The Telegraph: Swimming naked in Brazil's bubbly waters

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9205775/Swimming-naked-in-Brazils-bubbly-waters.html

The Latin Tiger may have overtaken France, Italy, and Britain to become the world’s fifth largest economy on some measures but it has also been relegated to 126th place by the World Bank for 'ease of doing business', behind much of Africa. Cyclical warning signs are flashing amber across the board.

It is far from clear whether this 195m-strong cub of the BRICs quartet has broken out of the "middle income trap" after half a century of tantalizing efforts, each dashed by events.

Has Brazil’s profile been flattered once again by a resource boom, this time juiced by exports of iron-ore and soya to China, and a property bubble of Irish proportions?

The jury is out, even if we all accept that Luiz Inacio 'Lula' da Silva - ex-Fiat car worker turned apostle of orthodoxy - did slay inflation and establish the Banco Central do Brasil as the Bundesbank of the Americas, and if we accept that the deep-water fields of the Campos Basin will eventually turn Brazil into the world’s fourth largest oil producer.

Knight Frank’s global survey shows that Brazil’s house prices rose 26pc last year, leading the world by far. The global average was 0.5pc.

"Prices are crazy," said Eduardo Paes, Rio’s mayor. Even 'favelas' are frothy as developers close in. A good slum is worth a four-bedroom house in Arizona - if you can prove ownership.

"Brazil is experiencing a typical housing bubble," said Samy Davy from the Getulio Vargas Foundation. "It risks widespread damage to the Brazilian financial system and economy as occurred in the US."

This is a hotly-disputed subject, explored on websites such as 'bolha imobiliaria' and 'Brazilian bubble'. Bulls say mortgage debt is low, so US comparisons are invalid. Yet the Minha Casa/Minha Vida scheme of 100pc mortgages from state-run Caixa Federal for poor families has a strong whiff of Fannie, Freddie, and America’s subprime.

Consultants Secovi-RJ said Rio property has risen 400pc to 700pc over the last decade, albeit from a low base. Average prices in the major cities have jumped 140pc since 2008, diverging from income growth in much the same way as the US, UK, and Spanish booms.

"We estimate that the market is overvalued by as much as 50pc," said Neil Shearing from Capital Economics. With luck, the bubble will "deflate slowly" as the economy motors at 3pc to 4pc and inflation erodes real debt.

The fear is that a Chinese hard-landing/credit contraction will intrude.

Brazil’s economy ground to halt late last year. It has since rebounded, but may struggle to repeat the great leap forward of the Lula years given the headwinds of a super-strong real (20pc overvalued says Goldman Sachs).

It is certainly far too strong for a country that has seen scant productivity gains for thirty years. Benjamin Steinbruch, head of Brazil’s steel group CSN, said it is now cheaper to bash metal in Germany.

Labour productivity has not remotely kept pace with China or the Asian tigers, which is why industrial output has almost halved to 14.6pc of GDP, a level last seen before the great industrialization drive of the of late 1950s. The country is becoming 'post-industrial' before it is rich.

President Dilma Rousseff - an urban guerrilla during the military dictatorship of the early 1970s - has blamed the real’s strength on a "monetary tsunami" of funds fleeing Anglo-Saxon QE in search of yield.

Her response is to throw up a screen of 40 protectionist barriers, with import surcharges and a Buy Brazil edict for procurement even where local products are 25pc more expensive. "We have to take measures to defend ourselves. We cannot let our manufacturing sector be cannibalized."

Ex-central bank chief Gustavo Franco said the policies are retrograde, damning the government’s "currency war" mantra as escapism. "They don’t seem to understand the real issues."

It is true that hot money has flooded the country, but this is because the central bank has kept rates at nose-bleed levels to offset the inflationary effects of government spending.

The fiscal error is not obvious at first sight since the budget deficit is under 3pc of GDP, but this was the case in Britain before the bubble burst. The commodity and credit cycle has disguised the rot.

Roberto Rigobon from MIT’s Sloan School said Brazil should have copied Chile and Norway, running fiscal surpluses of 8pc or 9pc of GDP - rotating the money into global assets through wealth funds.

Instead, Brazil has wasted much of its commodity bonanza subsidizing a bloated state, with "Greek" retirement at 54 and ruinous pension costs. A Santander study said Brazil has still "Cambodian-style" infrastructure.

Defenders of Lula retort that the GINI coefficient of social inequality has at least fallen to 54 from feudal levels of 60 a decade ago, and infant mortality rates have plummeted from the mid-20s to 17.

Brazil is not in imminent danger. Private credit will reach 58pc of GDP this year, up from 25pc of GDP in 2005. Debt service costs are 22pc of household disposable income, up from 18pc three years ago. These are not extreme levels by global standards.

Yet stress is showing. Non-performing loans for banks have reached 10.3pc, worse than during the post-Lehman shock of 2008-2009. Arrears of over 90 days on car loans have risen to 5pc.

"A recession next year is in the cards. Once the liquidity tide turns we will be able to see who is swimming naked," said Marcelo Ribeiro from Pentagono Asset Management.

Brazil has a hand of trump cards. Public debt is just 37pc of GDP. The central bank can slash rates - now 9.75pc - if need be. The country no longer owes debts in dollars. It holds $353bn (£223bn) in foreign reserves. It is an agrarian superpower in an era of scarce food supply.

Yet there is a jejune enthusiasm among those predicting that Brazil and fellow BRICs will keep advancing at breakneck pace and soon claim their crowns as the world’s dominant economic powers. Such extrapolations defy the time-honoured grip of political anthropology.

The equally plausible outcome is that the credit cycle in the emerging economies will turn down before the Old World has fully recovered. If so, pray.

Abs