Archive for the ‘G-20’ Category

Emerging Europe has fiscal problems, says Fitch

October 29, 2009
Emerging Europe: Fiscal woes  Source:
Emerging Europe: Fiscal woes Source:

Fitch Ratings published a report this week analyzing the fiscal deterioration taking place in 21 countries in what it calls “Emerging Europe,” which includes three sizable economies — “rising” power Russia’s nearly $1.7 trillion economy, struggling Turkey’s $745 billion economy, and Poland’s nothing-to-sneeze-at $525 billion economy. Like much of the rest of the world, Emerging Europe juiced its economies with fiscal stimulus packages due to the Great Recession, and therefore, needs an exit strategy over the medium term to this fiscal deterioration. 

Fitch rates Russian sovereign debt at BBB with a Negative Outlook (likely to be downgraded within two years); Turkey’s BB- with a Rating Watch Positive (likely to be upgraded, albeit from a low level, within the next three months); and, Poland’s debt A- with a Stable Outlook.

Fitch expects Polish GDP growth to languish before rebounding to about 3% in 2011; Russian growth to creep back above 3%; and, Turkey’s to move back to around 4% per year.  Government deficits in all three will remain sizable at between 3-6% of GDP per year, though quite small next to America’s 10% this year.  Poland’s government debt will rise to nearly 60% of GDP by 2011; Russia’s government debt remains very, very small (at below 15% of GDP); and Turkey’s will rise to nearly 50% of GDP before plateauing.  These levels are still modest relative again to U.S. levels approaching 90% in the coming years.  Poland’s and Turkey’s current account balances (a measure of trade) are in deficit, though forecast by Fitch to be below U.S. levels, which should exceed 3% of GDP in the coming years.  Russia, of course, as an energy exporting powerhouse, remains in surplus on its current account.

Central European economies, including Poland’s, are expected to move out of recession nicely, driven by links to the euro area, especially to the reviving German economy.  Baltic and Balkan states are rebounding less nimbly, according to the Fitch report.

A number of countries have been assisted by sizable IMF financing, including Turkey, Hungary, Armenia, Georgia, Latvia, Romania, Serbia and the Ukraine, not to mention that Poland obtained a $20.5 billion Flexible Credit Line with the IMF.    

Have a look at the Fitch Press release on the report below. 

Fitch: Public Finance Concerns Move to the Fore in Emerging Europe
29 Oct 2009 4:00 AM (EDT)

Fitch Ratings-London-29 October 2009: Fitch Ratings says in a new report that although external financing risks have eased somewhat for many countries in emerging Europe (EE) during recent months, rising government deficits and debt ratios mean that sovereign rating dynamics remain negative.

“Worst fears of a systemic economic and financial meltdown in emerging Europe have receded as global output has started to recover and financial conditions have eased, driven by the massive global fiscal and monetary policy stimulus, rescue packages led by international financial institutions and, in many countries, impressive economic resilience,” says Edward Parker, Head of Emerging Europe Sovereigns at Fitch.

“However, major challenges remain due to the scale of the negative shocks to hit the region; the costly legacy of the crisis, notably rising public debt ratios; and the uncertain “exit” from the crisis, recession and accommodative policy settings; while a relapse in one of the more vulnerable countries could trigger ripples across the region,” says Mr Parker.

Concerns over public finances have moved to centre stage. Fitch forecasts the impact of the recession – in some cases augmented by fiscal stimulus measures, lower oil prices and bank bail-outs – to widen the average budget deficit to 5.9% of GDP in 2009 from 1.1% in 2008, before narrowing to 4.6% in 2010. It expects the average government debt/GDP ratio to rise to 36% at end-2010 from 23% at end-2007. Failure to implement credible medium-term fiscal consolidation could lead to rating downgrades. In many countries, social pressures and elections will make it harder to implement austerity measures. This is fertile territory for political shocks. For countries reliant on IMF-led programmes for fiscal and external financing and for underpinning economic confidence, failure to stick to programme conditions poses additional risks to macroeconomic stability.

Fitch has revised its forecast for 2009 EE GDP to -6.1% from -4.6% in its June forecast round, owing to an even steeper drop than anticipated in output in H109. This contrasts with just -0.1% forecast for emerging markets as a whole. It forecasts only Azerbaijan and Poland will avoid recession, while Armenia, Estonia, Latvia, Lithuania and Ukraine will suffer double-digit declines in GDP. However, it has revised up its 2010 growth forecast to 2.6% (from 1.5%), owing to the unwinding of the deeper 2009 contraction and more supportive global conditions. Indeed, it estimates EE GDP rose by about 1% q-o-q in Q209, after plummeting 7% in Q109, led by a rebound in Turkey. But weak investment, rising unemployment, moderate capital inflows and credit growth, fiscal consolidation and a rebuilding of balance sheets point to a subdued recovery.

External financing and currency risks, which were the primary vulnerability of many countries in EE in the initial phase of the crisis, have eased somewhat, though remain material. This reflects a rapid reduction in current account deficits (CADs), substantial multilateral assistance, a boom in sovereign external issuance (USD19bn year to date) and relatively resilient private-sector roll-over rates. Fitch estimates the region’s gross external financing requirement (CAD plus medium- and long-term (MLT) amortisation) at USD304bn in 2009 and 2010, down from USD363bn in 2008.

In contrast to the rally in EE government bond prices, sovereign ratings dynamics remain negative, albeit at an easing pace. Following 11 notches of downgrades of foreign-currency Issuer Default Ratings in Q408, there were two downgrades in Q109, three in Q209 and only one in Q309. The balance of Outlooks and Watches has improved slightly since August 2009, but 12 countries are on Negative and only one on Positive. Fitch expects future rating actions to be driven more by country-specific developments than general trends.

The full report, entitled “Emerging Europe Sovereign Review: 2009”, is available on the agency’s website at

Contacts: Edward Parker, London, Tel: +44 (0) 20 7417 6340, David Heslam, +44 (0)20 7417 4384; Eral Yilmaz, +44 (0)20 7682 7554.

China: Anchoring the dragon

October 12, 2009

Last week’s Economist had a couple of nice articles on China’s National Day on October 1st, when the Chinese showcased their military, including the DF-31 nuclear-tipped ICBM, which can hit any city in America.  Most of these armaments have “Made in China” tags, not unlike all of our clothes and toys.

The Economist leader on the subject lamented this show of militarism, even comparing modern-day China to Prussia/Germany and Japan in the late 19th century.  I recall attending Bastille Day celebrations along the Champs Elysee in Paris in years past, when the glory-obsessed French showcased their military hardware; yet nobody got bent out of shape about French militarism.

Yet the rise of China should rightfully be compared to the rise of powers-past, such as Germany, Japan, Russia and the U.S.  We should consider how status-quo powers such as Britain might have mismanaged some of these rises in the 19th century and how we might avoid such mismanagement with regard to China today.  The blame for German militarism rests largely on the shoulders of Germans, this is true, especially on the fragile shoulders of Kaiser Wilhelm II and his cabal (though even Bismarck shares some of the blame).  Even so, the Western Powers could have better managed Germany’s rise.  They lacked an agenda for providing Wilhelmine Germany with enhanced international privileges to match its rising power.  Matching privileges with power is key to peacefully managing a power’s rise.  And, anchoring a rising power in the institutions of the status quo is likewise critical.

With the Concert of Europe and the Congress system of Metternich dead by the late 19th century, there were no international institutions to anchor Germany.  China, by contrast, is a card-carrying member of the U.N. Security Council, the WTO, the IMF and World Bank, the G-20, G-2, and other institutions.  Furthermore, although China may still feel somewhat dissatisfied because Taiwan and other East Asian assets (such as oil reserves in the South China Sea) are not being handed to it on a silver platter, Chinese privileges in the world are being equated step-by-step with Chinese power.  The “peaceful rise” of the dragon is taking place, at least in part thanks to Western statecraft.

The parallel with Wilhelmine Germany is a nice one, but on one key parameter, China falls short of authoritarian Germany.  Germany of that era was a pluralist, if not a liberal, society.  There was the Reichstag, in which the Social Democratic opposition was well represented.  Sure, the Kaiser and his ministers were not beholden to the German parliament.  Yet the nascent democratic institutions were there, whereas Chinese communism has not provided such vehicles for democratic development.  Likewise, Bismarck had provided Germany of those days with the most progressive social security safety net in Europe, neutralizing in part the appeal of the left.  In China’s Workers’ Paradise, the social safety net is woefully inadequate.

A few months ago, observers worried that the global financial crisis could weaken the Chinese Communist Party’s hold on power.  As long as the CCP delivered economic growth north of 8% a year, few questions were asked by the populace.  But this social contract was seen as at risk.  These days, observers are applauding the resilience of the Chinese economy at weathering the storm.  However, China’s recovery has been driven by a huge fiscal stimulus and a massive state-directed lending boom, which could lead to banking sector weakness in the future.  True, China is much less-leveraged than the US or almost any Western nation, so it has room to be a little profligate.  Nevertheless, an economic shock in China, followed by political turmoil, cannot be ruled out.  Note that China’s leaders told Beijingers earlier this month to stay home in their crowded apartments to watch the National Day Parade on television, instead of thronging over to the Forbidden City, which couldn’t have a more suggestive name.  Since 1989, popular protests are the nightmare of China’s leaders.

US/China trade policy blasted in NYTimes Editorial

September 19, 2009
Source: Google Images Source: Google Images

An update on a post I did last week on the Obama administration’s swing toward trade protectionism with its action against Chinese tires:  enclosed is this nicely written NYTimes editorialnot an Op-ed, an editorial. 

The Times editorial board understands economics.  American workers in the tire industry, many represented by the United Steelworkers Union, may well lose their jobs with or without the new 35% tariff against Chinese tires.  The reality about trade, the Times points out, is that Americans will likely buy low-cost tires from other countries in any case, perhaps in Latin America, rather than from American factories.  These Latin tires will cost more than the Chinese variety, making American consumers worse off.

The Economist article I attached to the last post included a comment from an analyst suggesting that President Obama, by imposing these tariffs, is shoring up his left flank in order to achieve support for health care reform, that $900 billion budget-buster.  Maybe the linkage is far-fetched, but if true, putting at risk the global trading system in order to expand entitlements, is that what sound economies are built on? 

I hope the president deploys his considerable charm and intellect next week, talking things out with Chinese President Hu Jintao at the G-20 Summit in Pittsburgh in order to avoid a nasty trade war.  That venue would likewise be a fine place for the president to tell the truth to Rust Belt workers, the truth John McCain started telling in Michigan last year:  that the economy is in transition, we cannot artificially protect manufacturing jobs, job training and outplacement will be required.  The higher value-added, knowledge-based economy beckons…

Trade: the test of Obamanomics

September 15, 2009
Chinese workers load tires for export.  Source:
Chinese workers load tires for export. Source:

During the Great Depression, international trade contracted by a third, as countries around the world erected barriers to trade, aggravating a sharp decline in output already under way and throwing millions out of work.  Thus far, in the Great Recession of 2008-09, the end of which some observers may have called too soon, the major powers have avoided trade protection.  Enter the Obama administration.

Last year, I published a piece calling for those supporting Democrats in America’s national elections to make sure they keep the Dems honest on trade.  Concerns about Obama’s commitment to free trade, due to his campaign strategy in Midwestern states last year, were dismissed as mere election-year politics.  His commitment to satisfying his friends in America’s trade unions is now abundantly clear, not only because he parrots their unfair accusations about abuses by the Colombian government, but also in the latest action by the Obama administration to raise tariffs against Chinese tires (see NYT imes article).

Trade wars can spiral out of control, even if this is not the original intention of protectionists.   During the 19th century, Britain, the unrivaled power at the time, ensured global prosperity through its commitment to free trade.  The U.S. since 1945 has played this role, through both Democratic and Republican administrations.  Doubts about President Obama’s commitment to free trade, a key pillar of international cooperation and a key strategy for broad-based global prosperity, have re-emerged, a point quite ably discussed in this Economist article.

Photo:  Chinese workers loading tires for export.  Source:

Focus: Brazil’s economy

September 11, 2009

Nilson Teixeira ( and his team at CreditSuisse Brazil, one of the formidable analytical teams among Brazil’s brokerage firms, today published a comprehensive 170 page guide to the Brazilian economy.  Timely, given that the world’s eighth largest economy is now one to be watched, invested in, and profited from.  CSFB says this guide is good for experts in Brazil’s economy as well as neophytes.  The summary pages can be found below.

An old Brazil hand myself who met annually for years with Teixeira and his predecessors (who included a number of members of the board of Brazil’s central bank), I found the work interesting and noticed only a few points that I would stress differently, add to or subtract.  They are as follows:

  • CSFB highlights as Brazil’s number one economic challenge to improve the quality of the country’s primary and secondary education system, including by adding more schools.  I couldn’t agree more. 
  • Brazil’s sovereign default in the 1980s-90s is blamed on the oil shocks and consequent balance of payments pressures, which is well and good; however, blame should be layed as well at the doorstop of  Brazil’s Import-Substituting Industrialization (ISI) policies and massive government borrowing program.  Brazil’s problems were (and are) everywhere and anywhere a fiscal problem.  While CSFB does mention Brazil’s “fragile fiscal accounts,” it does not stress this aspect enough.
  • I agree with the outlook for stronger potential GDP growth in the coming years (in the neighborhood of 4-5% growth per year, not stellar relative to other emerging market economies, but not bad, given Brazil’s history).  I agree that this is due to a decade of sound macro policies since 1999 — with the arrival of Arminio Fraga at the central bank — including inflation targeting, a floating exchange rate, and the Fiscal Responsibility Law.
  • On the other hand, I would stress more the role of the sharp rise in commodity prices earlier this decade, driven to a great extent by demand from China, for Brazil’s improved growth performance. Brazil is a major exporter of soy and other agricultural commodities, minerals, and soon, oil.
  • Brazil’s sound policy management has underpinned its weathering of the 2008-09 Global Financial Crisis.  In previous global crises, Brazil was always one of the first dominos to fall.
  • CSFB says that Brazil, in spite of running a countercyclical fiscal policy during this crisis, should see net government debt decline in the coming years, unlike in most countries where debt will be rising.  Fitch Ratings, which expressed its worries about fiscal policy in a publication earlier this month, may beg to differ.
  • Brazil, in spite of experiencing economic contraction last year and into this year, began expanding again in 2Q09, a good indicator for the future.
  • Brazilian banks are well capitalized.  I might stress a bit more concern about recent rapid credit growth in Brazilian banks.
  • I agree that Brazil’s infrastructure needs are sizable, and investment here could go far to raising potential GDP growth.
  • Likewise, Teixeira and his team were correct in highlighting the challenges of reforming a distorted tax regime, reining in social security deficits, and freeing up a very rigid labor market.

All to say, well worth the read.  Start with the summary below:

“In recent decades, the Brazilian economy has oscillated between periods of strong economic growth (late 1960s and early 1970s) and periods of low growth with high inflation (1980s). Despite the introduction of several economic plans since the second half of the 1980s, inflation was not effectively reined in until 1994, when the Real Plan was implemented.

In step with recurrent balance-of-payment crises in emerging countries, imbalances in Brazil’s external accounts persisted, and average GDP growth was relatively sluggish until the mid-2000s. As the global outlook improved and Brazil maintained responsible macroeconomic policies, the economy’s average growth gained speed in 2004, resulting in the longest cycle of growth and investment since the 1970s.

This growth cycle was interrupted by the global crisis of 2008, but the Brazilian economy has proved much more resilient to crises than in the past. The evolution of its economic fundamentals suggests that, after several decades, the country is likely to experience higher and – even more importantly – less volatile economic growth than in the past. But after fulfilling many of the necessary prerequisites, we believe there are still challenges to be overcome for Brazil to reach a higher level of development in the next decades. For instance, it will have to consolidate the process of making elementary and secondary education universally available, not only by expanding its network of schools, but also by improving the quality of education provided.

Brazil is a federal republic composed of 26 states and a Federal District, which comprise 5,565 municipalities. It is the world’s fifth largest country both in terms of population and land area and has the eighth-largest Gross Domestic Product (GDP). The Brazilian population has grown 1.5% annually on average over the past few decades to 189 million inhabitants in 2008, most of whom reside in cities.

From 1964 to 2008, GDP grew 4.5% per year on average. In the late 1960s and early 1970s (period referred to as the “Brazilian miracle”), GDP grew by more than 11% yearly in a scenario of heavy investment. At that time, Brazil was known as the “country of the future,” a title that has not been revisited in subsequent decades.
In the 1980s, referred to as “the lost decade,” Brazil’s economy was marked by high inflation and low GDP growth. During that period, an oil shock destabilized the global economy, and consequently several developing economies, including Brazil, were unable to roll over their large foreign debt and were forced into default. The balance-of-payments crisis was associated with high interest rates, a sharp depreciation in currency, and high inflation. In the second half of the 1980s and the first half of the 1990s, Brazil implemented several stabilization plans to thwart skyrocketing inflation. Some of these plans included price controls, a freeze on bank deposits, and some unorthodox inflation-reduction measures.

After several unsuccessful attempts, the government implemented the “Real plan” in 1994, which established the Real as its new currency and rapidly reduced monthly inflation from around 50% to less than 1%. Even after lowering inflation, the country experienced several balance-of-payments crises in the late 1990s and early 2000s, some originating in emerging economies and others homegrown. Brazil faced some onerous constraints for financing its foreign debt on several occasions. In order to keep inflation low, the government kept real interest rates very high for several years, which in turn led the economy into a sequence of stop-and-go business cycles. Fragile fiscal accounts and risk of insolvency revealed the weaknesses in the economic adjustment during this period and produced a steep devaluation in Brazil’s currency and a return of inflationary pressure. Despite lower inflation, economic growth remained weak during these years.

In 1999, the government adopted economic policy based on three main points: an inflation target regime, a floating exchange rate policy and adoption of fiscal responsibility law. After decades of huge economic uncertainty, observance of these policies for ten years has helped increase the predictability of the Brazilian economy.
Combined with a favorable global scenario in recent years, characterized by strong economic growth and high liquidity in financial markets, these policies contributed to a significant improvement in Brazil’s macroeconomic fundamentals. From 2003 to 2008, the government maintained relatively low inflation, bought back all sovereign debt originated from the 90s’ debt renegotiation, improved the risk profile of its government securities, maintained primary surpluses, and substantially increased the level of international reserves, contributing to Brazil becoming the fourth-largest holder of U.S. treasury bonds. The global crisis that began in 2008 has proven that the macroeconomic policies adopted in recent years have been effective; despite its magnitude, the impact on the mid-term fundamentals of Brazil’s economy have been rather moderate. One of the main differences versus other countries has been the absence of any balance of payments crises within Brazil. This greater freedom in relation to external accounts has allowed the government to implement a set of countercyclical fiscal and monetary policies to reduce the negative impact of the 2008-2009 crises on economic activity. The primary surplus has fallen, raising net debt to GDP in 2009. In upcoming years, we expect the net debt to GDP ratio to retract, unlike the forecast for many countries hit hard by the crisis. For the first time since the 1970s, the Brazilian economy has proved more resilient than most developed and developing countries, in our view.

Brazil’s potential output growth has increased substantially in recent years. Despite the retraction in 2009 brought on by the international crisis, we believe average GDP growth in the next few years will likely reach 4% or 5%, much higher than the average pace of 3% during the first half of the decade. This higher growth should be associated with a return to investments, which grew consistently from 2004 to 2008, forming the longest investment cycle since the 1970s. Over the past few years, investments have been spread out over various economic sectors, especially infrastructure and commodities. But despite this long growth cycle, the country’s infrastructure is still quite deficient. Heavy investments in infrastructure are needed to foster higher growth in areas ranging from transportation to expansion of the power grid.

Sectors with clear competitive advantages in the last few years are primarily those associated with commodities. Brazil is the largest producer of many soft commodities, such as sugar, coffee, and oranges, the second largest producer of soybean and ethanol, and the number one exporter of all these products. The country is also the second largest producer of beef and ranks third for chicken and fourth for pork. Brazil exports more beef and poultry than any other country. The cost of production in the Brazilian agricultural sector is currently lower than for most producer countries. The agricultural sector is likely to see sustained growth in upcoming years and reap benefits from existing competitive advantages, even if the elimination of non-tariff barriers and improvement within the logistics infrastructure are gradual.

Brazil has huge mineral reserves – especially iron ore, aluminum, copper, chromium, gold, tin, nickel, manganese, zinc, and potassium – and clear advantages in sectors associated with these commodities. Notwithstanding the halt in heavy investment in these sectors on account of the 2008-2009 global crisis, investments will likely remain high in the next few years to meet the growing demand, especially from emerging markets. At the same time, the huge discoveries of oil reserves in the pre-salt layer in recent years should make Brazil a major player in the world market and a net exporter of fuel in the next decade. In principle, much of the massive investments in this sector will be financed by government institutions, but the participation of private corporations, especially from abroad, will tend to attract rugged investment in years to come.

The capital ratio of local banks has been well above the Basel requirement for many years, resulting in a lightly leveraged financial system. This has prevented the international financial crisis from contaminating local banks. The government’s economic policy reaction has brought relatively low fiscal costs and has managed to contain the negative effects of the contrition in external credit. The economic policy response has shown that the banks are able to efficiently intermediate private savings and contribute to sustained high growth in credit, which reached nearly 45% of the GDP in mid-2009. Credit expansion in the next few years will probably have a different profile from the most recent cycle. The new phase will be marked by the lowest basic interest rate in 30 years, which will require a different set of financial instruments available to depositors. At the same time, financial institutions will change their focus, offering longer-term credit and reaching out to more corporate and real estate borrowers.

Greater stability in the local economy should continue to encourage a shift from short- to longer-term investments in addition to increased participation by foreign investors. The need for heavy investments in Brazil within the next few years will require increased risk capital, both from here and abroad, to finance activities. This favorable scenario is expected to stimulate growth in equity markets. Although investments in Brazil have historically been financed largely by public-sector institutions, corporations have been able to raise funds lately in capital markets to finance their investment plans. The private sector will account for a growing percentage of long-term investments in the next several years, either through bank loans or direct financing through equity offerings. High-risk investments will account for a large portion of these funds, and primary and secondary equity offerings are projected to increase significantly in the next few years.

The effects of the 2008-2009 global crisis were less drastic than expected at the outset, which signifies to us that Brazil’s growth pattern is less susceptible to changes in course as a result of the external outlook. However, this does not mean that the Brazilian economy is immune to the global crisis. On the contrary, the crisis has caused Brazil’s GDP to backtrack from an average expansion of 1.6% quarter on quarter from 1Q2008 to 3Q2008 to a peak-to-trough fall of 4.4% in 4Q2008 and 1Q2009. But the return to economic expansion has already taken hold in 2Q2009, demonstrating that Brazil’s solid fundamentals have enabled rapid adjustment to the change in global outlook.

This greater resilience to the external crisis has favorable consequences for the middle- and long-term outlook for the Brazilian economy. Uncertainty regarding the resilience of the country’s economic fundamentals dissipated fairly significantly as the crisis unraveled. Overall country risk and real interest rates should decline even further in the next few years, since severe macroeconomic crises in Brazil do not seem as likely as in the past, leading to higher investments and, therefore, higher potential output growth. Thus, the path of Brazil economic fundamentals suggests that, after several decades, potential GDP growth should be higher than in the past and, even more importantly, less volatile. We, therefore, think this dynamic should allow Brazil to regain its reputation as the “country of the future.”

There are still several challenges to be overcome. First, the country needs to consolidate the process of making elementary and secondary education universally available, not only by expanding its network of schools but by improving the quality of education. Second, Brazil needs to address certain structural constraints, such as its highly complex tax system, imbalances in social security and very rigid labor legislation. It will also be up to future administrations to reopen debate concerning the state’s role in the economy, particularly with regard to its efforts to stimulate manufacturing and strengthen the regulatory framework. These reforms will require serious discussion, because congressional approval tends to lag in light of the complexity of the issues. For example, although there is a consensus in society that the country’s tax structure is complex and tax burdens too high, approval of tax reform is uncertain, because it requires debate regarding which specific fiscal expenditures need to be reduced.

During the preparation of this publication, its target audience focused on those readers with a basic understanding of Brazil, wanting to learn more about the country’s fundamentals and economic outlook. For this group, this guide can hopefully serve as a starting point. Nonetheless, we believe the in-depth scope of this report will also interest readers with a more comprehensive knowledge of the country. We note that this publication is not meant to provide a complete guide to Brazil; it is not intended to offer extensive coverage of the individual topics included. This guide contains a sizable number of graphs and tables, which together provide a relatively general review of information we believe will be relevant for our readers, offering a broad reference base, with information and statistics supporting our overall view that Brazil meets many of the prerequisites needed to take it to the next level of economic development.

The guide is divided into nine chapters, including this introduction. The second section provides a panorama of the country’s geography, climate, mineral resources, biomas, and water resources. The third addresses topics related to population, age ranges, life expectation, labor market, and income distribution. Chapter four contains a brief history of economic policy since the mid-1960s and details policies implemented in the past decade, especially inflation targeting, the floating of the foreign exchange rate, and fiscal responsibility. This chapter also highlights the organization of the country’s political institutions. Chapter five describes the primary characteristics of Brazil’s infrastructure – especially modes of transportation and power generation, transmission and distribution. Chapter six enumerates the primary industrial sectors, such as oil, petrochemicals, steel, automobiles, mining, and construction.

In chapter seven, we present the most important issues in relation to farming, listing the main crops and herds, and describing how they are distributed throughout regions. Chapter eight addresses services, with an emphasis on financial services. In chapter nine, we discuss current business trends in Brazil and certain aspects of the local tax structure. Finally, the appendix provides useful reference material, acronyms, and Web sites to access for additional information.”

Brazil: Fitch Ratings not happy about fiscal deterioration

September 8, 2009
"G-2": Brazil's President Lula and Mexico's President Calderon: Whose fiscal ship faces calmer seas?  Source:  Google Images
“G-2”: Brazil’s President Lula and Mexico’s President Calderon: Whose fiscal ship faces calmer seas? Source: Google Images

Fitch Ratings published a report this month analyzing Brazil’s fiscal deterioration this year (see press release below).  Brazil’s public finances have slipped just like in just about every country in the world.  Fitch highlights Brazil’s heavy government debt burden relative to its emerging market peers.  Brazil’s fiscal deterioration — characterized by rising spending, tax cuts, and a poor tax intake — will at the very least slow any upward movement in Brazil’s credit rating, currently at BBB- for foreign currency debt, and could in fact lead to a downgrade if a fiscal consolidation is not forthcoming over the medium term, suggests Fitch. 

Yet Fitch rates Mexico fully two notches above Brazil (BBB+), albeit with a Negative Outlook (meaning the rating should go down within two years).  Brazil’s government debt to GDP ratio is nearly 70%, whereas Mexico’s is below 40%.  What they don’t highlight is that Brazil’s debt to tax revenue ratio is lower than Mexico’s (nearly 170% in South America’s largest economy vs. Mexico’s nearly 200%).  Mexico’s woeful tax performance is a perennial problem gone unfixed for decades.  Moreover, the Mexican government relies on oil-related revenues, even though oil production south of the Rio Grande is declining.  The Mexican government won’t allow private investment in the energy sector as a way to increase production (and can’t, due to popular opposition).  Mexico is a mess (not least because of its heavy dependence on one country, eh-hem, eh-hem, the United States), and Fitch acknowledged as much in July when it said it will monitor fiscal measures in the wake of the mid-term legislative election to decide whether or not to downgrade.  Signs are that an austere budget may be in the works.

Debt is measured against both GDP and revenues to indicate a country’s ability to grow out of its debt burden, i.e. to raise enough revenues to pay future debt obligations.  The debt to revenues measure is arguably a better proxy for this capacity, even though most analysts look at debt to GDP because GDP is more standardized…and perhaps out of laziness  Sure, Mexico has a vast untaxed portion of the economy it  could draw on to service its debt.  But it hasn’t ever done so and it won’t.  An owner of a Mexican trucking company once told me, he doesn’t pay any taxes.  So, Mexico’s fiscal picture is at least as bad, if not worse, than Brazil’s.  What’s more, Brazil’s external balance sheet is stronger than Mexico’s, with lower net external debt to exports and a stronger sovereign net external creditor position.  Its economy appears more resilient, not least due to its diversification.

Yet Mexico still remains two notches above Brazil due to sticky credit ratings and the inability of the rating agencies to take dramatic action.  Such dramatic rating action would suggest that rating agency analysts have been wrong for some time.      

Fitch: Brazil’s Fiscal Deterioration – A Slippery Slope
03 Sep 2009 2:05 PM (EDT)

Fitch Ratings-New York-03 September 2009: Fitch Ratings believes that Brazil will need to begin the process of fiscal consolidation, as an expected economic recovery begins to take hold, in order to preserve its fiscal credibility. Fitch has published a special report on Brazil’s deteriorating fiscal situation and the potential impact on its credit profile.

The degree of fiscal deterioration in Brazil’s public finances is quite evident when comparing the fiscal outturn of the first seven months of 2009 with the same period a year ago. The central government primary surplus has declined by 60% in the first seven months of 2009 compared with the same period in 2008 as a result of fast-paced spending growth and weak revenue performance.

‘The structure of Brazil’s public spending is deteriorating as a significant part of the increase is related to personnel and pension benefits, which will be harder to adjust in the future and cannot be classified as strictly ‘counter-cyclical’ in nature,’ said Shelly Shetty, Senior Director in Fitch’s Sovereign Group.

On the positive side, the scale of Brazil’s counter-cyclical fiscal stimulus package is modest by international standards, and the expected deterioration in the country’s fiscal balance is somewhat less than its rating peers. In addition, the government has domestic and external market access to fund the higher deficit. However, Fitch notes that the country’s starting fiscal position is weaker when compared with its peers. Brazil’s general government debt burden is significantly higher than the ‘BBB’ median (66% of GDP compared with 27% for the ‘BBB’ median) and will increase further this year.

Fitch recognizes that Brazil has a good track record in delivering and surpassing fiscal targets even when economic conditions are difficult, such as in 2002-2003. Across the globe, 2009 has been a challenging year, and many emerging markets have seen deterioration in their fiscal balances. However, the sharp increase in spending growth observed so far in 2009 needs to be curbed for the authorities to achieve even the reduced primary surplus target for this year, and more importantly, to return to the higher primary surplus target of 3.3% for 2010, as set under the Budgetary Guidelines Law.

‘Given the uncertainty in the pace of economic recovery and thus revenue growth, greater resolve to contain spending growth (especially current) would be positive for the credibility of fiscal targets,’ added Shetty.

While Brazil’s external finances remain strong and the country has weathered the global financial crisis relatively well, the deteriorating fiscal picture could potentially dampen the upward momentum of Brazil’s credit trajectory. On the other hand, persistent and significant deterioration of public finances and debt dynamics could undermine fiscal credibility, increase investor risk premia, and adversely affect investment and growth prospects, which in turn, could weigh on Brazil’s creditworthiness.

Fitch currently rates Brazil’s Long-Term Issuer Default Ratings at ‘BBB-‘ with a Stable Rating Outlook.

The full report ‘Brazil’s Fiscal Deterioration: A Slippery Slope’ is available on the Fitch Ratings web site at ‘’

Contact: Shelly Shetty +1-212-908-0324 or Erich Arispe +1-212-908-9165, New York.

Media Relations: Kevin Duignan, New York, Tel: +1 212-908-0630, Email:; Sandro Scenga, New York, Tel: +1 212-908-0278, Email:

Russia: Fitch Ratings Pessimistic on Sovereign, Banks

August 18, 2009

Fitch Ratings, one of the three global rating agencies, published reports this week on the state of play in Russia.  The government of Russia’s BBB rating was affirmed, but the Outlook for the rating (i.e., where the rating is likely to go in the next two years) remains negative.  Russia has been more negatively affected by the global downturn than other Emerging Markets (with GDP down over 10% annualized in the first half of this year).  Fitch quotes these reasons why:

“First, it [Russia] was highly exposed to the shocks to global commodity prices and cross-border capital flows, which were of the order of 25% of GDP. Second, monetary policy was overly loose, external borrowing and domestic credit growth was excessive, and the economy was overheating prior to the crisis. Third, vulnerabilities were exacerbated by structural weaknesses including an undiversified economy, a weak banking sector, high inflation, FX mismatches on private sector balance sheets, weak institutions and a difficult business climate – which the authorities failed to address sufficiently during the boom years.”

In addition, Fitch banking analysts expect non-performing loans at Russia’s banks to top off at 25% of total loans, up from 14% in June.  Under its “pessimistic” scenario, Russia’s NPLs rise to 40% and losses amount to 24% of total loans.  Press releases on the Sovereign and the banks are below.

” Fitch Affirms Russia at ‘BBB’; Outlook Negative   04 Aug 2009 7:12 AM (EDT)

Fitch Ratings-London-04 August 2009: Fitch Ratings has today affirmed the Russian Federation’s Long-term foreign and local currency Issuer Default ratings (IDR) at ‘BBB’ with Negative Outlooks. At the same time, the agency has affirmed the Short-term foreign currency IDR at ‘F3’ and the Country Ceiling at ‘BBB+’.

“The Russian economy and sovereign balance sheet have been severely affected by the global financial crisis and, despite signs of economic and financial stabilisation since March, risks to creditworthiness remain on the downside,” says Edward Parker, Head of Emerging Europe in Fitch’s Sovereigns team.

Russian GDP contracted 10.1% y-o-y in H109, a far worse performance than in other larger emerging markets, and foreign exchange reserves (FXR) have fallen by around USD200bn over the past 12 months. The severe impact of the global crisis on Russia reflects three sets of factors. First, it was highly exposed to the shocks to global commodity prices and cross-border capital flows, which were of the order of 25% of GDP. Second, monetary policy was overly loose, external borrowing and domestic credit growth was excessive, and the economy was overheating prior to the crisis. Third, vulnerabilities were exacerbated by structural weaknesses including an undiversified economy, a weak banking sector, high inflation, FX mismatches on private sector balance sheets, weak institutions and a difficult business climate – which the authorities failed to address sufficiently during the boom years.

Fitch forecasts Russia’s real GDP to decline 7% in 2009, before increasing 3.5% in 2010, helped by the inventory cycle, base effects, higher oil prices and a large fiscal stimulus. However, the length and depth of the recession is a downside risk and will have implications for bank asset quality, public finances and, potentially, political pressures on the Russian authorities. Fitch views the banking sector as a key credit weakness. In its base case, the agency projects impaired loans to increase to 25% of total loans by end-2009, requiring recapitalisation of at least USD22bn in addition to the USD24bn injected since Q308. The central bank faces a challenge in providing sufficient liquidity to the banking sector, while reducing inflation to single-digits and avoiding excessive rouble volatility.

The Russian private sector faces maturing external debt payments of USD137bn this year, which may be difficult to refinance in current market conditions. Fitch estimates the roll-over rate was 64% in Q109. Capital outflows and the dollarisation of household bank deposits have eased since the completion of the rouble devaluation process in February, but could re-emerge in the event of renewed financial stress. Nevertheless, overall the country has a strong external liquidity position, with FXR of over USD400bn, and it is a net external creditor to the tune of 17% of GDP at end-2008, compared with a net debtor position for the ‘BBB’ range ten-year median of 13%.

Public finances are a key sovereign rating strength. General government debt was only 8% of GDP at end-2008, well below the ‘BBB’ range 10-year median of 35%. Moreover, Russia has an aggregate USD184bn in its Reserve Fund (RF) and National Wealth Fund (at end-June, equivalent to around 15% of projected 2009 GDP) providing a strong liquidity position to finance budget deficits and to run counter-cyclical fiscal policy. However, Fitch forecasts the recession, fall in oil prices and anti-crisis measures to cause the federal budget to swing from a surplus of 4.1% of GDP in 2008 to a deficit of 8.5% in 2009 and 6% in 2010. Even with a return to the eurobond market next year, this will cause the RF to be depleted in 2010 and require significant fiscal consolidation over the medium-term.

A renewed deterioration in global economic prospects, oil prices and risk appetite leading to a material weakening in the sovereign balance sheet or macroeconomic instability could result in another downgrade (Fitch downgraded Russia’s ratings by one notch on 4 February 2009). Negative shocks from the banking sector or elevated financial pressures from low roll-over rates on external debt or large-scale capital flight would also be negative for the ratings. Furthermore, a failure to narrow the budget deficit, and a consequent rapid increase in government debt and depletion of the sovereign wealth funds could lead to downward pressure on the ratings in the medium-term. In contrast, a material easing of a combination of these risks could see the Outlooks revised to Stable.

Contacts: Edward Parker, London, Tel: +44 (0)20 7417 6340; David Heslam, +44 (0)20 7417 4384.

Media Relations: Peter Fitzpatrick, London, Tel: + 44 (0)20 7417 4364, Email:”

“Fitch Ranks 57 Russian Banks by Loss Absorption Capacity  
14 Aug 2009 5:07 AM (EDT)

Fitch Ratings-London/Moscow-14 August 2009: Fitch Ratings released a report today ranking 57 rated Russian banks based on their loan loss absorption capacity. Fitch considers this capacity to be currently weak at 10 of the banks reviewed, although most of the 10 could likely rely on capital support from shareholders, and moderate at a further 14.

The extent of Russian banks’ asset quality deterioration, their loss absorption capacity and contingency recapitalisation plans are likely to be the main drivers of rating actions over the next 12 to 18 months. Fitch-rated banks reported an average 14% impaired loans (5% non-performing and 9% restructured) at 1 June 2009, up from 10% (3% and 7%) at 1 March.

“However, management figures prepared at a still relatively early stage of the credit downturn are unlikely to fully capture the eventual full extent of asset quality problems,” says Alexander Danilov, Senior Director, Fitch’s Financial Institutions group in Moscow. “The gradual deterioration of banks’ asset quality metrics is likely to continue during the second half of 2009 and into 2010.”

Fitch had previously stated that it expects impaired loans at Russian banks to reach 25% in a base case scenario, resulting in ultimate loan losses of 12.5%. Under a more pessimistic scenario, impaired loans could reach 40% resulting in loan losses of 24%.

Fitch ranked the loan loss absorption capacity of the 57 rated Russian banks to demonstrate their relative vulnerability to loan losses. The agency assessed the banks’ loss absorption based on the maximum reserves to loans ratio they could have sustained at 1 June 2009 without breaching minimum regulatory capital requirements. However, Fitch notes that a lower or higher loss absorption capacity, as defined by this measure, does not automatically mean that a bank is more or less vulnerable to potential loan impairment, as credit losses at individual banks may significantly diverge from Fitch’s average sector assumptions.

For 10 of the 57 banks – VTB24, Rossiya, Bank of Moscow, Swedbank (Russia), VTB, Moscow Bank for Reconstruction and Development, AK Bars, Rosbank, Orgresbank and Unicredit (Russia) – the maximum reserves/loans ratio is below 10%, and Fitch thus regards these banks’ loss absorption capacity as currently weak. However, Fitch notes that the capacity of two of these banks – Bank of Moscow and VTB – should strengthen significantly as a result of upcoming equity injections, and that most of the other eight banks also have relatively strong shareholders, which the agency would expect to contribute new capital in case of need. Fourteen of the banks reviewed had moderate loan loss absorption capacity (a maximum reserves/loans ratio of 10%-15%), while capacity was significant at 14 banks (15%-20%), solid at 11 (20%-32%) and strong at eight (more than 32%).

Banks’ loss absorption capacity has increased significantly in recent quarters as they have received new capital, albeit mainly in the form of subordinated debt, and cut back on loan growth. However, this capacity still remains moderate on a sector basis relative to potential credit losses.

“The recently approved government programme to support banks’ tier 1 capital, if successfully implemented, could help to make recapitalisation a manageable process,” says James Watson, Managing Director, Fitch’s Financial Institutions group, “Defaults would still be possible, in particular at banks with major asset quality or corporate governance failures, although recent government actions suggest a determination to avoid destabilising, unmanaged failures at larger institutions.”

The report, entitled ‘Russian Banks: Measuring Their Loss Absorption Capacity’, focuses mainly on asset quality deterioration trends and banks’ loss absorption capacity. It follows and expands on the July 2009 presentation, entitled ‘Asset Quality Problems Weigh on Russian Bank Ratings’, which provided a summary of Fitch’s sector wide credit loss expectations and recapitalisation requirements. The report and presentation are available at

Contacts: Alexander Danilov, James Watson, Moscow, Tel: +7 495 956 9901.

Media Relations: Marina Moshkina, Moscow, Tel: +7 495 956 9901, Email:; Hannah Warrington, London, Tel: +44 (0) 207 417 6298, Email:”

Brazil: Another quiver in its bow

August 17, 2009
Brazil's President Lula with Petrobras's CEO and Lula's Heir-Apparent, Dilma Rousseff  Source: Latin American Herald Tribune
Brazil’s President Lula with Petrobras’s CEO and Lula’s Heir-Apparent, Dilma Rousseff Source: Latin American Herald Tribune

Brazil’s persistent economic weakness over the years has been its external balance sheet — heavy indebtedness to foreigners, weak foreign trade sector, and low external liquidity (e.g. low fx reserves).  This was in addition to a heavy government debt burden (government borrowing abroad in fact drove the fragile balance of payments), a poor business climate (a huge tax burden, heavy regulation and a state-dominated economy) and huge social challenges (e.g. poverty, wealth inequality, crime). 

Yet since the arrival of President Fernando Henrique Cardoso in 1994, whose stabilization and market-oriented policies were largely continued by President Lula since 2002, Brazil has improved somewhat on all these fronts.  What has changed like night to day is the external balance sheet  — as the country’s diversified commodity exports have fueled growth of such economic smokestacks as China.  Brazil, traditionally an energy importer — both hydro and fossil — due to its heavy consumption needs, has recently become a net oil exporter.  No longer do higher energy prices mean balance of payments problems for Brazil, but rather rising fx reserves. 

And, the news keeps getting better. With the technology available for deep-sea drilling, Brazil is set to become a quite sizable oil exporter (read a NYTimes article on the subject).  Petrobras, the part-government-owned energy company, is set to take the lead in developing the deep-sea fields.  It is no accident that Lula’s heir-apparent, Dilma Rousseff, is chairwoman of the board of directors of Petrobras.

Brazil’s fx reserves should continue to mount, providing an almost China-like fortress against external shocks.   This should provide the country with the room it needs to confront its other ills, enumerated above, and move higher and higher among the ranks of today’s Rising Powers.

China, Latin America and the US

August 17, 2009

China: Learning to enjoy the Brazilian bear hug.  Presidents Lula and Hu.  Source: Xinjuanet

What would President Monroe say?

An Economist article discusses the growing presence of Great Powers, especially China, in Latin America, flouting nearly two centuries of U.S. dominance in the region, since the articulation of the Monroe Doctrine in the early 1820s.  In the near term, this worry is overdone.  Longer-term, if the U.S. continues to damage its sovereign creditworthiness, i.e. by not putting in place a medium-term fiscal consolidation program (that is, to reduce America’s rising government debt) — a program that should include putting health care reform on hold, then America’s relative decline will accelerate and this will affect its projection of power in the Western Hemisphere. 

In the 1820s, as revolution in Spain led to unrest in its colonies in the Western Hemisphere, the Holy Alliance of autocratic east European courts — Russia, Austria and Prussia, threatened to intervene in these colonies.  President Monroe in 1823, backed by the British Navy, warned Europe that any extension of European power to the Western Hemisphere would be “dangerous to our [U.S.] peace and safety.”

Nowadays, as the world moves increasingly toward a multipolar system, power projection in Latin America is largely in the form of commerce.  China, India and others seek, above all, the region’s raw materials to fuel their rising economies.  True, with economic influence comes political influence.  True as well, such powers as Russia and Iran seek direct political influence through arms sales and energy deals with the likes of Chavez’s Venezuela, Cuba, and Evo Morales’s Bolivia.  But these countries are on the fringe.  More of interest to U.S. policymakers are China’s economic relations with the major economies of the region, notably Brazil.  China’s economic relations with Brazil have been hand in glove — raw materials fueling a manufacturing juggernaut, while with Mexico, they have been competitive.  Brazil is also a manufacturing nation and will one day find China an unwelcome competitor. 

So, the thrust of the foreign “intervention” is commercial and good for Latin America.  This is good for the United States as well, insofar as China supports growth in the region and the U.S. no longer has to be relied on so heavily as the source of demand and investment for the hemisphere.  In previous U.S. downturns, Latin countries hovered on the brink of default (or in fact defaulted), whereas this crisis they have weathered, due in part to demand from China and elsewhere. 

China, for its part, is “intervening” in Latin America as a rule-abiding member of the global capitalist system, wrought by the U.S. and its allies.  This should not worry American policymakers.  Sure, they should keep an eye on the mischief-making of countries like Iran and Russia that seek to upset the U.S. in its own backyard, much as Krushchev did with Cuba in the middle of the last century (however less dramatic and threatening the current mischief-making is).  Again, the smartest thing U.S. policymakers can do is get America’s fiscal house in order — by first of all, postponing health care reform — and revive the formidable U.S. economy — upon which the country’s power projection is based — not least through continued banking overhaul, workout of real estate loans, policies to increase household savings, and a reform of monetary policy (by discarding Greenspan’s discredited approach).

China & Africa: Imperialism, Corruption, Growing pains

August 2, 2009

China's rising presence in Africa.  Source:  Google Images

An article on a corruption investigation in Namibia related to Chinese investment there appeared in the NYTimes on Friday.  China is confronting the growing pains of being an “imperial” power, as this giant nation increases its FDI and access to raw materials and markets in Africa, Latin America and elsewhere.  Just like imperialists that came before, since the scramble for Africa in the late 19th century, bribes and other forms of less-overt control are hard to resist.  I explored China’s challenge of cleaning up corrupt practices related to international commerce in an earlier post, and my colleague David Kampf  looked into the BRICs rising profile in Africa

One question is whether China, as it rises, will follow the path of the U.S. (and other Western powers) of attempting to reduce corrupt practices in international commerce.  The U.S. Foreign Corrupt Practices Act of 1977 sought to eliminate the bribing of foreign officials and increase the transparency of business relations.