MENTION Brazil, and the first thing likely come to mind is commodities, or the acronym BRIC.
Brazil is indeed the first country represented in the BRIC asset grouping, which has gained much traction since 2003 when Goldman Sachs first proposed a BRIC investment case.
But Pedro Bastos, chief executive of HSBC Global Asset Management - Brazil, says the investment case for the country goes far beyond commodities.
He talks of 'economic karma' and a 'free lunch', thanks to fairly high real interest rates.
'We trade at 11 times price earnings today, but we have higher growth prospects and better potential in the future,' he says.
'The market has priced in what has happened in the past, but not any future gains. We see earnings growth of 17 to 27 per cent, but that's not reflected in investor perception - that story is not well known yet.
'People think of Brazil as commodities only, and think there is a bubble. They also fear the past. But ask (Brazil's) voters what they fear most, and number one is inflation. There is no room for populist incentives that will bring back high inflation.'
Between 1980 and the mid-1990s, Brazil struggled with frightening inflation of as much as 0.9 per cent a day, as the government resorted to printing money to finance projects.
But reforms put in place since in mid-1990s, including an ambitious privatisation programme, put the brakes on inflation and transformed the country.
Earlier this year, Brazil's foreign currency sovereign debt was upgraded to investment-grade, making it possible for a wider range of institutional investors to invest in its markets.
Mr Bastos says foreign direct investments (FDI) are set to 'change the face of Brazil'.
'Last year saw an all-time record of US$35 billion in FDI, more than the privatisation years.' he says.
'That's the same level of investments that Vietnam received last year, but the two are not comparable. As people become more comfortable with Brazil, and the fact that interest rates have come down, FDI should be a multiple of that in the next two years.'
Nominal interest rates have fallen since 2005, with the average fiscal surplus expected to hover at 3.9 per cent.
Lower rates have spurred a real estate boom. But interest rates are expected to tick up to an expected 14.25 per cent, alongside higher inflation.
HSBC forecasts inflation this year of 6.1 per cent, compared with 4.5 per cent last year, making for a real interest rate of more than 8 per cent.
Despite the positive macro-economic backdrop, Brazil's GDP growth lags that of Asia and Eastern Europe. Last year Brazil's GDP grew 5.4 per cent, compared with .2 per cent for Eastern Europe and 5.9 per cent for Asia.
'Because of the two decades of very high interest rates and hyper-inflation, there were no investments in Brazil,' says Mr Bastos.
'It's much easier to make money in fixed-income markets than real assets. Today we have an increased level of investment at 18.5 per cent. Assuming productivity at 2.2 per cent, that means the potential GDP growth is 4.5 to 5.5 per cent. Anything above that triggers inflation.'
The firm has upgraded its earnings per share growth forecast for corporates to 26 per cent, thanks to a strong steel sector. Next year's forecast is 16 per cent.
'The market had a very good run in the first half. It reached an all-time high in March and April despite the fact that most other markets were correcting,' says Mr Bastos.
HSBC expects upside from current levels of 12 to 13 per cent until the end of the year. On a 12-month view, the upside is expected to be a robust 30 per cent.
'There are very few countries with these attractive valuations, with high growth rates,' says Mr Bastos.
'It offers a nice combination of being a commodity producer, a major domestic consumption play and, on a long-term basis, a demographic dividend. The latter means that with a relatively young population, demand on pension resources between now an 2050 is unlikely to be high.'
In terms of commodities, Brazil's credentials are impressive.
It's the world's largest producer of ethanol, sugar, beef and coffee; and the second largest producer of soybeans, corn, poultry and pork.
Commodities account for 30 per cent of exports but have disproportionate representation on the benchmark Bovespa index, with Petrobras and iron ore companies accounting for 55 per cent.
'What I think will be the most attractive in 20 years is the agricultural sector. Brazil will be the bread basket of the world,' says Mr Bastos.
Brazil has 20 per cent of the world's unused arable land. Investors can participate in Brazil's investment proposition through a diversified emerging markets fund, a BRIC fund or single country fund. HSBC's Brazil Equity fund is pitched at sophisticated investors.
'We did feel that some of the commodities had over-reached their price targets. Now we're a bit heavier in cash anticipating a correction, but we're in a very interesting buying territory,' says Mr Bastos.
The dividend yield on the Bovespa index is 5 per cent.
This article was first published in The Business Times on 23 July 2008.
