Brazil and Russia – two big economies with lots of potential, both hoping to pull in plenty of foreign investment to help realize that potential. And now one big difference: Russia has been granted investment grade status by Moody’s, while Brazil is still waiting.
Brazilians are understandably perplexed, given that they have just staged one of the greatest economic and financial turnarounds in history. But it is worth restating that Brazil’s trauma last year was mostly hype, not substance. Brazil’s economic fundamentals were just about as good one year ago as they are today – and just about as bad. Brazil may have weathered the perfect storm, but the country remains vulnerable to ill winds, and hurricane season comes every year.
The fallout from last year’s collapse in investor confidence continues to play out in Brazil. The economy will show zero growth in 2003, after only 1.5 per cent in 2002. But inflation is falling, bond yield spreads have come in from 24 percentage points to about six percentage points and the currency has recovered. The central bank is gradually taking advantage of this improved climate to cut interest rates, and prospects for 2004 are for around 3.5-per-cent growth.
Meanwhile, Russia’s economic growth was more than four per cent in 2002, will exceed six per cent this year and is likely to be around five per cent in 2004. Inflation is declining in Russia, too, and international investors have driven its bond yield spreads down to just over two percentage points, much lower than Brazil.
The real financial difference between the two countries is the stock of foreign debt. For Brazil, external debt stands at well over 50 per cent of GDP, and annual debt service is approaching 70 per cent of export earnings, which is among the highest in the world. In contrast, Russia’s debt stock is 40 per cent of GDP, and that figure is falling fast. Debt service is running at less than 20 per cent of export earnings.
Economically, though, Russia is still a one-horse town highly dependent on the health of global energy markets. Oil and gas represent 20 per cent of Russia’s GDP and 50 per cent of exports. With oil prices riding high and expected to remain north of $20 US for the foreseeable future, Russia is riding a wave of prosperity. But continued failure to develop the rest of the economy will leave Russia prone to the same sort of volatility that has plagued many other oil-producing nations in the past.
Bond investors clearly agree that Russia deserves its investment grade rating, while Brazil does not. Foreign direct investors have a different perspective. They are reluctant to go to Russia until they see more evidence of a reliable legal infrastructure and more political stability in the Kremlin. In contrast, Brazil is seen as a friendly and professional place to invest. The economy is very diversified and its political uncertainties are believed to be relatively short-term in nature.
The bottom line? Brazil has good long-term fundamentals and worrisome financial ratios, while Russia has good financial ratios and worrisome fundamentals. Time is on Brazil’s side – continued progress along the lines of the past few months will produce an upgrade in due course.
(Stephen Poloz is vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)
