Brazil's Rising Rates Threatens Economic Growth

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Brazil's Rising Rates Lead Companies to Buy Bonds 


May 19 (Bloomberg) -- Rising Brazilian interest rates are encouraging companies to buy higher-yielding bonds rather than new equipment, threatening to slow economic growth more than central bank policy makers want.

The bank yesterday lifted the benchmark lending rate for a ninth straight month, to 19.75 percent from 19.5 percent, in a bid to curb inflation. Real interest rates in Brazil are now at about 11 percent, the highest since 2002.

``Any businessman that faces this level of interest rates thinks not twice but a thousand times before buying a machine,'' said Josue Gomes da Silva, chief executive of Cia de Tecidos Norte de Minas, Brazil's No. 2 textile company based in Montes Claros, Minas Gerais. ``There is no productive activity that offers a higher return than the benchmark interest rate.''

The shift in investment by Brazilian manufacturers may deepen a slowdown in South America's largest economy, said Ilan Goldfajn, former chief economist at Brazil's central bank and a partner at Rio de Janeiro-based hedge fund Gavea Investimentos Ltda.

Investment in machines, construction or other projects aimed at increasing factory production fell 2.2 percent in the first quarter from the fourth quarter, according to the government's Institute of Applied Economics. So-called fixed capital investment rose 3.8 percent in the first quarter compared with the same period a year earlier, below the institute's 7.3 percent estimate.



`Bad Result'

``This was a bad result, below our expectations,'' said Merida Herasme Medina, an economist at the institute in Rio de Janeiro. ``From an industrialist's point of view, maybe it made more sense to invest funds in the market than in production until the picture becomes clearer.''

The government's five-month Treasury bills yielded 19.9 percent at last week's auction, compared with a 3.16 percent yield on six-month U.S. Treasury bills.

Brazil's benchmark rate is now more than 11 percentage points above the 8.1 percent inflation rate in April, putting real interest rates at their highest level since December 2002, a month before President Luiz Inacio Lula da Silva, 59, took office.

Only Turkey has higher real interest rates, according to an April survey of 40 countries by Curitiba, Brazil-based research company GRC Visao. Brazilian inflation is about 3 percentage points above the central bank's target for 2005.



`No Risk, No Effort'

``Where else in the world can you get a return of 20 percent for almost no risk and no effort?'' said Christiano Freire, president of Frefer SA, a Sao Paulo-based steel distributor that is selling inventories to raise cash to invest in floating-rate bonds.

Brazil's economic growth rate will slow to 3.5 percent this year from 5.2 percent in 2004, according to the median forecast from a weekly central bank survey of about 100 economists. The economy has started to show signs of weakening under the strain of rising borrowing costs: Industrial output rose at its slowest pace since November 2003 in March at 1.7 percent.

Sao Paulo-based steel distributor Ferro e Aco Nossa Senhora da Fatima has put off plans to purchase a plant to house two steel-cutting machines in order to collect interest on fixed-income assets, said Rogerio Ribeiro Vieira, the company's quality control director. Fatima has been buying certificates of deposit, said Vieira.

The average 60-day certificate of deposit rate offered by Brazilian banks yesterday was 20.53 percent, according to Bloomberg data.



`Best to Wait'

Rather than invest to expand now, ``it's best to wait for interest rates to come down and take the financial gain,'' Vieira said in an interview in Sao Paulo. ``It's not what anyone would call a bad return.''

Frefer, which had revenue last year of 200 million reais ($81 million), sold 5,000 tons of steel stocks since February to generate cash to invest in floating-rate government debt, Freire said. The company has been buying government bonds that offer interest rates that fluctuate with the central bank's target overnight rate, Freire said.

Companies that are sinking cash into fixed-income assets risk losing market share to competitors that keep investing in expanding their business, said executives such as Francisco Gros, chief executive of fertilizer manufacturer Fertilizantes Fosfatados SA.



20-Year Horizon

``You take decisions on investment looking to a horizon of 20 years and not because you see a short-term opportunity,'' said Gros, a former president of the central bank and the state- owned development bank, in an interview. Fosfertil, as the company based in Minas Gerais state is known, has 125 million reais in cash but has no plans to scale back a 230 million reais expansion plan to boost output of products such as phosphates, Gros said.

Antonio Palocci, Brazil's finance minister, said at a news conference this week in Sao Paulo he doubts the higher interest rates will cause companies to ``desist from investing'' over the long term.

Companies representing about 52 percent of the Brazilian economy plan to increase purchases of machines and equipment, according to a December survey by the Fundacao Getulio Vargas, a business school in Rio de Janeiro.

``The animal instinct of the industrialist is to produce,'' said Paulo Francini, head of research and economic studies at the Sao Paulo State Industrial Federation. ``I don't believe he would swap the opportunity to supply market demand because he reached the conclusion there'd be a greater return from the financial markets. This goes against the instinct of industry.''



Last Updated: May 19, 2005 11:51 EDT