Brazil to reach “full investment grade” status by end 2008

Brazil is on track to achieve “full investment grade” status within 18 months following recent upgrades by ratings agencies Standard & Poor’s and Fitch, according to Luiz Ribeiro, manager of the US$1.2bn HSBC GIF Brazil Equity fund, the world’s largest actively-managed Brazilian equity mutual fund.

Ribeiro works for Halbis, the fundamental active asset management specialist of the HSBC Group.

Standard & Poor’s (S&P) put Brazil on the brink of “full investment grade” status on 16 May 2007 when it raised its long-term foreign sovereign credit rating by one notch to BB+. At the same time, S&P also raised its less closely followed long-term local currency sovereign credit rating by two notches to BBB, meaning that Brazil has, in part, attained investment grade status. The S&P upgrades follow similar upgrades from Fitch, which raised Brazil’s foreign and local currency credit ratings to BB+ on 10 May 2007.

The highly coveted “full investment grade” status is important for Brazil since it potentially opens up a large number of fixed interest instruments to a wide range of large institutional investors, reducing the cost of credit, which in turn should stimulate faster growth within Brazil.

Ribeiro said: “The ratings upgrades were driven by a steady improvement in Brazil’s macro economic fundamentals that had led to the continued decline in Brazil’s fiscal and external vulnerabilities.

“Buoyed by record commodity exports and foreign investment in Brazil’s bond and equity markets, foreign reserves have reached a record high of US$122 billion. Meanwhile, President Luiz Inacio Lula da Silva remains committed to further reducing these vulnerabilities during his second term in office.”

Ribeiro believes economic fundamentals should also continue to improve. “Inflation is now under control with 2006 year end inflation of 3.1% being at the lower end of the inflation-targeting band. Interest rates continue to fall and are expected to decline further while credit availability has improved and real salaries have increased.”

He adds: “Provided that there is no major slowdown in the global economy and that the improvements we have seen to date continue, Brazil should gain its “full investment grade” status by the end of 2008.”

A further upgrade to the rating would place Brazil alongside other BRIC countries of India, Russia and China which have all recently achieved “full investment grade” status. India currently enjoys a BBB- rating, while Russia is rated BBB+ and China is rated A grade.

Ribeiro views Brazil’s move to the cusp of full investment grade status as having instilled further confidence in the equity market, which has performed exceptionally well over the past three years. The Brazilian Bovespa Index has gained 262% in US dollar terms, over the past three years to 30 April 2007 (bid to bid, income reinvested), according to Morningstar.

Despite this strong performance, Halbis believes that Brazilian equities continue to remain attractively valued compared to other emerging markets. As of 30 April 2007, the MSCI Brazil Index was trading at 9.1 times forward 2007 earnings (according to IBES), a significant discount to both MSCI Emerging Markets and MSCI World indices, which were trading at 12.6 and 15.0 respectively.