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Own Goal? | 3rd June 2014

Why Brazil needed to think beyond winning the World Cup on home turf  |  That Brazil might not be in the World Cup final on July 13th is to many Brazilians and football pundits around the world unthinkable. It is a shame that similar confidence cannot be applied to the Brazilian preparations for the World Cup or, indeed to the Brazilian economy more generally. Brazil, in the words of a German trade agency official, is the country that is “always going to promise growth just around the corner”.

Take Foreign Direct Investment (FDI) as an example. Since its peak in 2008 to the end of 2014, Delta Economics anticipates that it will have grown by just under 20% in nominal value terms despite the World Cup, the need for infrastructure around newly found oil reserves and the promises of a Latin American automotive hub. This includes a drop of 45% between 2008 and 2009, a subsequent 66% recovery and then growth of just 0.6% in 2012. Delta Economics anticipates that the forecast 6.8% growth in FDI this year will be nearly 1% lower than growth in 2013. Combined with flatter growth, high inflation and high interest rates, it is small wonder that the failure of the economy to deliver growth has frustrated investors as much as the failure of the World Cup to delivery prosperity has frustrated people.

The reason why interest rates are so high is not just to keep inflation under control, it is also to keep the value of the Real from tumbling. The Real-USD spot price is negatively correlated (-0.69) with Brazil’s total trade: after all, Brazil’s potential is defined by its capacity to become the Latin American growth engine with both natural resources, energy and manufacturing capacity to fuel its trade surplus (Figure 1).

 

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Figure 1  |  Brazil’s total trade (USDm) June 2001-April 2015 vs Real per USD, Last Price Monthly, June 2001- April 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

Except for the period during the financial crisis the value of the Real rose with trade consistently to the middle of 2011 but has slipped back against the US Dollar since then. Trade has similarly slipped back since then. What this suggests is that the currency is driven by increases in trade because investors see this as a route to growth in the economy and therefore returns. The currency itself has not necessarily influenced trade itself: as the currency has strengthed, so has trade, although, as a surplus nation, it might be expected that Brazil’s exports in particular would drop of with a strengthening currency.

By way of confirmation that there is a large speculative element in Brazil’s currency valuation, its Terms of Trade are not particular correlated with the value of the Real (Figure 2), but they are highly correlated with the oil price (0.89).

 

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Figure 2  |  Brazil’s terms of trade (value of exports in terms of the value of imports), June 2001-April 2015, vs Real per USD, Last Price Monthly, June 2001-April 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

What this suggests is that neither export nor import growth is particularly influenced by the value of the currency. This is because of the strong speculative element to the value of the Real which means that investment has little connection with the economic fundamentals in the economy – only its potential. The correlation with the oil price is unsurprising because it simply reflects the dominance of oil in Brazil’s trade structure.

And this structure of trade has changed little over the last 12 years. The Finger-Kreinin Index (FKI), which compares the structure of trade in one country against others, suggests that while other BRIC countries have become more like Brazil, Brazil itself has failed to capitalise on its manufacturing potential seen a decade ago in its car sector.

In the context of an imminent World Cup tournament, the irony that the Brazilian car sector is dominated by German manufacturers is not lost. As Figures 3 and 4 show, Brazil’s exports to Germany are most strongly correlated with the value of the Real of all its top five export partners. This is simple to explain: exports to the Netherlands are largely in oil, to the US are in Maize and Oil, to Japan in iron ore and oil and to China in iron ore, oil and soya.

 

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Figure 3  |  Correlation of Brazil’s exports to its top five export partners with Real per USD, Last Price Monthly, June 2001-April 2014

Source  |  Delta Economics analysis

 

Why should exports to Germany be more correlated with the value of the Real (Figure 4)? Perhaps it is because of the potential in that trade relationship: inward investment from German manufacturers has promised much for Brazil: innovative automotive production plants with a strong supply of automotive components from Argentina were regarded as the engine of a competitive nation that could move from being highly commodity dependent to one that could skip the intermediate manufacturing seen in other BRICs and focus on high-end automotives. Anticipating the

 

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Figure 4  |  Value of Brazil’s exports to Germany (USDm), June 2001-April 2015 vs Real per USD, Last Price Monthly, June 2001-April 2014

Source  |  DeltaMetrics 2014, Bloomberg

 

But Germany is Brazil’s fifth largest export destination and although the relationship has promised much, reflected in the high correlation it has disappointed investors, hence the pressure on the Real now.

Brazil is an increasingly open economy with trade anticipated to account for 46% of GDP in 2014 rising to 52% in 2018. However, this reflects two things in our forecast: flatter projected GDP and the dominance of commodities in its structure of exports in particular (Figure 5). While there is evidence that Brazilians are increasingly demanding more sophisticated products (automotive imports are forecast to grow 14% in 2014 while bio-pharmaceuticals are forecast to grow by nearly 12%, for example), the fact that two of the fastest growing import sectors are printing and ancillary machinery and telephone equipment suggests that infrastructures are still growing at catch-up rates.

 

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Figure 5  |  Where is the infrastructure?

Source  |  DeltaMetrics 2014

 

If Germany is the country amongst Brazil’s top importers that has the most to offer in terms of higher end export potential then Figure 5 also presents a more worrying picture. The fastest growing import sectors from Germany into Brazil do not reflect infrastructure development, but do reflect greater consumer demand for telephones, air-conditioning, medicines and medical equipment. The largest import sectors from Germany are similar: cars, medicines, car parts, fertilisers and biopharmaceuticals. Out of the fastest growing import sectors from Germany, the ones most correlated with infrastructure rank 25-30: pumps, car parts, machinery related to rubber and plastic processing, lifting & handling machinery and internal combustion engines.

It is not the place of an economist to predict who is going to be in the World Cup final, still less to predict might win it. But consensus (measured through the odds) of a Brazil-Germany final is not out of the question. Brazil must hope that, if this happens, it can avoid the own goals that have plagued the infrastructure and trade development since it was announced as the host nation for the 2014 tournament.