Brazil
What Is the FDI Outlook?
September 22, 2009

By Marcelo Carvalho | Sao Paulo

Brazil's foreign direct investment (FDI) prospects look promising. FDI is a key component of Brazil's balance of payments. We think FDI should recover after a slowdown this year, but risks look biased to the upside if global healing advances while Brazil remains a darling among investors. FDI into commodity areas (by sector of destination), and perhaps from emerging Asia (by country of origin), would seem to have particular upside potential for coming years, if all goes well. In turn, if they materialize, rising FDI inflows could help finance a wider current account deficit as domestic demand recovers. Brazil's market size and growth are already important attractors for FDI flows. However, boosting Brazil's infrastructure and improving its public sector efficiency are remaining challenges to further attract FDI inflows. 

FDI Dominates Brazil's Capital Account

Capital flows to Brazil should improve going ahead, along with recovering global flows into emerging markets (EM) in general. Global capital flows to EM should rebound in 2010, according to IIF projections (see Capital Flows to Emerging Market Economies, Institute of International Finance (IIF), June 11, 2009), after a sharp decline in 2008 and another drop on average for 2009 as a whole. For Brazil, our forecast sees a similar down-and-up pattern.

Portfolio flows into Brazil have picked up lately, with resumed equity inflows. After a remarkable run-up through early 2008, Brazil's initial public offering (IPO) market dried up with the global turmoil. Brazil's local capital markets are now picking up again, as seen most visibly with the large Visanet transaction. Looking ahead, the local press talks about R$20 billion of upcoming IPO deals, based on registrations at CVM, Brazil's local version of the American Securities Exchange Commission. Foreign participation in local IPOs is historically estimated at about three-quarters of the total. Spurred by recovering local markets, foreign capital inflows into the local equity market have picked up, to almost US$10 billion so far in 2009, or about double the figure seen in the same period a year earlier, after large outflows in the second half of 2008, according to central bank data. By comparison, recent fixed income flows seem relatively muted, with cumulative flows close to flat so far this year.

For its part, FDI remains the largest single item in Brazil's capital account. So far this year (January-July), net FDI into Brazil was US$14 billion, down 30% from the same period a year earlier - or running at an average annualized pace of about US$24 billion so far this year. The trailing 12-month sum has slowed to US$39 billion. That is down from a peak of US$45 billion for 2008 as a whole.

Brazil's FDI prospects seem encouraging. Looking ahead, our forecast assumes net FDI inflows of US$25 billion for 2009 as a whole, in line with the central bank's own working assumption. We look for a FDI recovery to US$30 billion next year. But these figures may start to look conservative if global healing consolidates while Brazil remains a darling for the international investor community. For instance, if Brazil were to recover the market share of 3.5% of global FDI flows it enjoyed back in 1980, annual FDI flows into Brazil could potentially exceed US$50 billion in the coming years.

Note that outward foreign direct investment by Brazilian investors has also become relevant in recent years, as Brazilian companies expand their operations into the international arena. Brazilian direct investment abroad has jumped from close to flat before 2004 to an annual average of about US$14 billion during 2004-08, although these flows have also suffered with the global downturn.  Details show the US remains a top destination for Brazilian FDI abroad, besides Brazilian investments in the Latin America region, including investments in Peru, Argentina, Chile and Mexico. Across sectors, outward FDI by Brazilians concentrates on financial services, but also includes industrial sectors like metallurgy.

What sectors is FDI going to? FDI appears relatively widely spread across sectors of Brazil's economy over time. The services sector currently represents about a third of FDI into Brazil, with a pick-up so far this year in FDI into the insurance segment, despite a decline in the share of financial services. Industry has gained market share so far this year, on the back of a jump in the share of basic metallurgy and the automobile sector, followed by chemical products. The agribusiness sector has lost some share so far this year, with the unwinding of a jump in FDI into mining last year, perhaps in lagged response to gyrations in global commodity prices.

Will FDI into commodities gain prominence? Looking ahead, while opportunities can be found in a variety of areas, we suspect that the so-called primary sector (including agribusiness, oil and mining) has the potential to act as an important magnet for FDI. Judging by a recent UNCTAD report, there are indications that global FDI in agricultural production is on the rise and that this trend is set to continue in the long term (see World Investment Report 2009, United Nations Conference on Trade and Development (UNCTAD), September 17, 2009). In addition to Brazil's perceived comparative advantages in the agribusiness sector (including bio-fuels and food, given land and water availability), recent pre-salt oil discoveries have the potential to attract relevant capital flows over the years, if all goes well.

Where is FDI coming from? Historically, FDI into Brazil comes mainly from developed economies, although the US has understandably lost share as a country of origin for FDI flows into Brazil so far this year. Looking ahead, global trends and anecdotal evidence suggest that there might be scope for a potentially significant increase in the role of emerging markets like China as a source for FDI flows into Brazil over the years. After all, UNCTAD data indicate that China's total outward FDI has jumped by a factor of 18 times from 2003 to 2008. China's share as a country of origin for global FDI outflows has accordingly jumped from 0.5% in 2003 to 2.8% in 2008. China is a key global commodity consumer, while Brazil is a key global commodity supplier. Yet, China does not yet even appear in the list of the top 40 most important sources of FDI into Brazil. We suspect that this picture might start to change going ahead.

How Does Brazil Fit in Global FDI Trends?

Emerging markets are steadily gaining market share in global FDI flows. The share of developed economies has fallen to about 57% of global FDI inflows from a share of more than 80% at the start of the decade, while the share of EM economies has climbed to 43% of total FDI flows last year, from less than 20% at the start of the decade, according to UNCTAD data. Last year, while the US retained its position as the largest home and host country for FDI flows, EM countries became large FDI recipients (43% of global FDI inflows), as well as significant FDI investors (19% of global FDI outflows), amid rising so-called South-South flows.

Global FDI flows should recover from recent slump. The economic and financial turmoil has severely hurt FDI flows. Global FDI flows fell from a historical high of US$2.0 trillion in 2007 to US$1.7 trillion in 2008, and are expected to fall to below US$1.2 trillion in 2009, with a recovery in 2010 to a level up to US$1.4 trillion, gaining momentum in 2011 to approach US$1.8 trillion, according to recent UNCTAD estimates and projections.

Brazil has gained market share in global FDI flows. While global FDI flows dropped 14% last year, FDI into Brazil actually increased 30% last year. As a result, Brazil's share in global FDI flows has increased to 2.9% of the total in 2008, or a percentage point higher than a year earlier. Brazil had already reached a share of 3.5% of global FDI inflows back in 1980, but lost ground during the ‘lost decade' of the 1980s, before regaining market share in the current decade. By comparison, China's share as a recipient in total global FDI inflows has climbed sharply over the years, from close to zero in 1980 to almost 7% of global FDI inflows last year.

Brazil seems well placed in investor perceptions about global FDI prospects, based on a survey by UNCTAD among the largest transnational corporations regarding FDI prospects for the 2009-11 period. According to the survey, Brazil has climbed to fourth place (from fifth place a year ago, displacing Russia) in the ranking of countries that investors mention as most attractive locations for FDI for the next three years. Brazil comes behind China, the US and India. 

Which factors drive FDI decisions, and how does Brazil perform? According to the latest UNCTAD survey on FDI prospects (see World Investment Prospects Survey 2009-2011, United Nations Conference on Trade and Development (UNCTAD), July 2009), Brazil does well regarding size of the market and growth of the market, but lags behind the global average on the quality of infrastructure and on government effectiveness. That is, size matters and growth helps, but improving Brazil's infrastructure and boosting its public sector efficiency remain a challenge. As for labor markets, Brazil's labor force is seen as relatively cheap, but availability of skilled labor and talents lags behind, which underscores the importance of investment in education and human capital.

What are the possible macro implications of rising future FDI? If Brazil fulfills its potential to attract rising FDI inflows in coming years, all else constant, then constraints on Brazil's balance of payments could ease, which could help to facilitate financing of a potentially larger current account deficit than faster domestic growth typically entails.

Bottom Line

Brazil's FDI prospects look promising. Risks seem biased to the upside if global capital flows recover while Brazil remains a darling among investors. We suspect FDI into commodity areas, and possibly from emerging Asia, would seem particular areas of potential upside in coming years. In turn, rising FDI could help finance a wider current account deficit as domestic demand expands. Brazil's market size and growth help attract FDI flows, but its infrastructure and public sector efficiency remain challenging.

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United States
Review and Preview
September 22, 2009

By Ted Wieseman | New York

Treasuries posted significant losses, led by the intermediate part of the curve over the past week - except at the very short end, which was squeezed by a big pending decline in bill supply as Treasury winds down the SFP and quarter-end positioning - as equity and credit markets continued ramping higher and economic data remained solid. Supply was also a problem, with very heavy corporate issuance through the week and another run of record Treasury supply announced for the coming week. A better-than-expected retail sales report, with the expected surge in auto sales and boost from higher gas prices added to by the best ex autos and gasoline gain in six months, pointed to a slightly larger rise in 3Q consumption. We raised our consumption forecast to +2.7% from +2.5% and GDP to +3.8% from +3.7%. The housing market recovery also continues, with upside in housing starts and the homebuilders survey. And the huge recovery in industrial production, which has led the turnaround in the economy, continued in August. Upside was again autos-led, but there has been a notable broadening out in the factory sector rebound. Meanwhile, early indications from the claims and regional manufacturing surveys were generally positive for the next round of key data. We look for a further moderation in job losses in September with a 150,000 decline in payrolls and a stabilization in the ISM at 53 after the surge into positive territory last month. The looming flood of 2-year, 5-year and 7-year supply and the FOMC meeting will be the market focus for most of the upcoming week, which has a fairly quiet economic data calendar, especially in the first part of the week. We're not expecting much to come out of the FOMC meeting, as it's probably too early to start talking about plans to taper off MBS and agency buying similar to what was announced for Treasuries at the last FOMC meeting, and while the New York Fed is making sure the Street is prepared for the Fed's eventual move to start draining the huge amount of excess reserves in the banking system, the FOMC seems unlikely to be ready to act soon.

On the week, benchmark Treasury coupon yields rose 6-17bp, led down by the belly of the curve. This was the first week of broad losses since early August. The 2-year yield rose 10bp to 1.00%, 3-year 13bp to 1.56%, 5-year 17bp to 2.49%, 7-year 17bp to 3.11%, 10-year 14bp to 3.47% and 30-year 6bp to 4.23%. Elevated August inflation readings ultimately didn't help TIPS too much, though they did outperform the bigger nominal losses, with the 5-year yield up 11bp to 0.98%, 10-year 7bp to 1.65%, and 20-year 4bp to 2.14%. The headline readings in both the CPI (+0.4%, -1.5%Y) and PPI (+1.7%, -4.3%Y) were sharply boosted by temporary upside in energy prices, and the core reading for both - +0.1% and +1.4%Y, a five-year low, for CPI and +0.2% and +4.3%Y for PPI - were boosted by higher-than-expected readings for autos. New car prices in the CPI were down, but much less than seemed reasonable, given the prevalence of cars sold with cash-for-clunkers discounts in August, so there will probably be a lingering negative impact on September. PPI was not impacted by cash for clunkers, but motor vehicle prices in PPI appear to be little better than random on a month-to-month basis. The very short end of the Treasury market saw a big further rally from already rich levels, as the Treasury announced that it would be winding down the Supplemental Financing Program, which will reduce outstanding bill supply by about 10% over the next six weeks. This program was put in place a year ago to help the Fed drain reserves from the banking system. It became almost immediately pointless when the Fed shifted to quantitative easing and stopped worrying about draining excess reserves, but the Treasury had kept the program around until now anyway. On the week, the 4-week bill's bond equivalent yield fell 5bp to 0.03%, 3-month 6bp to 0.08%, and 6-month 1bp to 0.20%. Mortgages outperformed Treasuries on the week, but current coupon yields still rose up towards 4.4% from recent lows approaching 4.25% at the end of the prior week. The recent MBS strength has lowered average 30-year mortgage rates to just above 5% the past few weeks from near 5.25% for most of July and August after a back-up from the record lows near 4.75% seen from late March to late May. Swap spreads gave back some ground after having tightened to recent lows (and for the 5-year almost a record low), with the benchmark 2-year spread rising 5bp to 37bp, 5-year 1bp to 37.5bp and 10-year 4bp to 21bp. This widening was seen despite renewed improvement in interbank rates and spreads, at least on a spot basis. 3-month Libor resumed setting new daily record lows, moving 1bp lower on the week to 0.289%, which reduced the spot 3-month Libor/OIS spread a couple more basis points to another more than two-year low of only 11bp. Forward Libor/fed funds spreads saw modest widening on the week, however, and are a lot higher than spot at around 25bp in 2010 and 2011. This widening reflected a sell-off in eurodollar futures that slightly exceeded a more hawkish medium-term Fed outlook in fed funds futures ahead of the coming week's FOMC meeting. There wasn't any dramatic shift in the Fed outlook, though, with the first rate hike still priced in April and a 1.50% funds target priced for year-end 2010 instead of 1.25% after the May 2010 contract lost 6.5bp to 0.54% and Jan 2011 17bp to 1.525%.

It was another great week for risk markets, with stocks moving back again more into the lead in the second half of the week after credit, particularly high yield, had been out ahead for the first half of the month. The S&P 500 gained 2.5% on the week to extend the year-to-date rally to 18%. Financials were the best-performing sector with a 4% rally. Credit stalled out and gave back some ground late in the week after a big prior run. Late Friday, the investment grade CDX index was 9bp tighter on the week at 102bp after having closed below 100bp for the first time since May 2008 on Wednesday. High yield had been on a rampage through midweek before also stalling out Thursday and Friday. After trading as tight as 633bp Wednesday, the best close since June 2008, the HY CDX index was another 72bp tighter on the week and almost 200bp on the month at 648bp at Thursday's close, and Thursday's small pullback was being extended a bit further Friday. During this mild late-week softness, the leveraged loan LCDX index started to catch up with HY CDX after previously lagging (though while still doing very well). Through midday Friday, the LCDX index was 62bp tighter on the week and 156bp better on the month at 557bp, just off the best close in nearly a year hit Wednesday. The fundamental news certainly isn't getting any better, and the TALF program continues to show little activity in its CMBS programs, with only US$1.7 billion in loans requested this month to buy legacy CMBS and again no new issuance, but the commercial mortgage CMBX market had an incredibly strong week in the lower-rated indices. With the TALF confined to AAA issues, the AAA index did lag but still performed well with a 1-point, or 1.4%, gain to 80.61. This was way behind an enormous squeeze in the lower-rated indices, however, with the junior AAA up 19%, AA 36%, A 40%, BBB 30% and BBB- 28%. After barely moving at all from 27.00 for several weeks, the AAA-rate subprime ABX index also suddenly ripped higher for no obvious reason, surging 4.7 points (+17%) to 31.75, just off the best close since February hit Thursday.

Retail sales surged 2.8% in August, boosted by a 10.6% spike in auto dealers' receipts, as the cash-for-clunkers incentives pushed unit sales to their highest level in over a year. Ex auto sales were also robust, gaining 1.1%. Much of this upside reflected rising gasoline prices, which led to a 5.1% gain at gas stations, but sales ex autos and gasoline still advanced 0.6%, the biggest rise in six months. In line with the improved back-to-school sales results reported by major chain stores, good gains were seen in the clothing (+2.4%), general merchandise (+1.6%), sports, books and music (+2.3%), and electronics and appliances (+1.1%) categories. The weakest categories remained the most directly housing related, building materials (-1.2%) and furniture (-1.6%). Incorporating the upside in ex autos and gas sales, we slightly boosted our 3Q consumption forecast to +2.7% from +2.5% and our GDP estimate to +3.8% from +3.7%.

On top of the rebound in consumer spending in the current quarter - largely as a result of surging auto sales, but with the August report showing some encouraging signs of life in ex auto sales - residential investment continues to appear likely to show the first gain in quite some time in 3Q, with housing starts and the homebuilders survey both continuing to improve even as nervousness remains among builders about the potential impact of the looming expiration of the first-time homebuyers tax credit. Housing starts rose 1.5% in August to a 598,000 unit annual rate, a nine-month high after a 25% rebound from the record low hit in April. All of the August gain was accounted for by a 25% bounce in the multi-family component to 119,000 after a collapse to a record low in July. Single-family starts fell 3% to 479,000, the first decline since a record low was hit in January. Single-family starts are still up 34% from that low. Although starts have rebounded, housing completions continue to catch up with the prior collapse in starts, so for now new home inventories can continue normalizing if sales are sustained. Total completions were down 5% to 760,000 and single-family 2% to 489,000, both new record lows. We continue to see real residential investment on pace for about a 17% rise in 3Q, which would be the first increase in four years.

The ongoing turnaround in the economy is broadening, but continues to be manufacturing and particularly auto production-led, though the IP report showed encouraging signs of a broadening of the factory-sector revival. IP surged another 0.8% in August on top of an upwardly revised 1.0% gain in July, the biggest two-month rise in a decade outside of the post-Katrina rebound. The key manufacturing gauge was up 0.6% on top of a 1.4% surge. Motor vehicle and parts production was up another 5.5% in August on top of July's 20% spike. Ex motor vehicle factory output was surprisingly robust, gaining 0.4% on top of an upwardly revised 0.5% rise in July, the best two-month gain in five years, indicating that the auto-led recovery in the factory sector is quickly becoming more broadly based. Sectors other than autos showing good growth in July and August include primary metals, machinery, high-tech, aircraft, food, chemicals and plastics.

Early indicators for the key upcoming round of early economic figures for September were generally encouraging. After seeing a huge improvement in July, but then stalling out in August - consistent with the big moderation in payroll declines in July but lack of follow-through in August - initial jobless claims have resumed improving notably in the past couple of weeks moving into the survey period for the September employment report. As a result, our preliminary forecast is for a 150,000 decline in September non-farm payrolls, which would be the smallest drop since July 2008. Meanwhile, the initial round of regional manufacturing surveys was mixed, suggesting that the ISM will probably stabilize in September after the surge into positive territory in August. On an ISM-comparable weighted average basis, the Empire State manufacturing survey improved further in September to 50.1, a high since April 2008, from 48.7, but the Philly Fed declined to 47.0 from 48.5, though these were still the two best readings since the end of 2007. Based on these mixed initial results, we look for the national ISM to be little changed in September at 53.0 after having surged four points in August. We will update our estimate as the remaining regional reports are released over the next couple weeks.

Treasury market focus in the coming week will be mostly on supply and the Fed, with not much economic data of note until the end of the week. The FOMC meets Tuesday and Wednesday. With no change in rates likely to be contemplated any time soon, focus will be on any announcements about MBS and agency buying and any plans to start draining excess reserves. Eventually the Fed will probably introduce a plan to gradually taper off MBS and agency buying, currently scheduled to wrap up at year-end with US$1.25 trillion of buying of the former and US$200 billion of the latter, similar to the plan announced at the last meeting to extend and slow the planned buying of US$300 billion in Treasuries through October instead of finishing in September, but it's probably too early to make any announcements on this now. Meanwhile, the already enormous amounts of excess reserves in the banking system will sharply ramp up soon, as the SFP bills roll off over the next six weeks and Fed buying continues. The New York Fed was in touch with dealers in the past week to make sure that systems were in place to allow them to begin implementing sizeable reverse repos to start draining all this money, and they will certainly report on their findings to the FOMC, but it seems unlikely that the FOMC is prepared to begin moving on this yet or make any announcement about it. So, generally, we're not expecting much of interest from the FOMC statement. On the supply calendar, the market will have to absorb another record run of US$112 billion in 2-year, 5-year and 7-year supply in auctions Tuesday, Wednesday and Thursday. However, there's been a persistent run of strong auctions that began with the refunding in early August, so market anxiety about supply, which was a consistent problem through the first part of the year, is low at this point. The data calendar is light. Notable releases include leading indicators Monday, existing home sales Thursday and durable goods and new home sales Friday:

* We look for a 0.7% gain in the index of leading economic indicators in August, which would be the fifth consecutive sizable advance, with significant positive contributions from the supplier deliveries, yield curve and stock market components. These swings should more than offset a big drop in the money supply.

* We expect existing home sales to rise to a 5.40 million unit annual rate in August. Elevated levels of affordability and the impetus associated with the first-time homebuyer tax credit have triggered a sharp rebound in resales over the course of recent months. Indeed, the July sales pace was about 17% above the low point seen in January. We look for a further 3% gain in August.

* We forecast a 0.6% decline in August durable goods orders. A pullback in the volatile aircraft category, following a sharp jump in July, should contribute to an outright decline in headline orders. However, the key core component - non-defense capital goods excluding aircraft - is expected to post a solid rise (+0.8%) consistent with the recent climb in the ISM orders index.

* We expect new home sales to rise to a 450,000 unit annual rate in August. Sales of newly constructed residences have risen by nearly one-third since the January low. And the homebuilder sentiment survey points to another uptick in August. So, we look for a 4% advance spurred by a rush to beat the expiration of the new homebuyer tax credit along with heavy discounting by developers.

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