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Foreigners increase caution with local assets

Foreign banks show signs of concern with directions pointed by new government

01/09/2023

After the noises emitted by the new government provoked days of high tension among local market players, foreign banks have now started to send messages of greater caution with the directions indicated by the Lula administration, worsening their projections for the trajectory of Brazilian assets.

Besides increasing the uncertainties about the performance of the local market, the move seems to give strength to the thesis that foreign players take a little more time to react to domestic political news.

For Morgan Stanley, the context of fiscal worsening and uncertainties about the framework that will discipline public spending in the coming years was translated into a worsening of the prospects for Brazilian assets. The American bank even cited in a recent report “echoes of the fiscal deterioration experienced in 2015 and 2016” in local markets.

“We reaffirm that, from the exchange rate point of view, the attractive spread [i.e., high-interest rates] will not be sufficient to avoid more significant depreciations if external accounts and the fiscal outlook continue to deteriorate,” stated the report. The bank’s strategy team reaffirms a pessimistic view of the real. “We believe that the BRL [real] should underperform emerging market peers due to the risks of political uncertainty and we have opened a short position against the South African rand.”

As for interest rates, the institution considers a process of falling rates unlikely, preferring to adopt a trend which gains from rising local rates. “We remain very focused on inflation expectations for 2024 and 2025, as further de-anchoring may lead markets to price a resumption of the high cycle in 2023 — which is not the base scenario, for now,” they assess.

The higher interest rates for longer are expected to undermine the story of apparently attractive valuation for local stocks. “If we are correct in our assessment, the next few years should not be good for domestic stocks,” said the Morgan Stanley analysts, who maintained a “neutral” recommendation for local stocks.

In the first week of the new administration, Commerzbank sent its clients a note asking, “what does Lula represent for the real?” In response, the German bank said “probably nothing positive.” According to Antje Praefcke, Commerzbank’s senior foreign exchange analyst, Brazil’s fiscal scenario and the sustainability of public debt has been a stumbling block for investors for some time. Now the situation is likely to get worse, as the government plans adjustments to the spending cap to facilitate the increase in social spending it promised during its election campaign.

“Lula will have to manage to improve it [the debt], either with the help of spending cuts or revenue increases. No easy task in times of high inflation and deep political division. The prospect of higher spending will probably make investors even more skeptical and may drive them away completely.”

For the analyst, two questions will be decisive for the Brazilian currency over 2023. The first is whether Mr. Lula will manage to control the fiscal situation or whether it will deteriorate with adjustment to the spending cap. The second is how the Central Bank will react to the evolution of the budget and whether the monetary authority will continue to be an anchor for the stability of the real. “It is likely that times will get tough for the real. If investors question Mr. Lula’s budget policy and the Central Bank’s monetary policy, the currency is likely to depreciate rapidly, with the biggest risk probably being fiscal policy.”

Wells Fargo: fiscal fears materializing — Foto: Scott Eells/Bloomberg

Wells Fargo: fiscal fears materializing — Foto: Scott Eells/Bloomberg

Another foreign institution to raise concerns about the new government’s early directions was Wells Fargo. “With Lula now officially sworn in, the fiscal fears that have pre-emptively shaken investors are beginning to materialize and further affecting market participants’ confidence,” the institution said in a report.

Wells Fargo calls attention to the fiscal expansion already approved in the Transition PEC, while there is the prospect of using state-owned banks to leverage economic activity. “We believe that this new direction of fiscal policy will end up being inflationary, and we now believe that the CB will delay monetary policy easing until the third quarter of 2023,” said the bank report.

Thus, Wells Fargo recognizes that its projection made at the beginning of the year, that the dollar would end the first quarter trading in the R$5.30 range, runs the risk of not materializing. “Should future policy decisions indicate further erosion of fiscal responsibility, we will adjust our USD/BRL outlook to reflect likely pending capital outflows that would put depreciation pressure on the currency,” he said.

For Eirini Tsekeridou, Julius Baer’s fixed income analyst, the announced extension of the tax exemption on fuel prices not only affects tax collection but was also a “rug-pulling of Minister [Fernando] Haddad,” who was against the measure, weakening his credibility and also the country’s commitment to fiscal responsibility.

“There is still no clarity regarding Brazil’s fiscal structure, including the replacement of the spending cap, so until we have more visibility on Lula’s strategy, the real will likely remain volatile and affected by news flow,” Ms. Tsekeridou told Valor.

The Oxford Economics consultancy was another institution that revised its scenario for the country. As pointed out by Regis Chatellier, director and emerging markets strategist, Brazil’s fiscal outlook has deteriorated following the recent increase in the spending cap and Mr. Lula’s post-election speech. “In this context, inflation should remain relatively high and the CB’s interest rate cuts will be much slower than anticipated. We believe risk premiums will remain high, with strong investor positioning also limiting the appreciation of Brazilian bonds,” he said.

Mr. Chatellier says that premiums on Brazilian bonds are relatively high, which ends up being a buffer for risks. “However, we believe that risk premiums embedded in LTNs and NTN-Fs will remain elevated given the deteriorating fiscal outlook and slower normalization of monetary policy,” he added. “We cut our recommendation for exposure to local Brazilian bonds to ‘neutral’ from the above market average.”

*By Arthur Cagliari, Gabriel Roca, Matheus Prado — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Foreigners to get more space in government procurement

Brazil takes to WTO proposal to expand access of companies in public bids

06/13/2022

Lucas Ferraz — Foto: Edu Andrade/Ascom/ME

Lucas Ferraz — Foto: Edu Andrade/Ascom/ME

In negotiations to join the Agreement on Government Procurement (GPA) of the World Trade Organization (WTO), Brazil will make this week a new offer that expands accession for foreign companies in the country’s public procurement. This includes giving more room for foreigners to participate in bids in financial services subsectors and also in more states.

On Monday, Brazil will also submit to the WTO the request for accession to the organization’s Agreement on Trade in Civil Aircraft, as revealed by the Economy Ministry’s secretary of foreign trade, Lucas Ferraz, who is in Geneva for the conference of trade ministers.

The secretary said the negotiations to enter the GPA are advanced, “with preservation of our public policy space, especially the one focused on stimulating small and medium enterprises, health, and science and technology.”

For him, “Brazil’s joining the GPA will represent a turning point in the fight against corruption in public procurement in the country, increasing the efficiency of public spending and aligning Brazil’s regulatory framework with international best practices.”

According to the secretary, after the internal consultation process, “the country will be able to make some movements in financial subsectors,” confirming that this includes the insurance area.

So far, Brazil has increased to 10 from 6 the number of states, plus the Federal District (Brasília), that will allow foreign participation in public procurement of goods, services, and works. But industrialized countries are asking for the inclusion of states with “substantial procurement volumes,” such as São Paulo, Rio de Janeiro and Bahia.

Mr. Ferraz informed that the number of states to be presented in the new offer will be substantially higher. “In recent weeks, we have had strong demand from federal entities to join the agreement, after clear evidence of its benefits for public administration,” he said.

The expectation was that it could be accepted at the current WTO ministerial conference in what is known as the “anti-corruption deal” in global trade rules. But the appetite of industrialized countries is great and demands for further concessions continue.

Australia presented new demands last week. One of them is for Brazil to offer access also to bids in construction services of the Ministry of Defense. It also asked the inclusion in the procurement list of the National Nuclear Energy Commission and the Brazilian Space Agency.

Brazil had already signaled that it could improve its offer but warned its partners to keep their feet on the ground, because it would not give the full opening demanded by some. The Brazilian evaluation is that what is on the table is already an ambitious offer, especially being the first Latin American country to join this agreement.

As for seeking accession to the WTO Agreement on Trade in Civil Aircraft, the goal, according to the Economy Ministry, is to try to facilitate the country’s access to a world market estimated at around $3 trillion. Brazil is the only relevant aircraft producer and founding member of the WTO still outside the agreement, which came into force in 1980 and brings together 33 members of the organization.

This agreement eliminates the import tax on civil aircraft, their parts, pieces and other goods used in air services. It also prohibits quantitative restrictions, licenses, and certifications that restrict trade and are contrary to the General Agreement on Tariffs and Trade (GATT).

A participation in the agreement, according to Brazil, has the potential to reduce the negative impact of the Covid-19 pandemic on the airline industry, aggravated by the war in Ukraine, according to the government.

*By Assis Moreira — Geneva

Source: Valor International

https://valorinternational.globo.com/
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Brazil stock market sees strong inflow of foreigners

The battle for listings and stock market reforms: evolution or revolution? | International Financial Law Review

The macroeconomic challenges and uncertainties brought by the presidential elections this year have not prevented the arrival of a substantial amount of funds from foreign investors in the Brazilian stock market, which has ensured positive returns for the Ibovespa in 2022, unlike the New York markets. By January 21, the net inflow of foreign funds into the B3 secondary market had reached R$20.1 billion, the highest since January of last year, when inflows totaled R$23.6 billion.

Representatives of foreign firms told Valor, however, that they don’t see better fundamentals here and that external factors, including the monetary tightening led by the U.S. Federal Reserve and more optimistic prospects for commodities, explain the flow. Those factors, they say, have increased global demand for assets in emerging countries.

The dynamics has been helping Ibovespa to outperform peers from developed markets. While Brazil’s benchmark stock index rose 5.13% in 2022, the S&P 500 fell 8.6%.

Juliano Arruda, head of Latin American equities at Goldman Sachs, said that last year the global equity funds raised about $950 billion – an unprecedented amount – and Brazil ended up benefiting. This year, equity funds are still raising funds and, by mid-January there were about $67 billion of inflows in products of this type around the world.

“The difference is that, with the repricing of interest rates in the U.S. driven by a more hawkish Federal Reserve, there is an outflow of resources from the United States and record flows to emerging markets,” Mr. Arruda said.

Another factor expanding the demand for emerging market stocks, especially Latin American, is the favorable wind for commodities in 2022. While the main oil benchmarks are up more than 10% for the year, iron ore sees gains of the same magnitude.

“About $15 billion has flowed into emerging markets in the last three weeks, roughly in a distribution of 80% to equities and 20% to debt. Latin American equity markets have done especially well – probably in the wake of the strong start to the year for commodities, as well as signs that China is ready to start boosting its economy after resetting its strategy last year,” said Chris Turner and Francesco Pesole, strategists at ING.

According to David Beker, head of Brazil and Latin America Economics at Bank of America, there is greater optimism about the growth of China today and this benefits companies related to the dynamics of the Asian country, especially Vale. The mining company – which have a weight of nearly 15% in Ibovespa – is up 7.8% in 2022.

“The more attractive price levels we saw at the end of the year, the weakened real and less political noise probably also helped,” Mr. Beker said.

In the view of Esteban Polidura, head of products for the Americas at Julius Baer, there is a gradual rotation from growth – share classes that have high future growth prospects built into their prices, typically found in the technology sector – to value companies, which have cheaper multiples and are typically from the financial and basic materials sectors.

This is because, he said, higher interest rates tend to impact growth stocks more than any other type of stock. “I would link the flow precisely to a global shift to value stocks and Brazil is a good example of a market that is now perceived as value. However, we need to wait to see whether this will be lasting or not. It will depend a lot on Fed signals, and one must also monitor how the global appetite for risk will be,” he said. Still, according to Mr. Polidura, it is key to follow the elections in Brazil, which are likely to increase the volatility of local assets.

For Mr. Beker, with BofA, it will be difficult for the Ibovespa or the emerging markets to continue to see a better performance than the developed markets as interest rates go up in the U.S. “On the other hand, this rise in the basic materials and energy sectors may continue to benefit us, as we saw at the beginning of the year,” he said.

From the local standpoint, nothing justifies a great improvement in local fundamentals, said Mr. Arruda, from Goldman Sachs. “This will only change when we have more visibility regarding the elections,” he said.

He also mentions the possibility of this flow reversing course. As the United States face tightened financial conditions, including falling stock markets and rising interest rates, at some point the Federal Reserve could signal a pause in the monetary tightening cycle. “The flow from growth to value and from developed to emerging can be reversed if the Fed slows down the pace,” he said.

Robert Davy, emerging markets fund manager at Schroders, has a more constructive view regarding the local market, based on the perspective that the monetary tightening cycle started early in Brazil, which can be advantageous for local risk assets.

“In 2021, the country suffered with inflation and the consequent cycle of high interest rates. In 2022, the rest of the world will look at the same issues, while Brazil has already started this process. So, we may still have, this year, inflation falling and a reversal of interest rates, which would put Brazil in a great position,” he said.

The view is similar to that of Emy Shayo Cherman, J.P. Morgan’s strategist for Latin America and Brazil. According to her, the country seems to be well advanced in the monetary tightening cycle, which means an advantage relative to other emerging economies.

“In principle, this flow is likely to continue. The multiples of the shares have risen in recent days, but are still quite discounted and we have the impression that the downward revision of profits has also begun to stabilize,” she said.

According to her, the earnings season ahead will be very important to define how sustainable is this foreign flow. “I think that on the macroeconomic side, nobody expects big improvements; the expectation here is just that the peak of inflation is behind us,” the strategist said.

Mr. Davy, with Schroders, said he is not too scared about the upcoming presidential election. He says the polls have given clear indications of who the new president will be, and it remains for the market to wait and see how the new government will build its policies.

“I was already working with emerging markets in 2002, when Lula first won,” he said, citing former president Luiz Inácio Lula da Silva (2003-2010), which is a presidential candidate again this year and is ahead in the polls. “We were tense and some local analysts calmed us down, saying that his administration would be better than expected.” He added: “The result seems clear now. We just need to understand what will happen with the state-owned companies, the country’s fiscal policy, the dynamics between [Brazilian Development Bank] BNDES and private-sector banks.”

Frederico Sampaio, chief investment officer of equities at Franklin Templeton in Brazil, also says that foreign investments are not explained by an improvement in the fundamentals of national assets. For him, the flow is a direct consequence of the low prices of local stocks, a move that was driven by withdrawals from investment funds since the end of last year.

“When the Selic was at 2% a year, even hedge funds focused their funds on the stock market. Now we are seeing the reversal of this, often forced by investor withdrawal. It is a brutal change that does not speak to the fundamentals of the companies. The macro has even changed, but there was not such a big revision in the companies’ results to justify this”, he says.

He cites the example of digital retail and technology stocks so cheap that managed to rise this year in sessions in which interest rates were advancing strongly. Despite higher interest rates and some disappointing results, the devaluation of these stocks was so “bizarre” that it opened space for “less obvious” trading moves, he said.

From here on out, however, Brazil depends on Brazil, Mr. Sampaio said. “Moves out there have impacts here, but the long term depends more on what is done at the local level. The country and the market need a positive growth perspective, and the problem is that, again, we haven’t managed to put in place the necessary structural changes to get to this point,” he said.

Source: Valor international

https://valorinternational.globo.com/

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