Today's Letter IEDI analyzes the external vulnerability of the Brazilian economy from three complementary perspectives. Firstly, it analyzes the situation of flows, i.e., the result of external accounts in 2013. Secondly, it examines the situation of stocks, that is, the evolution of net external liabilities (NEL) and their components. Thirdly, we calculate a set of external vulnerability indicators that take into consideration both dimensions (flows and stocks) and thus summarize the current status of this vulnerability in the short (external liquidity) and medium to long term (external solvency).

 

This issue is of the utmost importance given the beginning, in January, of the so-called tapering of the U.S. FED. Moreover, Brazil has been included, alongside Turkey, South Africa, India, Indonesia, in the group of "the five fragile", which would be the most vulnerable to the gradual normalization of monetary conditions in the United States due to high current account deficits, high rates of inflation and/or growth deceleration. 

 

Regarding the size of the flows, one of the main evidence of the deterioration of Brazilian external accounts in recent years is the upward trend of the current account deficit (CAD) since 2009. In 2013 this deterioration has intensified due, specially, to three negative outcomes: 

 

 

The accumulation of DTC over the years has led to an increase of the NEL, which is the result of the difference between the gross external liabilities (GEL) and the gross foreign assets (GFA). Besides the size of the liabilities, their composition is also relevant for two main reasons. The first, relevant to the situation of external liquidity, refers to different degrees of volatility of each type of GEL, which are: IDE, FPI, and other foreign investment (OFI). The second, which interferes with the situation of external solvency, concerns the rate of return (or financial services) of each type of NEL (that is, net remittances of interest, profits and dividends and debt repayments), which is also quite heterogeneous. 

 

During the period 2009-2013, the GEL grew 40% (from US$ 1,080 billion to $ 1,515 billion), due primarily to the increase in the FDI stock, which rose 82%, against 75% of the OFI and only 3% of FPI. Thus, during the phase of large capital flows that followed the global financial crisis, the less volatile form of foreign capital was the main responsible for the increase in the GEL, which is equivalent to the external assets (rights) of non-residents in Brazil. This result is explained by both factors of attraction of FDI - investments in commodity producing sectors, with high prices until 2011, and in trade and services sectors benefited by the growth of labor earnings - as well as factors that prevented a more expressive expansion of FPI inflows: the mechanisms for management of capital flows in effect until May 2013, and the turbulence in international financial markets caused by the Euro crisis and the uncertainties regarding U.S. monetary policy.

 

Moreover, these mechanisms also contributed to the reduction of foreign short-term liabilities - FSTL, which include the short-term external debt and the stock of portfolio investment in the country. These liabilities, which totaled US$ 501 billion in December 2013, are one of the key variables for the analysis of the situation of external liquidity, since they are equivalent to funds that can quickly leave the country (interruption of the rollover of foreign loans and/or redemption by non-resident of applications in the country in question). 

 

As for external solvency, which reflects the external vulnerability in the medium and long term, it depends on the trajectory of the NEL and its financial service (i.e., their rate of remuneration). The NEL of the Brazilian economy reached US$ 758 billion in 2013, a figure 26.2% higher than that recorded in 2009 (US$ 550 million). This growth was a result of the advance of 83.9% of direct investment (DI), 1.6% of portfolio investment (PI) and 122% of other investments (OI). However, there was a decrease compared to the results of the previous three years (2010, 2011 and 2012) due to a combination of factors. Firstly, the maintenance of the strategy of accumulation of foreign reserves. Secondly, the effect of the exchange rate depreciation and of the depreciation of the Brazilian shares in 2013 (which reduced the dollar value of the non-residents’ stocks of assets). Thirdly, the larger growth rate of GFA against GEL (57.9% vs. 40.3%), a result of the progress in the internationalization of Brazilian capital, under the leadership of direct investments of Brazilian firms. 

 

To complete the analysis of the current situation of external liquidity and solvency of the Brazilian economy, we calculated a set of indicators, much more comprehensive than that used in recent studies on the subject - generally, indicators related to external debt, which provide an incomplete view of the external vulnerability of an economy. This is because the short-term external debt is currently a very small fraction of FSTL and the net external debt is negative since 2007 (due to the reduction of public debt and the accumulation of international reserves).

 

The external liquidity situation was evaluated from four indicators, whose common factor is the use of international reserves in the denominator (i.e., the foreign exchange resources that can be mobilized on short notice against a sudden outflow of foreign capital), differing only in the composition of the numerator, which are:

 

 

Comparing 2007 with 2013, the four indicators show an improvement in the situation of external liquidity of the Brazilian economy, but there are clearly two distinct groups. The first group, which includes indicators 1 and 2, indicates a favorable external liquidity situation in Dec/2013 (indicators smaller than 1), as well as better than that recorded at the threshold of the global financial crisis (December 2007). While at that moment the short-term external debt absorbed 22% of reserves and the GEFN 24%, in 2013 these percentages were, respectively, 9% and 13%. As for the second group of indicators (indicators 3 and 4, which include in the numerator the stock of FPI in the country), it reveals an unfavorable situation of external liquidity, because they are greater than 1, that is, the reserves are insufficient compared to either the FSTL, or the sum "GEFN + FPI stock in the country". However, in both cases there was also improvement compared to Dec/2007. Considering the broadest indicator (indicator 4), it dropped from 3.06 to 1.37; this means that on the eve of the global financial crisis the potential pressure for foreign currency was 206% greater than the reserves, a percentage that dropped to 37% in Dec/2013. It is worth clarifying that we use the adjective "potential" because when there is liquidation of investments in the domestic financial market by foreign investors in a floating exchange rate regime, the foreign currency value of the FPI in the country decreases as a function both of the fall in asset prices as well as of the exchange rate depreciation caused by the outflow of capital. 

 

To assess the situation of external solvency of a country, a key indicator is the ratio of the NEL to exports. The reason is that, in the case of developing countries, like Brazil, exports are the source of autonomous generation of the foreign currency needed to pay the remuneration of the NEL. The ratio indicates the number of years, given a certain annual export flow, necessary to pay the NEL. The condition for this ratio to not have an explosive trajectory is that the rate is lower than the pace of expansion of exports. Otherwise, the ratio NEL/exports follows a path of unlimited expansion. 

 

In the case of Brazil, whose export performance in the last decade was anchored in external sales of commodities, it is also important to include in the analysis the manufacturing industry’s (MI) ability to generate foreign exchange. Given the exhaustion of the upward trend in commodity prices and the changes underway in China - slowdown and reorientation of the growth pattern, which will result in lower demand for agricultural products and minerals - the future trajectory of Brazilian exports is dependent on the performance of the MI foreign sales. Thus, besides the traditional indicator NEL/export, three additional external solvency indicators were calculated:

 

 

The evolution of these four indicators shows that, unlike the external liquidity situation, solvency has deteriorated in the comparison between Dec/2007 and Dec/2013. Although the indicator 1 (NEL/total exports) has remained virtually at the same level (2.98 and 2.70, respectively), the indicator 2 (NEL/MI exports) increased from 4.63 to 5.19 in the same period (that is, considering only the exports of the MI, it would take over 5 years to pay the NEL). Indicators 3 and 4, which consider the service of the NEL in the numerator, also indicate a worsening, especially indicator 4, which increased from 0.37 to 0.58; i.e., in 2013, the service of the NEL "consumed" 58% of the manufacturing industry’s exports.

 

The worse performance (between 2007 and 2013) of the indicators that consider exports of the MI in the denominator is explained by a lower growth rate (23%) relative to total exports (52.4%), to NEL (37.8%) and to NEL service (90.7%). The growth in the MI exports in 2013 (1.3% against a 0.4% drop in total exports) - benefited by the exchange rate depreciation and the recovery in advanced economies - has been positive, but insufficient to offset the negative effect of falling commodity prices. In 2014, if this recovery continues (as predicted in the baseline scenarios of the IMF and the World Bank), these exports may gain additional momentum, which, however, can be mitigated (or even canceled) by the currency crisis in Argentina, the main destination of our industrial exports. 

 

Thus, to ensure a sustainable growth trajectory of the MI foreign sales - crucial to avoid a situation of foreign insolvency - economic policy actions are needed. Besides avoiding a new movement of domestic currency appreciation, the government should promote better coordination with the private sector to stimulate investment and the re-industrialization of the country, together with the intensification of trade negotiations for the (re)integration of the Brazilian industry into global value chains (as already highlighted in the Letter IEDI n. 608). Moreover, it is worth remembering the benefits to the country of exports of the MI compared to commodities (including industrial): they generate positive cumulative effects on the productivity of the industry, are less subject to price fluctuations in the international markets and have greater income elasticity of demand.