COUNTRIES OF INTEREST: SUSPECION RESIDES IN BRAZIL AND SPAIN

by Ron McWilliams

Latin America, Brazil and Europe; A Combination For The U.S. To Take A Look

Interesting implications could be developing with Brazilian economic results and their association with European, especially Spanish, banks. Brazil is undertaking major infrastructure development to prepare for hosting the 2014 World Cup and the 2016 Summer Olympics. Inflation is now looking to sustain amid declines in GDP and production; and despite tax cuts to domestic industry, interest rate cuts and increased tariffs to protect domestic industry.

 

While growth looks to sustain in Mexico and Argentina, Latin America's second and third largest economies, Brazil's largest economy in the region is showing an effect on one of the largest banks in the world, and certainly Spain's major bank to watch given trends in Brazil.

Banco Santander's Part, Given Its Role In Europe and Latin America

Spain's Banco Santander reported earnings on April 26 and showed net profits down for Q1 by 24% after “provisions” (potential losses) on non-performing loans that rose by 51%. Such poor loan performance appears to come mostly from Spain and the country's major deterioration in economic circumstances.

Santander said in their press release that the non-performing loan rate in Spain was 46%. They also told of Latin American results. According to Santander, some 52% of their profit came from Latin America. From this percentage, 27% came from Brazil....This does appear to account for a quarter of overall profits.

Santander's exposure to Latin America and Brazil in general is further focused by profit consequences from the respective locations. Santander said in their press release that profits dropped in Latin America by 4% in Q1 while profits dropped by 12% in Brazil specifically.

 

Though Spain leads Europe's economic connections with Latin America, Europe in general garnered significant exposure to the region.

IMF Description Of The Exposure of Spain and Europe To Brazil

IMF data reveals that foreign bank claims on the “LA6” (being Brazil, Chile, Colombia, Mexico, Peru and Uruguay), amount to 30% of the Latin region's GDP. Of these bank claims, European banks account for 60%.....essentially on 30% of the named countries' GDP production.

This amounts to heavy exposure against LA6 countries, and in reality against Brazil given its global size.

Brazil's economy has been experiencing a decline unlike other BRIC nations, or other Latin American nations. According to the CIA's World Fact Book, Brazil is the 8^th largest economy in the world, ahead of the United Kingdom, which is number 9. Ahead of Brazil is Russia at 7, Germany at 6, Japan at 5 and India at 4.

 

Because of Spain's exposure to Brazil, and Europe's exposure in general, looking at Brazil's surprising economic results are telling.

Brazil's GDP declined through 2011. Q1:2011 results showed a GDP of 4.20% which declined by Q4:2011 to 1.40%. Currently analysts are expecting Q1:2012 results to show a GDP of .5% to 1% according to a Reuters report dated April 16.

Particular Brazilian Economic Reports And The Future

These numbers seem to be generating significant support given recent data. Industrial production in Brazil isn't showing recovery right now. Instead, and according to the Brazilian Institute of Geography and Statistics (IBGE), Brazil's Census Bureau, numbers are in a trend of decline.

IBGE reports industrial production as having gained 1.3% month over month (Jan. to Feb. for April reports) .However, industrial production showes a Y/Y decline of -3.9% and an accumulation of loss for the first two reporting months of 2012 of -3.4%.

According to the IBGE, the year over year (Y/Y) loss of -3.9% is the 6^th consecutive negative rate (on a continuing basis) and the most for such a duration since 2009 (-7.6%).

Implicated from this is evidence that Brazil is finding a sort of drag from Europe's economic slowing. Also implicated is the association of Brazil to Europe's ability to over come its current circumstance. Naturally, with Brazil going into economic decline following Europe's sustained trouble, can Brazil decouple and show rates more congruent with “BRIC” performance. Probably not. It does appear that organic growth in Brazil, as with Europe, has been compromised.

 

Brazil And Europe Seem Linked To Suspicions Of Economic Disappointment

Other evidence indicates a cause for thought. Brazil's manufacturing data reported on Wednesday, shows corroboration for other indicators of decline. According to the manufacturing report from Reuters, Brazil showed a PMI manufacturing result that decreased below 50, finding itself at 49.3. An actual decline in manufacturing.

Conventional thinking attributes Brazil's economic situation to a strong currency, derived from years of being an export driven economy. A strong Brazilian currency only degrades its export competitiveness amid other countries. Which of course impairs economic performance.

But not expressed in conventional thought is Brazil's need for importing products due to its major infrastructure campaign.

Brazil grew a strong currency due to heavy exports, which grew year after year. While this export strength grew, many sought to engage either in direct investment in Brazil, or purchased its financial assets such as stocks and bonds.

Brazil's Balance of Payment Surplus

Emerging economies are very dependent on the balance of payment dynamic. Current accounts and capital accounts hopefully equal and thereby result in balanced growth. It appears that given Brazil's evolving economic weakness, with European and especially Spain's economic trouble, investors appear to be showing growing hesitation in Latin America.

Brazil's current account deficit (more imports than exports) has fallen year over year from 2011 through 2012. Brazil's capital account surplus has also fallen year over year. All a telling of progressing Brazilian economic circumstances. The real issue to be noticed, however, is Brazil's substantial and disproportionate capital account surplus.

Heavy capital account surpluses drive up the value of Brazil's currency, the real or reais. Also implicated are sustained declines in exports, inflation, declining economic performance and then comes unemployment.

Specifically, Brazil's current account shows that in March of 2011, it stood at -5,737 and its capital account at 16,811. And in March of 2012, current account showed -3,320 while the capital account revealed 13,607 (in $U.S. billion).

Looking only at March differences between current and capital accounts for 2012, a troubling spread exists. While both have fallen, the capital account surplus looks like an over-hang that can sustain Brazil's currency value by itself aside from other influences.

High And Sustained Capital Account Surpluses Look To Reveal Sustained Export Decline And Inflation

Should Brazil's current account deficit continue through building roads and stadiums to host coming events, the current account deficit will continue. Also, should Brazil's capital account surplus continue at its current spread versus the current account, and  due to declining organic economic growth created by global demand decline, it seems that inflation could overwhelm the economy.

Results amount to continuing inflation and an inflated Brazilian Real currency price. Both degrade not only domestic production, but also export potential due to currency differentials. With current and capital account balances declining, but a capital surplus likely to remain for sometime, inflation seems a given. Perhaps this is why Brazil is looking to become aggressive on cutting interest rates. 

From here, where is Spain's deeply extended Banco Santander, and other European banks?