Controlling inflation, curbing the growth of credit and supporting exports are just some of the challenges facing Brazil, writes Esin Celasun.

Exports are expected to continue to grow in Brazil and, reflecting this trend, the demand for export financing is likely to rise further. Whether imports will grow at the very high rates observed in 2010 is less certain.

Demand for investment is also set to grow, given the significant infrastructure deficit Brazil faces.

Exporters had a very good year in 2010: exports grew at a record rate of 28% in the first 11 months of the year, despite the fact that the Real appreciated in excess of 11% against the US dollar over the same period.

As exports grew and the banks’ risk appetite returned, competition among them resumed and margins went back to pre-crisis levels.

Exporters’ demands have also changed, with companies asking for more long-term financing, with tenors rising to five or six years.

“We have noticed the development of the so-called ‘untied ECA financing, where the financing is not linked to any specific project.”

According to Marline Millan, director of international banking at Banco Bradesco, banks have also been forced to prolong the tenors of their own funding which are mainly sourced from international capital markets, bank-to-bank lending as well as securitisation deals.

Export credit agencies (ECAs) have been another source of liquidity for Brazilian corporates, and often at the height of the crisis the only long-term financing option.

But there has also been a change in the nature of ECA loans being provided. Fabricio de Sant’Anna Miranda, vice-president, export finance, Société Générale in São Paulo, Brazil, notes:

“Although the classic ECA provision is to finance a specific project or supply contract, we have noticed the development of the so-called ‘untied ECA financing’, where the financing is not linked to any specific project or contract. This type of transaction gives the borrower more flexibility in terms of the use of the proceeds,” Miranda explains.

Overheated economy

In the meantime, importers have been enjoying the benefits of the strong currency and imports grew by more than 40% during the first 11 months of the year. There has been an especially significant surge in the imports of consumer goods, highlighting Brazilian consumers’ capacity to stomach one of the highest interest rates in the world.

However, this has not translated into a parallel increase in import finance volumes according to Millan at Bradesco.
“Importers have mostly preferred either to pay at sight or even fund themselves in local currency this year. As a result, import financing has grown well below the 40% annual growth observed in imports,” comments Millan.

Prospects for 2011 are somewhat clouded by increasing worries about whether the economy is over-heating. Over the course of 2010, the Central Bank of Brazil increased Selic, its benchmark interest rate, by 200bp to 10.75%. However, despite this, inflation continues to run above the 4.5% target and the consumer loans are growing at a dizzying rate.

As part of its efforts to slow down inflation and the growth of credit, the central bank announced in December 2010 the introduction of a further set of monetary tightening measures.

The measures include an increase in the reserve requirement on deposits, an increase in the risk weighting of consumer loans, and a gradual reduction of the limits of deposit guarantees offered by the deposit insurance fund, Fundo Garantidor de Crédito (FGC).

Market participants do not expect these measures to have a significant impact on export finance volumes; that said, they are likely to be effective in containing growth of imports, particularly those of consumer goods.

Furthermore, finance minister Guido Mantega announced that the government is planning to cut its funding of the state development bank BNDES by 50% in 2011. Since the global financial crisis, BNDES has played an increasingly important role in the Brazilian economy, but now the government thinks that it is the right time to slash its funding and avoid further expansion of its credit portfolio.

Carlos Suarez, banking analyst at IHS Global Insight, notes that it is highly likely that the central bank will have to continue to tighten monetary policy as inflation is unlikely to rein in enough with the recent measures. He expects a further hike in the Selic within the first 6 months of 2011.

“However, the central bank will also try to avoid further appreciation of the Real and therefore, should the need arise, rather than continuing hiking Selic, they will opt for implementing alternative measures such as increasing reserve requirements and restricting the growth in BNDES’s short-term credit portfolio further,” Suarez observes.

It is unlikely that the efforts to control credit growth will have a negative effect on the infrastructure projects. Brazil has a significant need for infrastructure investments, but given its notoriously low savings rate at just around 16% of GDP (compared with China’s 55% and India’s 35%), it has so far been unable to make a significant leap on this front.

Long-term investment

The deadlines for the country’s mega-projects are approaching: The World Cup and the Olympics will be held in 2014 and 2016 respectively, and the projects under the government’s investment programme PAC II worth R$960bn (USD570bn) need to be completed until 2014. This means that the demand for funds will increase further in the coming years.

At this stage, BNDES is the main government institution that can finance and support the investments in the pipeline. It is expected that it will continue to fill the bulk of the funding gap for a while longer, maintaining its lending operations either via its special lines or via commercial banks which then use the funds for on-lending. Consequently, the cut in its funding by the government is likely to have a bigger impact on the bank’s short-term lending programme rather than on its long-term portfolio.

Millan at Banco Bradesco expects project finance transactions to steadily increase in the coming years and the private banks to start participating more intensely with the support of ECAs. As for their funding, Millan expects the cost of funding for both Brazilian banks and for the international players operating in the local market to continue to be favorable as long as Brazil’s strong standing in the international capital markets is maintained.

Meanwhile, Miranda at Société Générale points towards the distinction between the local and foreign currency financing of infrastructure projects:

“Brazilian infrastructure projects in the last 10 years have needed local currency financing. Except for some port and airport projects that have some of their revenues in US dollars, ECA financing is less likely to be required. Brazilian banks have led the crowding-out process of US dollar financing in favour of local currency funding from different sources such as BNDES and debentures obtained from capital markets. Brazilian banks have also got the natural advantage through their local bank deposit networks. This trend is likely to intensify as prospects for the Brazilian economy look favorable for the coming years.”

Indeed the market does think that the prospects are overall favourable. It will be up to the new administration under Dilma Rousseff to keep this positive sentiment going. GTR