2004 Spring Forum

Brazilian Analyst Murillo de Aragao Addresses EMTA Spring Forum
A standing room only crowd of 150 EM professionals attended EMTA's Spring Forum in New York on Thursday, April 15, 2004.  Bear Stearns hosted the event, which included a panel discussion on prospects for emerging countries, as well as a presentation by noted Brazilian economic and political advisor Murillo de Aragao.

De Aragao began his talk by noting that, “clearly after a great year in 2003, the Brazilian administration lost its pace, especially after last October when we saw a succession of mistakes that impaired the ability of the government to promote reforms and to produce good news.”  He subsequently addressed what he termed five important “vectors of influence” which would confront the administration of President Lula: economic factors, social pressure, management capacity, political factors and the reform agenda. 

On the economic front, Lula seems to have given his full support for Finance Minister Palocci, “and this means the major fundamentals of economic policy – fiscal pragmatism, realistic exchange policy and high tax collection — will be protected,” de Aragao opined.  He asserted that the financial markets can be confident that Lula will continue to stick to the current economic plan in the short term.

As for social pressure, Lula is “trapped by his past in some manner – the speeches he gave and the huge expectations he created,” declared de Aragao.  Without spectacular performance with the economy and with poverty alleviation programs, social pressure on Lula will mount.  However, de Aragao pointed out that currently Lula has no obvious rival for the leadership of Brazil, as former President Cardoso is not seriously interested in challenging Lula in the next presidential election.

Briefly addressing recent investor “preoccupation” with the MST, the landless movement, and its campaign to accelerate the agrarian reform program, de Aragao speculated that the MST “will remain a problem for many years because the government doesn’t have the funds to implement the reform program MST is fighting for.”  He quickly added, however, “The good news is that Lula can control the MST, and he is the best person in Brazil to have a dialogue with them, and to contain them.”  De Aragao also analyzed the “management capacity” of the administration.  He commented the level of government efficiency is “to be elegant, uneven” because of the division of the left into so many factions.

As for politics, de Aragao stressed that important reforms last year were passed because of the cooperation of opposition parties.  He reasoned that, in the future, opposition parties might not cooperate as they seek to distinguish themselves prior to the next election.  In addition, he advised the audience, municipal elections will lead to confrontations between allies contesting local votes and will have spillover effects on the federal level.

The upcoming elections will no doubt impede reforms, warned de Aragao, while he also expressed cautious optimism that if the administration pushes Congress, at least debate on some important reforms could go forward.  He argued that it was not impossible that reforms such as the regulatory agency bill, the new bankruptcy bill, judiciary reform and union reform legislation could be passed.  De Aragao acknowledged that such reforms were not as important as the social security and tax reforms, but their passage would “nonetheless improve the conditions in Brazil.”

De Aragao concluded his prepared remarks by stating that, while the current picture “is not a rosy scenario, there is a sort of window of opportunity for Brazil to progress and continue to implement reforms.”  He underscored the importance of the apparent “decision or intention of the government to protect current economic policy to create and restore economic credibility in Brazil.” 

De Aragao fielded a wide variety of audience questions after his formal presentation.  Among his responses was a prediction that Brazilian GDP growth could approach 3% (“a good result, not a great result”) and a discussion of Central Bank autonomy.

Panel Discusses Brazilian Sell-Off, Argentine Deal Prospects
A panel discussion of EM industry sages followed De Aragao’s presentation.  Moderator Carl Ross of Bear Stearns reviewed his notes from the 2003 Spring Forum panel as a prelude to this year’s debate.  Last year, he reminded the audience, the mood was one of cautious optimism, but speakers were hard-pressed to offer any “compelling ideas” because of the high valuations in the market.  Comparing the strong returns on EM debt last year and the lackluster returns to date in 2004, Ross commented, “It feels as if we borrowed last year from this year’s performance.”

Prompted to offer his assessment on Brazil, Citigroup’s Tom Trebat argued that Brazil’s importance in the EM marketplace had been somewhat inflated even beyond its justifiably heavy influence due to the awarding of investment grade ratings to EM countries such as Mexico and Russia, and the disappearance of Argentine debt from benchmark indices following the country’s default.  “To have a view on Emerging Markets debt today, as I think my colleagues on the panel will agree, is to have a view on Brazil,” declared Trebat.

Trebat observed that the most important question for the marketplace was whether the sell-off in Brazilian assets debt in the weeks preceding the Forum should be attributed to fundamentals or “market hysteria.”  Trebat discussed Brazilian economic statistics and concluded “the fundamentals look all right to me but Brazil is in the way of an emotional freight train that seems to be gathering steam,” a reference to industry concern over US rate hikes.  Trebat voiced his positive impression of the dedication of Lula administration officials, including lower level staff members, “and how much they stick to the game plan.”  Even some of the major opposition parties, while delighting in “making Lula’s life as miserable as possible,” agree with the Lula administration’s economic plan, according to Trebat.  “Politics in Brazil continues to be noisy and messy, but fundamentally governability is not an issue today,” Trebat asserted.  Despite his analysis that Brazilian fundamentals remained relatively good, Trebat concluded he was not “favorably disposed” about the outlook for Brazilian external debt in the context of interest rate uncertainty, but remained more positive on local currency opportunities.

Evaluating the prospects for Brazil’s neighbor, Trebat predicted an Argentine debt deal could be accomplished over the next couple of months, “maybe somewhere between a strict interpretation of Dubai terms and current market prices of about 30…but there are huge risks of miscalculation on both sides,” he warned.  Trebat conceded his optimism on a deal was greater that current market consensus. 

In response, Mike Gagliardi (TC) acknowledged he had a gut feeling that Argentina was a buy at current levels, while conceding he had “no intelligent reason” to justify his instinct.  He concurred with Trebat’s assessment that a deal, or at least “some solid progress,” could be achieved within three months. 

Asked for his thoughts on the large amount of new issues in recent months, Gagliardi declared that, while a lot of the new issuance is in investment-grade paper, in line with new money entering the market, he is concerned that  “every Tom, Dick and Harry is out borrowing money.”  Gagliardi encouraged investors to remain diligent in their purchases of new bonds.  “Most of us in the market don’t know second tier banks in Kazakhstan or third tier banks in Russia,” and we are going to have to do a lot more credit work, he advised.

Karim Abdel-Motaal (Morgan Stanley) spoke enthusiastically of the potential for credit derivatives.  “The credit derivative market is the most exciting development in the emerging financial markets in a decade,” he declared.  These instruments offer investors the ability to take positions that might not be available on a country’s bond curve, to short a credit for any length of time and to avoid the “idiosyncrasies of bonds that are collateralized, puttable or callable.”

Tom Cooper (GMO) noted he was also a fan of credit derivatives, opining that it was easier to buy credit derivatives with some new accounts than to buy bonds.  Cooper confirmed that money continues to enter the asset class, “maybe a couple of hundred million here and there, but nothing in the billion dollar range.”  Cooper attributed recent inflows to European or Japanese accounts, rather than US investors.

Ross polled the panelists for their assessments of risks in the market in addition to US interest rate concerns.  Cooper voiced concern that a major reversal of course in Brazil would lead to a collapse in Latin America generally.  Abdel-Motaal reasoned that the strongest components of the asset class were also its most vulnerable – an accident in the “consensus bullish trades” of Brazil, Russia (oil prices) and Turkey (EU accession) were potentially more dangerous than a rise in US rates, he warned.  Gagliardi replied that he did not foresee a major country “blowing up,” and affirmed, “everyone in the sandbox is trying to play by the rules.” 

At the conclusion of the discussion, Ross requested panelist investment recommendations.  Trebat conceded that, while he maintained a “guarded outlook” on EM debt, he found it hard to argue with owning Russian debt, and Mexican debt “makes sense for some investors.”  Trebat also spoke positively on Uruguay, and urged investors to continue to watch Venezuela with the “possibility” of a favorable political outcome.  Abdel-Motaal recommended long positions in the Brazilian real and Polish zloty, while shorting the South African rand.