Brazil Goes Investment-Grade

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Doing Well Against the Dollar

Brazil is also benefiting from high world commodities prices, which since 2003 have tripled foreign reserves on deposit at the Central Bank, to a record $195 billion at the end of April—an amount that is roughly equivalent to the country's total outstanding public and private foreign debt. That's a far cry from the 1980s, when Brazil—which then imported all of its oil—was crippled by high oil prices and defaulted on its international debt. Today, thanks to large offshore oil finds, Brazil is oil self-sufficient and its state oil company, Petrobras (PBR), also boasts an investment-grade rating.

Also, today most of Brazil's government debt is denominated in local currency. That reduces the country's vulnerability to exchange-rate fluctuations, such as the ones that rocked Brazil's economy in 1998. The Brazilian currency, the real, floats freely and has appreciated some 7% against the U.S. dollar this year. A U.S. dollar currently fetches 1.695 reais, down from 1.81 reais in mid-January.

The International Monetary Fund estimates that Brazil is on track to grow 4.8% this year, following on 5.4% growth in 2007, when the country racked up a $40 billion trade surplus. It is the world's largest producer of iron ore, coffee, and sugar, and is a major exporter of soybeans, pork, beef, and other foodstuffs. Companhia Vale do Rio Doce (RIO), known as Vale, the world's largest iron-ore miner, is in the midst of a multibillion-dollar expansion (BusinessWeek.com, 3/11/08).

Spending is Up, Even Among the Poor

Brazil is more than an exporter of raw commodities, it is a leading, low-cost producer of value-added products such as hot-rolled steel and processed orange juice concentrate, as well as more sophisticated products. Its Empresa Brasileira de Aeronáutica (ERJ), or Embraer, is a leading producer of commuter aircraft used by major U.S. and European airlines. Cosan, the world's biggest sugarcane processor and a major ethanol producer, has seen its share price rise 54%, while shares of USIMINAS, a leading Brazilian steelmaker and exporter, have risen 60%. And Brazil's export markets are diversified worldwide, shielding the country from the U.S. economic slowdown.

Several years of strong economic growth and low inflation have boosted consumer spending, including among the working poor who constitute the majority of Brazil's 190 million people. Expanding opportunities in retailing, wireless telephony, housing construction, auto sales, and physical infrastructure last year attracted $34.6 billion in foreign direct investment, an amount expected to be matched in 2008. To keep that consumer boom on track without sparking inflation, which rose to an annual rate of 4.7% in March, the Central Bank in mid-April tightened monetary policy, a prudent measure applauded by S&P in its upgrade announcement. The bank increased interest rates by 50 basis points, to 11.75%.

A Boost to Investor Confidence

Still, Brazil has been the slowest-growing of the so-called BRIC countries, a term coined in 2003 by Goldman Sachs (GS) to include the most promising hot-growth emerging markets: Brazil, Russia, India, and China. Brazil could be chalking up more robust growth if politicians could manage to approve structural reforms that would trim the country's high tax burden, whittle bureaucratic red tape, improve crumbling infrastructure and logistics, and reduce the inequality of income distribution.

Still, with Brazil's BOVESPA outperforming the world's top equity markets, the nod from Standard & Poor's should give a boost to investor confidence and perhaps give a nudge to necessary economic reforms. "We believe the investment-grade status will attract more capital inflows going forward, which have already been on the rise on the back of a responsible policy framework that has been delivering faster output growth and well-controlled inflation," UBS Securities analyst Claudio Ferraz said in a note to clients.

And it should help bring down further the risk premium that the Brazilian government must pay investors: Just before President da Silva was elected in October, 2002, when investors were jittery about a possible default, Brazilian government bonds carried a spread of 2,400 points over U.S. Treasuries. That had dropped to 300 by mid-March and fell to just 217 basis points after the S&P upgrade.

Smith is BusinessWeek's Mexico bureau chief.