Recent news from the emerging markets paints two contrasting pictures. On the one hand, stock market...
Recent news from the emerging markets paints two contrasting pictures. On the one hand, stock market prices have been falling, suggesting weakness. On the other hand, economic and policy indicators have been exceptionally strong.
The growth of economic activity has picked up, as good growth has spread beyond the US, becoming more evenly distributed among developed countries and exceptionally good among emerging economies.
This must be very helpful to company profits, so earnings per share can be expected to grow very rapidly. Despite the winter peak in oil prices, inflation has been well contained and currencies have stabilised.
Now, oil prices have fallen, inflation should abate further, allowing interest rates to go further, particularly in emerging markets where they are still high relative to inflation.
After Brazil's devaluation crisis at the start of last year, interest rates soared and output fell while a huge budget deficit was recorded. However, the financial situation was normalised so inflation has remained contained while interest rates have fallen back and the currency has recovered some of its lost value.
Despite the rise in oil prices, the real has been trading over 10% stronger than a year ago. Inflation fell slightly in February to run at 7% and interest rates have halved to 18%, still high in relation to inflation, but historically low for Brazil. In response, industrial production has risen spectacularly, being 16% higher than a year ago in February.
The balance of trade has improved to yield a number of surpluses in recent months. The current account remains in deficit owing to large interest payments on Brazil's accumulated debts. However, inward fixed investments in Brazil's highly competitive industries have been sufficient to enable Brazil to follow Korea in repaying an IMF loan early.
Brazil has also been able to improve its public finances dramatically. Early last year it seemed certain the 1999 budget deficit would be well over 10% of GDP, swollen by the effects of devaluation and high interest rates. Legislation and the improving economic situation contained this percentage into single figures.
The economic recovery, falling interest rates and a rising real have brought a good start to 2000. The new legal and political environment makes it likely the public finances will be close to balance this year if those trends continue, pushing interest rates yet lower. This sets up a virtuous circle in public finances as lower interest rates lead to lower deficits, leading to yet lower interest rates. As the government no longer pre-empts the savings and liquidity available, interest rates can be expected to remain low enough for private investment to be undertaken profitably. It seems, therefore, that the weakness in share prices is driven by factors exclusive to the equity market.
Brazil's equities seem to be following the US Nasdaq rather than domestic factors. Indeed, domestic investment in equities has been exceptionally great recently, while there are reports that international investors are withdrawing funds.
Just as the government is buying back its debt from foreigners, so the private sector is buying back its equities. The present weakness in Brazilian, like other emerging market equities, seems to be the product of US investors losing their taste for risk. For the moment, blue-chip Brazilian companies are suffering along with the latest US dot.coms.
The fundamentals point to a strong bounce in Brazilian share prices, whatever the ultimate fate of those dot.coms.
Rodrigo Pinheiro is Latin American Portfolio Manager at Old Mutual Asset Managers (UK)
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