Brazil offers attractive growth rates and access to a range of dynamic markets, which have been boosted since its debt was lifted to investment grade by Standard & Poor’s in early May, and then by Fitch just a few weeks later.

The Latin American nation’s natural resources, including oil and iron ore, have helped it develop and its large agricultural sector leaves it well placed to benefit from rising food prices.

As it continues to outperform, which sectors are likely to offer the best returns and what are the strongest indicators to provide clear insight into Brazil’s medium and long term prospects?

Marc Chandler, global head of currencies at Brown Brothers Harriman answers readers questions now.

---------------------------------------------------------------------------------------------------------------------

If it’s time to get into Brazil, what are the best current ways for US-taxed retail investors to play?
SJ, New York

Marc Chandler: There are several ways for US retail investors to invest in Brazilian equities. There are of course various mutual funds, where you defer to a mutual funds manager’s discretion.

Alternatively, there is the I-Share exchange traded fund for Brazil. The symbol is EWZ. Year to date it has returned about 23 per cent and over the past year is up nearly 70 per cent.

One could broaden out the strategy and invest in the Latin American I-Shares (ILF). Year to date it is up almost 21 per cent and over the past year up almost 45 per cent . Its holdings are heavily concentrated in Brazil’s oil company and largest iron ore producer.

One could just invest in individual Brazilian companies through American Depository Receipts. That is what my family has done. We own some Petrobras, the oil company, which is up about 22 per cent year-to-date and split early last month.

Valuation in the Brazilian stock market has become stretched as price/earnings ratios are near 4-year highs and some investment banks have expressed caution.

---------------------------------------------------------------------------------------------------------------------

How much stronger can the Brazilian real get before it begins to impact upon the country’s exports, particularly in manufacturing, and what long term effects is this trend likely to have on the economy?
Nick Rawdon-Jones, London

MC: Many Brazilian exporters are already feeling the bite from the currency’s appreciation. The Brazilian real is up about 9.5 per cent against the dollar thus far this year and has gained about 17 per cent over the past 12-months.

Brazil, though, is benefiting from a positive-terms-of-trade shock. It is the top exporter of soy, sugar, orange juice, coffee, beef, poultry and a growing producer of rice and corn.

Last year it exported $58bn of farm products (a little less than 20 per cent was soy). It is also an important iron ore exporter. At the same, time it is nearly self sufficient in meeting its own energy needs.

Its appreciating currency is allowing some Brazilian companies to invest abroad more cheaply and forces local manufacturers to boost competitiveness rather than rely on currency weakness to make their goods competitive.

--------------------------------------------------------------------------------------------------------------------

Will Brazil’s growth continue with the real as strong as it is against the dollar and with a possible fall in commodity prices?
Andrew Ireland, Campina Verde, Brazil

MC Brazil’s challenge, it seems to me, is to take advantage of this positive-terms-of- trade shock to finance investment and diversification. Brazil’s productivity is about a fifth of the US. For the last 20-years Brazil’s purchase of business equipment and machinery has grown on average by about 2 per cent to 3 per cent a year. Investment was growing around 10 per cent for the previous quarter of a century.

It seems as if the scars of the over investment and poor productivity has made Brazilian businesses more cautious. High real interest rates also deters investment. Why invest when one can garner double digit returns by lending to the government?

---------------------------------------------------------------------------------------------------------------------

Can Brazil stifle inflation given the rising price of energy and its increasing internal consumer demand?
Graham Smith

MC: Brazil’s central bank hiked rates earlier this year and most likely will do so again this week.

The overnight rate is currently set at 11.75 per cent and a 50 basis point rate hike is the most likely scenario, though a largest 75 basis point move cannot be entirely ruled out.

Inflation is running near 5 per cent, but inflation expectations are creeping up. The central banks’ weekly survey showed inflation is expected to rise 5.48 per cent this year up from 5.24 per cent last week.

By contrast, the other BRIC nations (Brazil, Russia, India and China) have higher inflation.

China is at 8.5 per cent. Russia is at a 5-year high of 14.3 per cent and India’s inflation is just below 8 per cent. It is not clear the extent to which higher energy is fuelling Brazilian inflation.

I would suggest another culprit is the subdued investment, which means that the economy runs into capacity constraints earlier on in the business cycle.

---------------------------------------------------------------------------------------------------------------------The Brazilian real looks good, and I noticed the Mexican peso is rising strongly in tandem. What is your long term outlook for the Mexican peso, is it as favourable as the real?
MW Illia

MC: The Brazilian real has been among the world’s strongest currencies for the last few years while Mexican peso has only recently been strengthening - It lost 1 per cent last year against the US and was one of the weakest currencies. In contrast, the real appreciated 20 per cent against the dollar.

With the Federal Reserve cutting US interest rates in the first four months of the year and Mexico’s central bank hiking rates in Oct 07 the peso has strengthened, with further upside from expectations of further Mexican rate rises.

You are right the peso is off to a good start this year, rising about 1.1 per cent a month on average this year. But I am concerned it has seen its better days for a while.

There has been a backing-up in US rates amid a greater conviction that the Fed is done cutting rates.

Oil prices, which did not seem to help the peso last year, also appear to be have begun a correction of unknown duration. I have more confidence in the real than I do the peso at current levels.

---------------------------------------------------------------------------------------------------------------------

Brazil’s government continues to be saddled with a costly pension system that remains in deficit despite reforms by Cardoso and Lula. Should investors, regardless of sector, worry about the size or the balance of the government’s social sector budget when making investment decisions in Brazil?
Sarah Brooks, Ohio, USA

MC: You are right Brazil’s pension programme is in desperate need to reform and Cardoso and Lula had limited if any real success here.

However, that assessment is likely to be true of many countries and it has not prevented Brazil from: 1) increasing its growth to 5.4 per cent last year and nearer 5 per cent this year; 2) from having one of the world’s strongest currencies and strongest bourses in recent years, including this one, and 3) enjoying investment grade status by Fitch, S&P and DBRS.

Brazil has a number of challenges pension reform being one and an important one.

One that may be even more important, and perhaps even related to the pension problem ,is the informal economy, according to recent estimates from McKinsey, may be as large as 40 per cent of economic activity.

The judicial system also needs reform as part of the deepening the rule of law and transparency.

---------------------------------------------------------------------------------------------------------------------

What is your forecast for the economy growth rate in the BRIC countries during the next decade?
Viktor O. Ledenyov, Ukraine

MC: Frankly, I don’t know what I am eating for dinner tonight let alone the growth rate of the BRICs a decade from now! I wouldn’t have much confidence in such forecasts in any event.

That said, the technology gap between the US and India and China seems to be larger than with Brazil. Therefore it seems to me that India and China can grow significantly faster than Brazil in the coming years.

Russia is a different story. It is riding the waves of rising energy prices. A more compelling argument; of the downfall of the Soviet Union, rather than the arms race with the US; was the precipitous decline in oil prices.

The opposite is true now, with rising oil energy prices (but also grain prices) helping give rise to Russian nationalism.

Brazil may grow slower, but the trade off also seems to be a more stable situation and one that generates lower inflation, which has been historically one of Brazils’ key challenges.

---------------------------------------------------------------------------------------------------------------------

Are any other Latin or South American countries with rich natural resources like Brazil going to enjoy upgrades and potential growth? What are the major risks Brazil faces in its economic growth and capital markets?
Will, Shenzhen, China

MC: Latin American equity markets are among the best performers globally this year. In addition to Brazil, Chile also has investment grade status by a majority of the major rating agencies.

Peru’s rating is split, with Fitch giving it credit rating status. Colombia also enjoys investment grade status by S&P.

Typically institutional fund managers do like split rating.

Brazil faces the usual set of risks to its economy, like a drop shift in the terms of trade and the threat that higher rates chokes off the growth momentum as it was just building.

The appreciation of Brazil’s equities in recent years leave the market stretched on valuation grounds.

The initial public offering market is slowing down. Roughly two-thirds of last year’s IPOs have down poorly (lost money as of May 21) according to Bloomberg data. Almost two dozen companies have postponed or withdrew IPOs this year. Three Brazilian companies have issued IPOs this year and raised about R$780 mln ($473 mln or GBP241 mln).

---------------------------------------------------------------------------------------------------------------------

What is your general opinion on the Brazil’s economic reform strategy, which led to the transition from the resource based economy to the hi-tech economy?
Viktor Ledenyov, Ukraine

MC: I am not convinced Brazil has truly transitioned to a high-tech economy.

While there has been some progress, I think the record shows that Brazil has remained a primary goods producer and has benefited from the high price of these commodities and as well as monetary policy and debt management policies that were aimed to putting the country on better footing that inherited from the former president Cardoso.

That said, Brazil’s commodity production appears highly capital intensive and technologically savvy. In the past century, if not longer, those countries that relied on primary goods exports, did not fare as well as those with a diversified economy or producers of manufactured goods.

How a country produces is arguably just as important as what it produces. The economy of scale achieved in agriculture for example, meant consolidation and concentration of land ownership, which helped create landless peasants who do not necessarily have the skills to get one of the limited manufacturing jobs.

Brazil may be doing a good job marshalling its physical resources, like land and energy, but it is doing a relatively poor job developing its human capital.

---------------------------------------------------------------------------------------------------------------------

Brazil has continued to outperform other emerging markets this year. Has this been because of speculative investing or are there strong fundamentals behind this?
Calum Austin, Madrid

MC: Speculators do not simply flip a coin to decide if they should buy Brazil or not.

Speculators and investors have been attracted to Brazil’s fundamentals.

High nominal interest rates attracts flows into its bond market. Strong and well positioned commodity companies attract foreign portfolio investment. Momentum traders have also benefited from and help fuel the equity market and currency gains.

---------------------------------------------------------------------------------------------------------------------

While Brazil is experiencing exceptional performance as a result of high global commodity prices and globalisation Is it correct to have concerns about company reporting and transparency by Brazilian companies ? There have been reports of a tendency for Brazilian based companies to adopt local practices which would not be acceptable in investment grade first world countries.
Andrew Brown, New York

MC: I am not fully aware of the different regulatory and reporting practices for Brazilian companies. I must admit to being shocked at times with corporate reporting that takes place in ostensibly open and transparent economies, like the US.

That said, investors who share your concerns may be best served by investing in Brazilian shares through American Depository Receipts that trade on the US exchanges. For example, Petroleo Brasileiro (Petrobras) trades as an ADR on the New York Stock Exchange.

---------------------------------------------------------------------------------------------------------------------I notice Argentina’s government next door seem to have snatched defeat from the jaws of victory by putting a high tax on agricultural exports and causing farmers to strike. Can the Brazilian’s be relied on not to do something similar?
Paul Howarth, Leeds

MC: The government in Argentina and the government in Brazil are two radically different animals.

President Lula of Brazil may head up the main left-of-center political party but he has been extremely good for Brazilian business and investors. He may be critical of the Washington consensus, but he has more or less adopted it in practice.

For all the clamor of the threat that Lula presented before getting elected--remember George Soros’ claim that a vote for Lula was a vote to bankrupt the country--Brazil has prospered under his administration, perhaps not as much as it could, but more than it did before.

Brazil was a country of the future before Lula and it will remain so after him. His legacy of adopting neo-liberal policies is to illustrate the general consensus in Brazilian politics. The political elite sees little alternative.

---------------------------------------------------------------------------------------------------------------------

Related reading:
Lift to Brazil credit rating boosts stock markets (May 1, 2008)
Lex: Brazil gets investment grade (May 1, 2008)
Leader: Re-rating Brazil (May 6, 2008)
Brazil pricing bond spreads lower than Buffett (May 14, 2008)