BRIC Begins With Brazil

| About: iShares MSCI (EWZ)

In 2006, while investing in BRIC countries was the rage, China and India received most of the attention. The China ETF (NYSEARCA:FXI) was up 84% and India’s SENSEX index was up over 50%. Meanwhile almost lost in the shuffle, the Brazil ETF (NYSEARCA:EWZ) was up 45.4% - not bad, not bad at all.

With 187 million people and an area only slightly smaller than the United States, this leading South American economic power together with Chile and Colombia are changing attitudes toward the region as a whole. But the lingering question is whether Brazil’s economic recovery is sustainable or just another stage in the economic cycle.

What is most interesting to me is that Brazil’s stock market’s performance during the past four years is not due to superior economic growth. It has had an annual average growth rate of only 2.6%, about half of world economic growth during the same period. My view is that Brazil has been primarily a balance sheet story supported somewhat by the commodity boom.

With Brazil’s President Luiz Inacio Lula de Silva being sworn in for a second term today, let’s review Brazil’s accomplishments and challenges.

Inflation is muted and was only 3% during 2006. Brazil is almost energy independent and foreign exchange reserves are now almost $100 billion after paying off its nettlesome IMF debt. In 2006, it recorded a trade surplus of $46 billion and while i!nterest rates are high, they are beginning to fall.

As a global investor, what I now want to see is Brazil turn into more of a growth story. This will depend on the second term reform agenda of President Lula. He is in a strong position with a 70% plus popularity rating and a solid governing coalition.

Here are some of the issues Brazil needs to tackle to build a sustainable platform for economic growth and a continuing bull market. The tax burden needs to come down from current 50% levels. Public spending needs to be cut but also re-directed to infrastructure projects. Corruption needs to be sharply curtailed and overregulation slashed, especially in labor markets. Finally, Brazil needs to substantially improve its education standards if it hopes to compete head on with India and China.

If Brazil even takes small incremental actions to address these issues, global investors will take note and the Brazil ETF (EWZ) will continue its upward trend. If interest rates decline as well - it could be another impressive year for investors who don’t forget that BRIC begins with Brazil.

EWZ 1-yr chart

Disclosure: Author has no position in EWZ.

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