Brazil: As If The Government In Brazil Were Not Enough (EWZ, GGB)

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November 15, 2012 3:12pm NYSE:EWZ

Joseph Hogue: While the Brazilian central bank has lowered interest rates to an historic low to stimulate economic growth, the government’s policies seem to be a weak patchwork of support for favored industries. The administration of President Rousseff has increased tariffs

and cut taxes for industrial goods, especially in the auto industry.

The government announced its largest ever stimulus package in August and aimed at increasing private investment in an outdated system of roads, rail and air transportation. Government estimates put the package of concessions up to 133 billion reais ($66 billion). The current round of stimulus has followed an on-again, off-again environment for government support with the administration increasing taxes on investment last year.  Brazil lags other emerging markets in the time it takes to move goods within the country. The problem is so prevalent that business owners call it the ‘Brazil Cost’, a euphemism for the high amount of bureaucracy and logistics problems within the country.

These policies seemed to be helping to support growth until industrial production fell for the first time in four months in September. Output fell by 1% for the month and almost 4% from the year prior. The drop has led many to reassess their forecasts for economic growth this year. The central bank cut its forecast to just 1.6% this year and 3.3% in 2013.

In contrast to the economic boom seen under the previous administration, policies by the current administration seem to be doing little more than bringing forward sales to take advantage of tax holidays and keeping energy use elevated due to government mandates on prices.

As if this were not bad enough, the country may have to face problems brought on by the neighboring government in Argentina as well.

Exports to Argentina, which represent roughly 20% of Brazilian manufacturing exports, are down 14% from last year. While the economy could get a boost from spending leading up to the 2014 World Cup and the 2016 Summer Olympics, economic problems in Argentina will almost certainly act as a headwind. Hyperinflation and rising crime rates have led to protests across Argentina and the situation has recently degenerated with major blackouts due to poor grid infrastructure. Besides the general economic loss to Brazilian exports, equities are prone to sharp declines on sentiment around headline risks in Argentina.

Gerdau (NYSE:GGB) could be a good long-term bet on Brazilian infrastructure spending but would face headwinds over the short-term if manufacturing sees further declines. The $11.2 billion iron and steel company produces and sells its products principally in the domestic market but also generates revenue throughout Latin America and the United States.

The iShares MSCI Brazil (NYSEARCA:EWZ) provides the most general form of investment in the economy with exposure to all major sectors. Investors may want to hedge weakness in the overall economy or in specific sectors with a short position in the diversified fund against bets in stronger sectors or industries.

Written By Joseph Hogue From Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments.  CNBC Emerging Markets Contributor Tim Seymour leads the team of  Emerging Money to bring you cutting edge global news and analysis.

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