Brazil will not make chips in the short term, says economist – 04/24/2023 – Market

Brazil can benefit from the geopolitical context that causes the diversification of production chains in the midst of tensions between China and the US and the Ukrainian War, since it has natural resources, is far from conflicts and close to large consumer markets, evaluates Cassiana Fernandez, head of economic research for Latin America at the American bank JPMorgan.

This does not mean, however, that the country will enter the advanced technology chain, such as the production of chips, in the short term. In her assessment, more favorable conditions are needed for private investment in research and technology in Brazil.

In an interview with SheetFernandez also talks about the environment for foreign investment in the country and the expectations for a reduction in interest rates and the price of the dollar.

How do you see the environment for foreign investment in Brazil today? Brazil was the first large country among emerging countries to start normalizing monetary policy, as early as 2021, and the first to stop the cycle of high interest rates, which positioned it for faster disinflation. Part of this disinflation has already happened: at the end of 2022, the IPCA ended at 5.8%. Core inflation measures are still at very high levels, but we are starting to see a reduction.

The big concern comes from the lack of definition and uncertainties regarding the direction of fiscal policy and the political environment, more troubled since last year’s elections, but we have a more constructive view. The disclosure of the new fiscal framework significantly reduces a more negative tail risk on the conduct of economic policy. But you still have many uncertainties regarding the approval and the way it will go over the next few years.

Brazil has one of the lowest growth rates in the world among middle-income countries. How to attract investors like this? Brazil has two great advantages and two great problems. Among the problems, low economic growth and the level of government debt and cost. One of the worst consequences of low growth is a very poor distribution of growth, even more so for a middle-income country, which generates greater demand for spending and social transfers.

On the positive side, Brazil has one of the most solid external accounts among emerging countries. And not only because of the fact that we finance our entire current account deficit with direct investment flow, which is more stable, but also because of the fact that we still have around 20% of GDP in international reserves, much higher than than the level of public external debt, which provide a reasonable cushion. Add to that the fact of having the luck of the availability of natural resources, oil reserves, iron ore and the entire area for agriculture, which place Brazil in a very privileged position.

If I look at the current geopolitical context, the commercial and geopolitical tension that exists between the US and China and the war between Ukraine and Russia, there is a perception that the world will try to diversify production chains. Brazil is expected to benefit not only from the availability of natural resources, but also from being further away from conflicts and closer to consumer markets, the US and Europe.

Does Brazil have the conditions to enter the advanced technology production chain, such as the production of chips? In the short term, no. You need to create more favorable conditions for private investment in research and technology to be able to participate in higher value-added product positions within the technology sector. But without a doubt it is something that we have the potential to develop.

This discussion that takes place both in Brazil and in Mexico is very positive in the long term, but it is still very difficult to see this being a decisive factor in the economic performance of the countries in the short term. There is still a lot of homework to be done in order to attract these investments. Creating favorable conditions for private investment involves stability of rules, legal certainty and macroeconomic stability, decisive factors when defining these investments.

Do questions about Central Bank autonomy make Brazil less attractive? In fact, autonomy is an important institutional advance that can generate gains, especially in the medium and long term. Criticism of Central Bank policy happens everywhere, it is part of independence itself. The current management of the Central Bank is very transparent in relation to assuming that it is the role of the monetary authority to also justify its work before society, rulers, Congress, etc. That part of the discussion is part of the game. Depending on how it is driven, it may or may not generate more or less noise, but it is important.

The threat of you going back goes a little against what is important for investors: legal certainty, stability of rules and macroeconomic stability. Any decision that reduces any of these conditions tends to be unfavorable to the flow of investment and interest in the country.

A separate discussion, regarding the change in the inflation target, ended up generating a lot of noise in the market and, in my opinion, contributed to the discouraging of inflation expectations, mainly in the medium and long term, in relation to the current target of 3% . But there is still no definition of what will happen. The government has the power to define the target, and then we will have to discuss the costs and benefits of a change. In my opinion, today we have much more costs than benefits in changing the target level, especially in the medium and long term. It’s not the time for you to change.

And when is the time to lower interest rates? Economic activity has already slowed significantly. There was a first quarter greatly favored by the agricultural harvest, which should be a record this year, but domestic demand slowed down more significantly. Inflation already peaked above 12%, closed last year at 5.8%, we see a more positive number now. I see that there is room for the Central Bank to start cutting interest rates towards the end of the year. Our expectation is a first interest rate cut in November of this year.

There are conditions for the Central Bank to anticipate this first cut. A significant part of why it doesn’t do it faster is the fact that it has this anchorage in relation to inflation expectations and the target. If you take a communicated decision, not only the reduction of fiscal risks, but the definition of the fiscal framework and the discussion of the definition of the target, with a re-anchoring of expectations, the Central Bank could indeed start cutting interest rates before November .

Is the recent drop in the dollar likely to be lasting? What is the fair price for the dollar? We had a coincidence of factors on the day of the IPCA release, which was a weakening movement of the global dollar, it was not just the Brazilian currency that performed very well. Our models do not suggest that the currency is far off fair value given external conditions.

What will greatly determine the currency’s level in the coming months will be more the external sector, the development of the global economy. March and April were quite atypical months, because the regional banks event in the United States [falência dos bancos SVB e Signature Bank] ended up generating greater volatility and risk aversion, in addition to greater fear of recession in the US and a generalized repricing of assets. Our projection is R$5.30 for the end of the year. Recognizing the enormous uncertainty in relation to this projection, leading economists have already said that the exchange rate is there to teach economists humility.

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Cassiana Fernandez, 46
Since March, he has been head of economic research for Latin America at the American bank JPMorgan. From 2014 to the beginning of this year, he was Chief Economist for Brazil at the same institution. Previously, he worked at Mauá Capital and BNDES. She holds a degree in economics from USP and a master’s degree from PUC-Rio.