The sucking sound of Brazilian interest rates

Brazil’s economy leads the world in high interest rates. It is a blessing for banks but a burden on the economy – draining resources away from both new investment and consumption. Will new credit platforms finally jolt the established banks into a competitive response where previous strategies have failed?

Brazil’s sky-high interest rates have long been a source of amusement and bafflement for visitors who learn that credit cards charge (on average, in September, according to central bank figures) 475.2% a year, overdrafts 321.1% and unsecured personal loans 132.3%.

These exorbitant interest rates have also been a source of academic study, with many economists trying to break down the multiple, deep-rooted causes of the high-interest economy into their constituent parts. This is because Brazil’s interest rates are also a cause of economic harm, with the heavy debt-servicing burden on individuals sucking money out of an economy that would otherwise consume more goods and services.

And investment? Imagine the rate of return required on a business project that is based upon the average non-earmarked corporate lending rate of 30%. However, Brazilian rates may have become an opportunity: fintechs are looking at the staggering annual interest rates and concluding that there are margins to be made by offering lower rates on credit. Brazil’s banks – long blessed with an environment of super-high net interest margins (NIMs) – have noted the beginning of the advance and are reacting. Slowly.

Why is Brazil’s economy choked by usury rates? There are many causes but perhaps the most pertinent are the country’s historical high inflation environment and its related history of high default rates. Throw in long-standing low savings rates (the average is 14% in Brazil, compared with 40% in China) and, in simple terms, the cost of capital is structurally higher because of the scarcity of those savings.

There is also a fiscal issue facing Brazil, which is both a stock and flow problem. The fiscal deficit (flow) remains very high at around 10% of GDP a year, and is being added to a very large stock of around 70% of GDP, which is high for an emerging market.

Many of these problems compound each other. The large debt burden becomes larger because of the cost of servicing it – the country’s Selic rate is currently 14%, having been cut from 14.25% in October. That speeds up the debt build-up. All these fiscal imbalances drag down potential GDP rates and that prevents the country growing the debt away.

Then there are other structural issues. The banking system is extremely segmented, which prevents competition in all but a few credit products. It has also consolidated in Brazil to a dizzying extent – and that clearly does not help competition. The financial system is also quite heavily taxed, which again lifts the overall cost of credit.

“It’s a little bit of everything,” says Alberto Ramos, economist for Brazil at Goldman Sachs in New York. “Brazil needs to save more, and the entity that should be saving more – the one that has capacity – is the public sector. If they achieve a fiscal adjustment, and if they increased competition, and if they had liquidity requirements that aren’t so high, and if they didn’t tax financial transactions so much, and if they closed the budget deficit and reduced the crowding-out effect (of the public sector in investment in the economy) then, over time, Brazil could be operating under more normal conditions.”

Part of the segmentation of the credit market has been created by subsidized rates. The interest rates cited earlier were for free-market rates. But that is really only half the story. Earmarked credit is used for lending to specific sectors. The best-known example is the TLJP rate used by the Brazilian state development bank BNDES, which is currently 7.5%. Companies (many of the recipients are very large corporations that have access to the international financial markets) are in effect subsidized by this below-market rate. Despite the widely heralded restraint in new president Michel Temer’s federal budget, the Bolso Empresario will still provide Brazilian companies with a subsidy of R$224 billion ($70 billion) in 2017, according to research by Brazilian newspaper Folha de São Paulo – equivalent to 3.4% of GDP.

“It’s a chicken-and-egg situation,” says Antonio Nucifora, lead country economist for Brazil at the World Bank. “The government used to say it needed to intervene and give subsidized interest rates because the market-based interest rates were too high. But some of the analysis suggests the segmentation of the credit market is one of the main causes.” At the end of 2015 earmarked credit was back to about 50% of the total, after declining to one-third of total credit in 2007. It is now back to the levels of the late 1990s.

For the full article see Euromoney’s November issue

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