Published by Minyanville

Standard & Poor’s downgrading of the United States’ triple-A credit rating just before the weekend has left many of the world’s emerging markets wondering whether knock-on effects will hit their own economies.

Brazil is one of the world’s largest emerging markets, with growth last year of 7.5%. However, its economy is showing signs of overheating, with five interest rate rises already deemed necessary by the country’s central bank this year in order to curb inflation.

US President Barack Obama’s trip to Brazil in March failed to impress, leaving the Latin American giant looking toward China. While Brazil may not suffer directly from the US crisis, its close links to the Chinese economy will keep it on its toes, as China is the largest creditor of the world’s sole superpower.

A knock-on downturn in China will have an impact on its purchase of Brazilian goods. While it is currently soy, iron ore and ethanol that make up 80% of Brazil’s exports to China, President Dilma Rousseff is keen to push manufactured products there. Some success has been had in the aviation industry with Embraer (ERJ), however, others have been left out in the cold. Recent events in the US could keep them there.

Eduardo Borensztein, a South America economist analyst with the Inter-American Development Bank, told the Miami Herald that he believes Latin America will suffer from the US news, however, shouldn’t be too alarmed. “Latin American economies will grow at a slower rate, but it won’t be catastrophic,” he said. “It will be uneven impact: It will affect Mexico and Central America more than South America.”

Brazil, however, is the fourth-largest holder of US Treasuries. An official told Bloomberg on Sunday that Brazil has no plans to sell the Treasuries or change its foreign currency reserves holdings following the downgrading.

The country has had a policy in place for a few years whereby foreign reserves are being shifted from US dollar-based assets. Around $211 billion is held in US Treasuries. Foreign currency reserves have jumped 35% in the past year to $384 billion.

Luciana Lopez of Reuters also points out that Brazil is unlikely to fall into the debt crises that many countries are currently suffering thanks to its links with China. “The most vulnerable front for Brazil could be its currency,” says Lopez, “if US interest rates stay ultra low.” This would cause problems for exporters, struggling to compete with cheaper markets.

“On a microeconomic level, Brazilian companies are less vulnerable to a downturn among their US counterparts,” Lopez adds. “On the macro-economic side, it means Brazil has another source of investment and trade flows.”

Political Woes

Rousseff has her own problems at home to deal with, as her government suffered multiples blows this week as yet more high-ranking officials were forced to resign.

Nelson Jobim, the civilian head of the country’s military, quit after disparaging remarks about top government officials. In recent weeks, Jobim said that he is surrounded by “idiots” in the government and went as far as to admit that he voted for the president’s rival, José Serra, in last year’s elections. His problems were compounded this week as newspapers reported his criticism of Rousseff’s closest aides.

Jobim will be replaced my Celso Amorim, foreign minister under popular former president Luiz Inácio Lula da Silva. He is thought to be disgruntled as Rousseff overruled him in a multi-billion dollar fighter jet contract.

Both transport minister Alfredo Nascimento and Chief of Staff Antonio Palocci were forced to leave the government on corruption allegations in the last three months.

To top things off, Saturday saw the resignation of a top official at the country’s Agriculture Ministry, again on allegations of corruption. Milton Ortolan allegedly allowed a lobbyist to set up an office within the department to help businesses obtain contracts in exchange for payment.

The problems within Rousseff’s inner circle have fueled allegations that she is a “political novice.” Her work is seen in the shadow of Lula da Silva, one of Brazil’s most popular presidents and the man seen as the leader of Latin America’s new left, opposed to that of Hugo Chávez in Venezuela and the Castro in Cuba.

The major headache for Rousseff, though, is the country’s apparently out-of-control economy. Five interest rate rises this year alone are designed to curb inflation though are also likely to increase foreign interest and pump up the already inflated real.

Despite giving Brazil a reasonably favorable outlook, the board of the International Monetary Fund (IMF) has warned that the country’s economy is showing signs of overheating. The organization suggested that the government cut spending, further than announced in existing plans.