Future of Emerging Markets: A Brazil story By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

September 30, 2015 | Posted by bobbysrinivasan << back to blog

After the sub-prime of 2008 in the US, the Federal Reserve Chairman Ben Bernanke took a bold decision to pump in enormous amounts of liquidity through the process known as quantitative easing. According to the data available, nearly 4 trillion US dollars of fiat currency was created. The emerging markets were beneficiary of the US generosity and among them Brazil benefited a lot. But now things are different there.

Last week, credit rating agency Standard and Poor downgraded Brazil government debt from investment grade to junk status. Junk status means Brazil’s bonds are at a high risk of default. In 2011 socialist Dilma Roussef took over as President of Brazil. She has wrecked the country’s finances in just 4 years. Last year the Brazilian government racked up its largest deficit in history. It spent US $ 129 billion more than it took in Brazil has now entered into a worst recession since the great depression and their stocks are in a severe bear market. EWZ, a major Brazil ETF (Exchange Traded Fund) is down 52% in just one year. This indeed is a scary situation. The US Fed Reserve drove its fed funds rate to near zero. All companies used the dollar as the ‘carry on’ currency (borrow in US dollars because the interest rate is low). According to the data available, the dollar denominated loans by borrowers in emerging markets doubled since 2009 and is currently more than $ 3 trillion.

Brazilian companies alone have amassed $270 billion in foreign debt since the last financial crisis. Now that the dollar has appreciated nearly 40% against the Brazilian real, the cost of the loan would have sky rocketed as the payment must be made in US $.

Brazil has followed the Argentinian model. Argentinian currency has plunged from 1 peso equals to 1 dollar in 2001 to around 9 pesos to a dollar. Today Brazil is also facing the same destiny. Indian government has allowed our external commercial borrowing to exceed US $ 200 billion. If and when the US rates start moving up, serious cash flow problems are likely to arise for companies who need to pay their loan and interest in US dollars. The RBI should seriously consider monitoring the ECB. If it fails to do then the forex reserve may not be enough to settle these borrowings. This is a stark reminder of what happened in 1991 in India when the rupee value dropped from 16 to 32 to a dollar.

Finally, with trillions of dollars of debt denominated in US dollar many companies could become bankrupt, if the dollar moves up because of the fed policy to increase the fed funds rate. Hope Janet Yellen of US fed will take cognizance of this before she decides to jack up the interest rate.

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