Brazil: Hot or Too Hot? That is the Question.

August 13, 2011

Brazil: Hot or Too Hot? That is the Question.

[Maybe, I should be writing about Google and the launch of social games a couple of days ago in a direct move against Facebook. It has been debated and discussed in all the key newspapers along with Facebook's response, etc. But I don't want to and so I won't.]

Instead, I found much more intriguing food for thought and that was an article in the New York Times entitled "Foreigners Following Money to Booming Brazil, Land of the $35 Martini". [Besides the fact that I would enjoy a Martini right now…] The "BRIC" investment that is referenced in everyone's Annual Report and/or quarterly earnings call these days, is what let me to think about this article twice. I was also recently engaged in a market entry project for a client specifically looking at Brazil, so I figured I would ponder this one for a minute.

To take stock: Brazil experienced GDP growth of +7.5% in 2010 and is expected to grow an incremental +4% in 2011. The unemployment rate is the lowest it has ever been, reported at 6.2% in June 2011. The currency appears stronger than ever, and interestingly, Brazil is "now one of the biggest buyers of U.S. Treasury securities" aka, a significant stakeholder in this country's economy.

The economy is booming, expatriates are drawn to partake. Simon Romero's NYT article highlights that work authorizations for foreigners increased +30% in 2010, not shocking, considering the national U.S. unemployment rate and penetrating news of layoffs [see Job Cuts in the U.S. or "The Large Emigration"]. But, while there may be professional opportunities for individuals, is it yet a safe investment for foreign companies? 

Under the most recent leadership and the current government, Brazil seems eager to cement its strength in the global economy. It still ranks #6 behind Britain, but is reportedly on course to claim the title of 5th largest economy no later than 2026 (see Economist: Measuring Brazil's Economy, Statistics and Lies). Sounds appealing for investment, doesn't it?

Inflation has become a big problem, hence the $35 Martini reference. Infrastructure remains underdeveloped, labor laws favor local players, the educational system is still "behind". In many cases the remote undeveloped rural areas demand collaboration with local distributors. There seems to be little support for innovation and R&D. The economy is largely export driven, but the strong currency has made exports more challenging and hurt the local manufacturing businesses. These days, China is Brazil's largest trade partner. China surpassed the U.S. in relevance to Brazil in 2009; an interesting trade alliance between the two developing economies to say the least. Approximately 80% of the exports to China are petroleum, soy, and iron ore, which has Brazil reportedly somewhat concerned over a (de-)industrialization and in most recent trade negotiations with China, China appeared willing to consider "other products" for import as well.

Current concerns are that the economy is getting too hot. Already, June 2011 data indicates that industrial output is declining and the economy is slowing down even earlier and faster than initially expected. Experts also raised concerns about Brazil's stability during this new global financial crisis given its heavy dependence on external financing. Good thing, they have strong ties to China, which is still growing as an economy (+10.3% in FY:10).

Given the Olympics will be held in Rio in 2016 and the World Cup in 2014 [Go Germany!], money has to flow and will flow into continued development of the region. The question is [when] will the bubble burst? I recall that one of our project conclusions at the time was that investments in our particular sector remained risky. The currency may be strong right now, but I consider it far from stable. The devaluation of the currency occurred not that long ago. Notable is that those foreign companies that stayed put during the crisis at the time, benefited greatly from their commitment, both in terms of brand/image, as well as market share. In the sector that I was investigating, those players continued to hold over 50% market share well past the reentry of well-established global, competitive products once the crisis was over. There is something to be said about "sticking it out" in the hope of improving positioning once the crisis is resolved. It is all about the value of short-term ROIs versus long-term ROIs.

Finally, let's not forget corruption. Connections with key stakeholders are absolutely critical independent of which industry you are competing in.

Conclusion:  The promise of returns is high in this emerging economy, but as far as I am concerned, so are the risks to this day. The currency could depreciate any minute, economic growth could come to a screeching halt. Government is driving economic growth, but with interesting approaches and cautious tactics, carefully evaluating who gets to purchase land, and limiting volume imports of certain products to maintain local product dominance.

There are plenty of conflicting opinions on what the short-term future may hold for Brazil. While returns appear promising, risks remain high. It's a puzzle for anyone company that is interested, and by rights… all should be. There is no global company [or wanna be] that can afford to ignore or turn its back to Brazil at this stage, it's simply about "managing expectations"...

Let's just hope that this little piggy did not build its house out of straw and that the big bad wolf won't blow it in…