Brazil in Focus

Brazil reaps the benefits of its closed economy - for now

by Walter Molano
Russia may be a riddle wrapped in a mystery, but Brazil is a whirlwind in a teacup. One of its most criticized flaws, the closed economy, is now its greatest virtue. Open economies across the planet, such as Singapore and Chile, are bracing for 2012. The possible collapse of the euro and the growing probability of a hard landing in China darken the horizon. However, Brazil is an oasis of relative calm.

Economic activity remains strong, with record low rates of unemployment, even though the latest GDP numbers were a bit disheartening. New infrastructure projects are altering the urban landscape and consumers are still in overdrive. Nevertheless, economic activity will soften next year. The deleveraging of the European financial system is sending tremors throughout the private sector. The Chinese slowdown will also depress commodity prices, which will complicate life for many exporters. Brazilian paper and pulp, iron ore and beef producers are reeling from the combined effects of an overvalued currency and the decline in commodity prices.

Fortunately, foreign capital continues to pour in. The preparations to host the 2014 World Cup, the 2016 Summer Olympics, plus the development of the pre-salt oil fields, assure that hundreds of billions of dollars in foreign direct investment will continue to arrive. This provides strong support for the country's construction concerns, property developers and energy companies. It will further the incubation of a fresh crop of entrepreneurs and businessmen who will continue to revolutionize the economy. Teams of new billionaires are being created in the hinterland as Brazil develops its huge deposits of natural resources.

A new generation of brilliant businessmen, armed with Amazon-scale egos and impeccable connections, are making the country a player on the international corporate stage. Bolstered by a treasure-trove of cash and a cooperative government, these individuals see the unfurling global crisis as an opportunity to take the planet by storm. Therefore, Brazil can continue to thrive in relative isolation, regardless of what is happening abroad.

However, a recent incident raised some questions about the future of the offshore oil industry. Last month, Chevron suffered a major drilling accident 120 kilometres from the coast of Rio de Janeiro. The mishap raised a great deal of concern about the company's engineering competence and technical capabilities. There was also widespread anger after the company first tried to cover-up the incident and then downplayed the extent of the environmental damage. The government eventually prohibited Chevron from further oil exploration.

However, there were other questions that were more important. The oil spill occurred when the surface of the seabed cracked around the mouth of the drill hole. It was well known that the oil industry needed to develop much of the technology required to extract the oil from the pre-salt fields, without endangering the environment. The oil is under a great deal of pressure and the salt bed is extremely fluid and unpredictable brittle. Therefore, there are some worries that the extraction process may become an important obstacle to overcome.

So far, most of the media's attention is on Chevron, which was not drilling into the pre-salt reservoirs, but the incident may have serious implications for the overall development of Brazil's offshore oil fields.

A decision to limit the development of the pre-salt oil fields could have grave ramifications. The heavy capital inflow, particularly into the oil sector, is the main reason why the Brazilian Real (BRL) remains so strong, despite the deterioration of the global economy. The overvaluation of the currency is creating complications, and it was the main reason why the central bank eased monetary policy earlier this year.

A redesign of the consumer basket used in the calculation of the CPI will also alleviate some of the inflationary pressures. The new weightings should shave half a percentage point off the inflation rate in 2012, allowing the central bank to justify further monetary easing. This should allow the Brazilian economy to grow at a steady pace of 3% in 2012.

The moderate tempo of economic activity should also allow the inflation rate to dip below 6%. A more stable environment will allow the economy to consolidate some of the heady gains that were made in the last few years.

This will be particularly the case in the financial sector, which should see the amalgamation of several institutions. It should also allow the entry of new international players, particularly from Asia, as they try to establish a foothold in their strategic partner. Therefore, being such a closed economy has its benefits. Meanwhile, most of the planet shudders at the implications of a breakup of the euro and a hard landing in China; the impact on Brazil will take some time to materialize due to the insular nature of the economy.

Walter Molano is a managing partner at BCP Securities