Brazil’s comeback is all about China
The Olympics are over and judging from the Brazilian stock markets, there is good reason to celebrate. Sao Paulo’s Bovespa Index is up by 35 percent this year, making it one of the absolute best-performing stock markets in the world.
This comes after some rather dismal years both for Brazil’s economy and financial markets. In recent years the country’s economy has completely stalled and the currency has weakened significantly, which in turn has pushed up inflation.
To add to these woes, the political situation has become increasingly chaotic. This week, President Dilma Rousseff was impeached by the Senate and permanently removed from office, after essentially being sacked by the lower house of parliament back in May.
Given that background, this year’s market recovery in Brazil might seem a bit of a mystery. But what happens in local politics is much less important to Brazilian markets than what happens in global monetary policy – especially in Beijing.
A look at local stock prices over the past couple of years shows a very close link with policy changes at the People’s Bank of China (PBOC). A way of illustrating this correlation is to chart the exchange rate of the renminbi and the Bovespa index.
Starting in 2009, the PBoC eased monetary policy dramatically in response to the onset of the global crisis. In consequence, the renminbi weakened. That coincided with an upturn in the Brazilian stock market. The gain was short-lived because in early 2010, the PBOC started to tighten monetary conditions, causing the Chinese currency to strengthen. This coincided with another turnaround – this time for the worse – in Brazilian equities. The Bovespa index’s decline accelerated in 2011 as the renminbi kept appreciating, and this trend continued until the end of 2015.
Since January, however, we have witnessed a major rally in Brazilian stocks. Once again, the driver seems to be Chinese monetary policy, as the PBOC moved to devalue the renminbi to spur economic growth.
This is a striking illustration of how China’s central bank has become a global monetary superpower that in many ways determines whether there are headwinds or tailwinds for the Brazilian economy.
The PBOC’s influence works through three channels.
The first and most direct channel is through foreign trade. China is Brazil’s biggest export market, and any relaxation of Chinese monetary policy boosts the appetite for Brazilian exports. Secondly, easier Chinese monetary policy increases demand for commodities, and since Brazil is a commodity exporter, that boosts the price of Brazilian exports to other countries.
Thirdly, the combined effect of stronger exports and higher export prices is to strengthen Brazil’s own currency, the real. That pushes down Brazilian imports and inflation, which in turn allows the Banco Central do Brasil to ease monetary policy, boosting growth.
Conclusion: if you are interested in the outlook for Brazil’s economy, watch the actions of the Chinese central bank, not domestic politics.