off of GDP through foregone investment, while pushing up past due loans, loan loss provisions and loan restructurings to Petrobras’ suppliers, business partners and others.
On the positive side of the ledger is the structural change that Brazil has undergone in the past 10 years. Brazil’s rising domestic consumption was supported by four major sources – government transfers, rising income, growing employment and expanded access to credit. This growth in consumption was particularly pronounced among the poorer classes of the country and these sorts of widespread gains, among so many people, are very difficult to erode. The overall effect of a newly empowered consumer class is creating great resilience and stability in an economy, especially when paired with a structurally sound banking system, like that in Brazil.
The Banking System
The Brazilian banking system, similar to that in most countries, is highly consolidated with the six leading banks in the country accounting for 80% of the overall bank assets. In addition, Brazil’s banking system is divided among three major types of competitors – privately-owned banks (Itau, Bradesco, etc.), government-owned banks (Caixa Economica Federal, BNDES) and international competitors (Citibank and HSBC). Despite some concern, due to the economy, Brazil’s banks are judged to be well-capitalized and sound, according to the latest assessment from Fitch.
This structure has been an important part of the growth in the consumer class across the past decade, as the Lula government leaned heavily on the banking system to boost demand through the fostering of credit growth. According to The Economist, “State-owned banks like BNDES, a development bank, and Caixa Economica Federal, a retail one, made 35% of loans in 2009. Today their share is 55%.”
In addition to helping consumers, the government has leaned heavily on its state-owned banks as an important fiscal tool for businesses. “Since many Brazilian firms cannot pay private market rates (the average rate for new corporate loans is 16%) BNDES lends at a concessionary rate of 5.5%. The funding comes from the state, which borrows at a much higher rate than firms pay. The difference, a loss, is borne by taxpayers,” according to The Economist.
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