Back in February, in an earlier Insight column, we highlighted the major build up of consumer debt at extremely high rates of interest, putting a significant cash flow burden on the repayment capacity of borrowers.
Since then, the situation has deteriorated further. Pressures are building in the Brazilian credit cycle.
The average rate of interest on consumer lending has jumped from 41 per cent in 2010 to 47 per cent most recently in May 2011. This rise from an already elevated level reflects the cumulative effect of tightening by the Brazilian central bank in order to contain inflation.
The consumer debt service burden, which stood at 24 per cent of disposable income in 2010, is now slated to rise to 28 per cent in 2011.
This compares with 16 per cent for an “overburdened” US consumer and a mid-single digit reading for other emerging markets such as China and India.
In short, the cash flow burden is astronomical and rising.
We calculate that the debt service burden for the so-called “middle class”in Brazil has now breached 50 per cent of disposable income, as high income earners have little need to borrow at rates which are punitive and most of the consumer credit is therefore being directed to the “middle class” for consumption.
The strain is already evident among the smaller banks, which are finding it difficult to access funding. The central bank has now rescued or taken over three banks in distress over the past six months.
Meanwhile, delinquencies in Brazil (defaults in excess of 15 days) have begun to move up rapidly, from 7.8 per cent to 9.1 per cent of total loans between December 2010 and May 2011. Delinquencies are now rising at a very hectic rate. They have risen at 23 per cent in the first five months of this year in absolute terms or at an annualized rate of 55 per cent.
This is troubling as credit indicators have deteriorated even as the economy has stayed strong and the unemployment rates are at a record low.
Normally credit indicators cyclically follow (read lag) the economic cycle. When they begin to deteriorate before any economic weakness it usually represents a structural problem relating to underlying cash flow or underwriting weakness in the quality of credit – Brazil has both problems.
Over time as the economy weakens this is only likely to exacerbate weakness in the domestic credit cycle and could potentially create a fully fledged credit crisis.
Ultimately, Brazil needs to restructure the way it dispenses credit to consumers. More of the lending needs to be collateralized (ie housing related).
And the infrastructure to support credit expansion needs to be put in place, via a credit bureau which is able to share“positive” data (before a customer default) across the industry.
More strategically, we believe the country has to build a higher savings rate and reduce cross subsidies to bring down the cost of credit to levels which are less punitive than currently both in nominal and, more importantly, real (adjusted for inflation) terms.
Brazil has a national savings rate which was 17 per cent for 2010 (this includes savings by consumers, corporate and the government). This compares with a developed market average of 19 per cent and is significantly lower than an emerging market average of 32 per cent.
Hence, if Brazil is to grow to its “potential”, it has to build a reasonable stock of savings which allows it to invest as the economy grows without creating bottlenecks and inflationary pressures that exist as a growth constraint today.
Without these buildings blocks we are afraid that Brazil will be exposed to significant boom-bust cycles. Unfortunately, we are currently at risk of transitioning from a boom to bust.
The markets seem to be taking cognisance of these factors gradually with the Bovespa index now down 10 per cent since the start of 2011 in local currency terms, making it among the worst performing markets globally.
Despite this, most analysts and investors still seem to be sanguine about the prospects for Brazil. The disconnect will be answered one way or the other before the end of this year. (Wall Street Journal)