Pandemic Spending Threatens Brazilian Stocks' Hard-Won Climb

By Paulo Trevisani and Jeffrey T. Lewis

Brazil's government spurred big gains in stocks in recent years by pursuing austerity policies that allowed its central bank to cut interest rates to all-time lows. Now, some worry efforts to fight Covid-19 could unravel all that.

Brazil has more coronavirus deaths than any other emerging-markets country and its economy has taken a hit. To counter that, the government is ramping up spending and expectations are that it will have to do even more, triggering concerns Brazil could slide back to populist overspending that led to hyperinflation in the past.

The fear is that this will stoke inflation, eventually forcing the central bank to begin raising rates. From 2014 to this August, it had slashed its benchmark funding rate from 14.25% to 2%. A reversal could dim the allure of Brazilian stocks, which had rallied to records in recent years as Brazilians turned away from low-yielding debt.

Whether that happens matters for more than just Brazilian investors. Foreign investors hold about 46% of Brazilian stocks, and Brazilian companies compose a large portion of emerging-markets funds, thanks mainly to the country's big commodity producers such as miner Vale SA and oil major Petróleo Brasileiro SA, or Petrobras.

Concerns already are being felt in markets. Brazil's Ibovespa index is down 15% in the year to date, a deeper decline than Mexico's main stock index (down 12.5%) or India's (down 1.5%).

An increase in the amount of extra compensation investors demand for holding Brazilian stocks, along with a rate increase, could weigh on the stock market, said economist Fernando Ferreira, head of research at XP Investimentos.

"The market is worried about that," he said. Mr. Ferreira said he still believes the government will resume austerity after the pandemic and that will allow the stock market to resume its rise.

The austerity efforts include a reduced role in the economy for the Brazilian Development Bank, or BNDES, a mammoth institution that bankrolled many of Brazil's companies for most of this century by using vast amounts of taxpayer money to subsidize loans at interest rates well below market levels.

That started to come to an end in 2017, making room for the central bank to reduce interest rates, says Phil Torres, a senior portfolio manager at Aegon Asset Management, in Chicago.

"It's a gigantic change...very healthy and really very important to attract new money from offshore," he said, adding that BNDES's loan portfolio has shrunk.

A BNDES spokesman said the bank is responsible for 24% of all corporate financing in the country, down from 37% in 2015.

Brazilian companies increasingly have issued both debt and equity. But stocks are now the go-to option for Brazilian investors because of their higher return, driving more initial public offerings, analysts say.

"Brazilians can't make any money in savings accounts anymore, and they can't make any with government fixed income either," said David Flechner, a lawyer representing corporate issuers at Paul Hastings LLP. Companies, in turn, "are hungry for capital and recognize that investor demand has been jolted by the interest in equities as fixed income has fallen out of favor because of low interest rates," he said.

A major overhaul of Brazil's pension system passed last year and government spending limits approved by Congress in 2016 also reinforced expectations that Brazil would be able to keep rates low, at least for as long as developed economies hold theirs at current near-zero levels.

But the pandemic upended the multiyear effort to get Brazil's fiscal situation under control. The economy is forecast to shrink by about 5% this year, while the unemployment rate recently rose to 13.8%, the highest since the current series of employment data began in 2012.

To remedy the situation, the government has already spent more than 600 billion reais, equivalent to about $107 billion, on stimulus programs and is testing fiscal limits to provide economic support even beyond the pandemic. Right-wing President Jair Bolsonaro recently proposed an expensive antipoverty program and the budget deficit is expected to reach 16% of gross domestic product this year, down from 6% a year ago, frustrating efforts to narrow it.

If investors don't see the Bolsonaro administration as capable of getting Congress to approve legislation that keeps the budget under control, the currency could depreciate "in an uncontrolled manner and we'll see inflation rise," Mr. Torres says.

"Uncertainty about economic reform is contributing to closing the window for IPOs," says Marco Modesti, chief financial officer at transportation company BBM Logística SA. BBM was ready to go public in March, when asset prices collapsed as the world entered into lockdowns because of the coronavirus's quick spread. It is still waiting to float its shares.

"There still is too much volatility in the market," Mr. Modesti said.

For now, investors and corporations are betting current trends will hold.

"Now is the time [to tap the market.] Rates are low, stocks are going up, " said Thiago Silva, chief financial officer at Ambipar Participações e Empreendimentos SA, a waste-management company that raised 1.1 billion reais when it went public in July, as the Ibovespa was rapidly recovering from the pandemic lows. "I don't see rates returning to levels where they were before, I think the government will be able to control the situation."

Write to Paulo Trevisani at [e-mail] and Jeffrey T. Lewis at [e-mail]

Corrections & Amplifications

This article was corrected at 4:54 p.m. ET to show that David Flechner is a lawyer representing corporate issuers at Paul Hastings LLP. The original version incorrectly gave the firm's name as Paul Hastings LLC.

(END) Dow Jones Newswires

10-14-20 0914ET