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Miami Forum - January 17, 2012

Murillo De Aragao Warns of 2012 Brazilian Government “Friendly Fire” at EMTA Miami Forum

Noted Brazilian political analyst Murillo De Aragao of Arko Advice and Global Source Partners delivered the keynote address at EMTA’s first Forum in Miami.  The event, which was held on Tuesday, January 17, 2012, was hosted by at the Mondrian Hotel in Miami Beach.  Over 100 market participants attended the event.

In his remarks, De Aragao promised to provide a commentary of Brazil “free of MBA disease,” noting that he had earned his Ph.D. in sociology, not in economics.  He reviewed President Dilma Rousseff’s performance in 2011, calling the results “not extraordinary compared to [former president] Lula’s; but definitely composed of continued improvements.”  Such progress has kept up popular approval of the government.

The Brazilian economic situation should be considered very good or even excellent, De Aragao argued, with 2.3 million new jobs created in Brazil in 2011, unemployment at 5.2%, and GDP growth at approximately 3.5%.  However, politically, 2011 was a more lacklustre year, as De Aragao pointed out various scandals which resulted in the replacement of a number of government ministers.  Popular support has allowed the government to pass bills on the minimum wage, anti-trust rules and small business tax rules; on the other hand, the most important reform bills did not get approval due to a lack of consensus among the various inter-party factions, chieftains and power brokers among the governing parties.

Former president Lula remains a sort of “chairman of the Board,” De Aragao commented.  “He is not Putin; he is not in a day-to-day role, but he has input on any critical situation.”

Looking forward to 2012, Brazil was likely to grow another 3 to 3.5% in 2012, allowing for new job creation, while inflation would remain under control.  On a political level, De Aragao rated as “high risk” the possibility of increased “friendly fire” between the governing parties and their factions.

Following De Aragao’s remarks, Goldman Sachs’ Paulo Leme moderated a panel discussion on the outlook for EM in the context of the global economic environment.

Marty Schubert (Eurinam) voiced his concerns on the gravity of the financial crisis in Europe.  “The EU numbers are huge compared to Latin American numbers during the 1980s,” he stated, and the inability to find a solution could lead to the collapse of the Eurozone.  Schubert expected the current situation to “get worse before it gets better, and he noted that Greece’s efforts at privatization had proven a “dismal failure.”  Schubert was concerned that the current debt trend is unsustainable unless sovereigns can grow themselves out of the problem.  He cited the extent of the Greek haircut and the potential retroactive collective action clause, as 90% of the bonds were covered by Greek law to prevent holdouts a la Argentina and the likelihood that more countries will require huge debt haircuts.  However, Schubert, a veteran of the 1980’s restructuring added: “there is just too much debt, but there is life after debt.

“It’s hard to see a scenario where Greece and Portugal remain in the Eurozone,” commented Nomura’s Tony Volpon, who assessed the risk of a “hard default” as high.  Historically, there was no precedent for such highly-indebted countries escaping their debt crisis without a devaluation, he argued.  Volpon expressed greater confidence in a less painful outcome for Italy and Spain, pointing out their more competitive sectors (and northern Italy’s economic integration with Germany).  A large devaluation of the Euro will alleviate some of the Eurozone’s woes by “solving the problem of missing sucking in demand,” he suggested.  This could either lead to a currency war with countries such as China, Japan, the US and Brazil; or it could have a positive result by serving as a positive confidence shock.

Tulio Vera of Bladex Asset Management expressed a more optimistic view.  A multi-year, partial dismantling of the welfare state in Greece and the other crisis countries might be underway, but it must be accompanied by either lower real wages or gains in competiveness if countries are to stay in the Eurozone; the alternative is an exit from the common currency with a devaluation.  A Greek default was inevitable, with the size of the haircut remaining a question.  Vera agreed that Italy and Spain would avoid restructurings, while venturing that Portugal could still avoid a default.  He voiced less criticism of the ECB than some commentators, opining it was starting to move in the right direction.  The IMF was unable to play a major role due to resource constraints, Vera concluded.

Discussing potential global ramifications of a European recession, Bulltick Capital’s Alberto Bernal expressed confidence that the US could still avoid a double-dip recession.  “We are so lean in the US that we can’t fire anyone else,” he stated.  In contrast, Vera remained concerned that the American economy was “not out the woods,” and predicted a decline in some upcoming US economic data.

Anne Milne of Bank of America Merrill Lynch remained relatively upbeat on the outlook for EM corporate debt, despite ongoing market concerns with Europe.  She predicted a turbulent year for the asset class that would ultimately lead to a 10.5% return, highlighting that 70% of the asset class is investment grade.  EM corporate debt issuance would only decline 5% to US$180 billion in 2012, while defaults would rise to 3.5% on the high-yield segment of the market (vs. a 0.4% default rate in 2011).

Leme prompted panelists to address the effects of financial industry reforms.  Volpon expressed concern that if proposed regulations weren’t diluted, the importance of Singapore, Shanghai and Sao Paulo as financial centers would rise, at the expense of New York and London.  Milne observed that buy-side assets under management were increasing while the dealer side was in contraction mode.  This would lead to changes, as “buy-side firms will come up with their own solution if regulators continue to suppress the sell-side.”

Leme concluded by requesting speaker recommendations on EM assets for 2012.  EM currencies are likely to appreciate vis-a-vis the Dollar and Euro, according to Vera, who recommended the MXP, CLP and BRL.  He also would sell 2-year CDS on Argentina and 1-year CDS on Italy, assuming neither would default during those tenors.

Bernal predicted the S&P index to reach 1400, and would buy Italian debt while shorting French paper.  He recommended underweighting hard-currency sovereign EM debt and overweighting its local-currency counterpart.  The MXP could appreciate to 11.5 per Dollar by year-end, he added.

“There will be a time when the best trade is to buy southern Europe...but it is not yet,” Schubert mused.  He would sell the Euro vs. the US Dollar now, while adding that he would likely buy Euros later in 2012.  Volpon anticipated the ECB would eventually begin an aggressive (non-sterilized) quantitative easing program which could either solve the EU crisis, or would lead to a speculative attack on the Euro.  Milne noted her firm’s 1350 S&P forecast and optimism for Brazilian equities.  In the EM corporate arena, investors should overweight the oil and gas sector and top-tier EM financials while underweighting steel and food producers.

In addition to, additional support for the event was provided by Bank of America Merrill Lynch, Goldman Sachs and Nomura.