Brazil has received some lavish praise in recent months. The November 12 edition of the Economist is typical of the press attention it is garnering. However, the country’s late October decision to tax foreign equity and bond inflows makes the loudest statement about the country’s potent offshore appeal.
|To see the charts and tables accompanying this article, please click here.|
Back in 2003 Goldman Sachs coined the BRIC acronym to cover the countries it bet were growing to major power status. Brazil, Russia, India, and China have certainly lived up to that billing, but it should not be underestimated how risky the call was back then.
Russia and Brazil had both recently offered investors a sovereign default beating. Brazil was a prototypical Latin basket case with a succession of clownish leaders, crippling inflation, and any number of wealth destroying policies. Indeed, it was locked into stagnant relationships focused on the region, including what might be characterized as a virtual agreement with Argentina not to outperform each other.
The Economist mistakenly ignored the international context for Brazil’s recovery in the 1990s. Brazil was forced, like many other emerging markets, to adjust to the reality of globalization, driven by free market ideals under the Washington Consensus, unleashed in the wake of the termination of the Cold War.
It was no longer convenient to cultivate victim status because one superpower stopped being a sugar-daddy, and the other stopped being much of anything. This was especially true for India and Brazil who had played off the Cold War rivalry, and whose intellectuals thrived on the rubbish of core-periphery exploitation as an excuse to engineer mass poverty.
And so Brazil grew up and invented a new currency to match its maturity.
Add an ‘S’
One additional country was similarly thrust onto the global stage before it was necessarily ready for it – South Africa.
Indeed, some have added South African to BRIC to make BRICS. However, the relatively small size of the population and economy has made it less and less common. There are additional reasons related to general pessimism about South Africa because of several political dramas.
That aside, South Africa and Brazil share many similarities.
Negatively, both are highly stratified along race and class lines. They share high unemployment rates, staggering poverty, world leading levels of violent crime, and extensive petty crime. Their governments are reluctant free marketeers; there is a strong affection for Marxist interpretations of mostly everything because of their colonial histories.
Positively, they enjoy relatively stable climates and geologies that contribute to low cost bases. Both have vibrant and productive middle classes that punch above their weight globally given the constraints they chafe against. Their middle classes consume luxury goods in greater proportion to richer countries. That’s because savings are disincentivized through taxation and inflation, and also because of capital controls on citizens and business.
Both countries have won the right to host Soccer World Cups (SA in 2010, Brazil in 2014), both have pitched for the Olympics though only Brazil won its bid.
Both countries are richly endowed with a variety of minerals which have provided a base for industrial diversification and global integration. They also share many national security concerns and are nuclear powers, though Brazil is advancing to weaponization whilst South Africa is retreating from it. The countries are gravitating toward each other in a South Atlantic axis, especially as Brazil seeks to penetrate Africa’s former Portuguese colonies but still requires South Africa’s regional influence for leverage.
Similar but different
South Africa does not have oil and gas to speak of, but Brazil does not have much in the way of precious metals. South Africa does not have abundant water, but Brazil does not have abundant coal supplies. Each has complementary agricultural assets, though Brazil clearly has more ag potential.
And so we could go on. The point is that the countries and societies are surprisingly similar despite their very different cultures and histories. What’s more, the economies have been marching in some degree of economic lockstep.
We chose 1990 as a convenient marker for the new era of globalization. As the charts (see charts at end of article) make clear, both countries have followed a surprisingly similar track. Surprising because Brazil has benefits of scale and location that outweigh South Africa’s advantages. Indeed, were it not for South Africa’s higher birth rate, or rather immigration rate, gross national income per capita would have grown faster.
Also intriguing is the quite close tracking of the currencies – they share very similar trend lines. Whilst both countries are dominated by commodity exports, Brazil has many more manufactured exports than South Africa. It is also notable that both countries managed impressive GDP gains despite their currencies appreciating. The rand does seem to be a leading indicator for the real.
Their stock markets also share several similarities (see tables at end of article).
Unfortunately, South Africa’s more oppressive capital controls have reduced opportunities for local investment through Depository Certificates. It has also chased off a number of companies that have moved their headquarters abroad. That has deflated the value of the Johannesburg Stock Exchange relative to the Bovespa, but there is some parity when the emigrants are added to the fold.
There is a good case to be made for treating South Africa and Brazil as a single investing entity. The similarities suggest that a portfolio built on the combination thesis would provide additional diversification and exposure to a greater range of emerging market high yield stories in several industries. As a combination, South Africa and Brazil could mimic a larger and more diversified market.
That is all good and well, but how will the next two decades shake out for each country?
There is a strong case to be made that Brazil is about to step into a new era of sustained high growth rates that could eclipse South Africa. The primary concern for South Africa is the risk of a Chavez like lurch to the left should its populist factions gain sway. Brazil seems to have settled into the role of a more disciplined democracy that has dispensed with the economic claptrap of prior decades.
Another concern is the steady decline in South African gold production. There is little to substitute for the gold, especially whilst platinum group metal prices remain depressed. Compare that with Brazil’s massive oil and gas discoveries that will come on stream in the next decade, along with substantial new or expanded ag projects.
Brazil will also be building into the World Cup and Olympics whereas South Africa is coming off its infrastructure surge that spurred recent growth.
Brazil’s fiscal condition has been substantially repaired, with debt much reduced. South Africa is hinting about going the opposite way as the ruling party seeks to buy favor and pay for patronage.
Finally, Brazil is in a mutual courtship with China. Brazil has the resources and scale to meet a good portion of China’s demand. South Africa is interesting to China, but Beijing’s investment flows to Africa confirm that it is not critical; mostly useful as a trade partner.
Both countries may realize and accept that a formal alliance would be mutually beneficial, but we doubt it. So take care if you are convinced that this is a good combination trade – timing will be everything.
Disclosure: No positions