In December 2024, I visited Sao Paulo, Brazil, for the first time. The 4th most populous city in the world, Sao Paulo’s greater metro area is home to nearly 22 million people, so I was not surprised when it took painfully long to get anywhere by car.
Small motorbikes are all over the roads. They rode the white lines between cars regardless of whether there was traffic and skipped ahead at every traffic light, of which there were many.
At least a quarter of the motorbikes on the road appeared to be food delivery workers. The penetration of this service in Sao Paulo was impressive. Most of the cars in Sao Paulo are small, with European brands, particularly Stellantis, appearing to dominate. In contrast to the United States, I could count on one hand the number of large SUVs I saw during my week there.
I visited two malls in Sao Paulo—Morumbi Shopping and JK Iguatemi, owned by Multiplan and Iguatemi, respectively. What struck me was how clean and bright they were—more so than most malls I have visited in the United States. Both were more crowded than I expected on a weekday late afternoon. Those with disposable income in Brazil were gladly disposing of it.
During my meetings with management teams, executives conveyed a general sense of optimism, citing better-than-expected annual performance figures. Current estimates for Brazil’s real GDP growth in 2024 hover around +3.5%, well above the 1.2 – 1.5% most analysts predicted during 2023. Unemployment was consistently trending downward, falling to a record low of just 6.1% for the three months ending November 30, 2024.
Despite the stronger-than-expected backdrop, the MSCI Brazil Index (net) returned -29.8% in 2024, one of the worst-performing country indices worldwide. This was driven by two factors I will explore in detail: the return of inflation and growing concerns over deficit spending.
Inflation
Inflation in Brazil spiked in 2021, as it did in most countries following COVID-19. In March 2021, Brazil’s central bank began hiking its overnight lending rate (the “SELIC”), the first major central bank to do so. They kept this rate high until inflation began to normalize in 2023, and in August 2023 surprised the market with a larger than expected 50bps cut – more than a year before the Federal Reserve began easing. Inflation in Brazil continued to fall at the start of 2024, sinking below 4% in March, April, and May. While still above the official target of 3.0%, they continued to cut, ultimately pausing at 10.5% in May. In June 2024, however, inflation fears began to rear its head again, accelerating back over 4% and staying there throughout the summer. The Central Bank reversed course and began hiking in September 2024, again the first bank to do so. A factor contributing to their changing course was Brazil’s deteriorating fiscal situation.
Fiscal Deficit
President Lula took office in January 2023. He ran on a platform of raising social spending, hoping that tax revenues on high earners would cover these costs. These increased revenues did not materialize. Without a substantial enough increase in tax revenue, this fiscal stimulus was funded by debt. Brazil’s nominal budget deficit —including interest payments on public debt—has spiked to roughly 9.5% of GDP from 4.6% when Lula took office. Net public debt, as a percentage of GDP, ended November 2024 at 61.2% of GDP versus 55-56% in 2021 and 2022.
Spreads on credit default swaps (generally purchased as insurance against default) widened sharply over concerns about Brazil’s increased debt burden. While these spreads are nowhere near all-time highs, investors are increasingly concerned about the size and trend of the debt and deficit.
In November 2024, a spending containment package was proposed, and in December 2024, it was voted into law. With a focus on limiting increases to social programs, including tightening eligibility, many saw it as not substantial enough, with doubts as to whether the savings would be realized. Throughout 2024, the Brazilian Real fell against the US Dollar and was the worst-performing major currency for the year.
To defend its currency, the central bank hiked the SELIC by a surprising 100bps in December, issuing guidance that it will likely do so two more times in 2025. Today, the SELIC is expected to hit close to 15% by year-end. This is in stark contrast to the sub-9% rate it was expected to approach in 2025, as estimated in 2023.
Since most corporate debt in Brazil is floating rate, the higher SELIC rate had an immediate and adverse impact on cash flow and net income expectations for companies with levered balance sheets. This sent the stock market reeling. Today, Brazil trades at or near all-time large discounts vs the MSCI EM Index.
Looking Forward
I met with companies in various industries. In each of my meetings, one thing was clear—although most were surpassing expectations, their priorities had changed due to the spike in rates. Expansion plans were reduced or deferred as the cost of funding had increased. Companies refocused priorities away from revenue growth and market share gains.
Investor presentations that once discussed store openings, product launches, or fleet expansion now focus on debt repayment, working capital management, and cost-cutting. These are the steps such firms should take in this environment, but they also weigh on revenue growth. Assuming most firms follow this playbook, a national reduction in investment should reduce inflation.
In short, Brazil’s Central Bank’s monetary tightening is having its intended effect.
Over the next few years, I am encouraged by this newly found financial discipline, both at the company and country levels. Strengthening balance sheets will ultimately give way to expansionary opportunities in the future, hopefully with lower costs of capital. Firms should exit this hiking cycle stronger than they entered it.
With valuations near historic lows and the government making efforts to reduce its deficit, Brazilian equities appear to be poised to outperform.
In this piece:
In December 2024, I visited Sao Paulo, Brazil, for the first time. The 4th most populous city in the world, Sao Paulo’s greater metro area is home to nearly 22 million people, so I was not surprised when it took painfully long to get anywhere by car.
Small motorbikes are all over the roads. They rode the white lines between cars regardless of whether there was traffic and skipped ahead at every traffic light, of which there were many.
At least a quarter of the motorbikes on the road appeared to be food delivery workers. The penetration of this service in Sao Paulo was impressive. Most of the cars in Sao Paulo are small, with European brands, particularly Stellantis, appearing to dominate. In contrast to the United States, I could count on one hand the number of large SUVs I saw during my week there.
I visited two malls in Sao Paulo—Morumbi Shopping and JK Iguatemi, owned by Multiplan and Iguatemi, respectively. What struck me was how clean and bright they were—more so than most malls I have visited in the United States. Both were more crowded than I expected on a weekday late afternoon. Those with disposable income in Brazil were gladly disposing of it.
During my meetings with management teams, executives conveyed a general sense of optimism, citing better-than-expected annual performance figures. Current estimates for Brazil’s real GDP growth in 2024 hover around +3.5%, well above the 1.2 – 1.5% most analysts predicted during 2023. Unemployment was consistently trending downward, falling to a record low of just 6.1% for the three months ending November 30, 2024.
Despite the stronger-than-expected backdrop, the MSCI Brazil Index (net) returned -29.8% in 2024, one of the worst-performing country indices worldwide. This was driven by two factors I will explore in detail: the return of inflation and growing concerns over deficit spending.
Inflation
Inflation in Brazil spiked in 2021, as it did in most countries following COVID-19. In March 2021, Brazil’s central bank began hiking its overnight lending rate (the “SELIC”), the first major central bank to do so. They kept this rate high until inflation began to normalize in 2023, and in August 2023 surprised the market with a larger than expected 50bps cut – more than a year before the Federal Reserve began easing. Inflation in Brazil continued to fall at the start of 2024, sinking below 4% in March, April, and May. While still above the official target of 3.0%, they continued to cut, ultimately pausing at 10.5% in May. In June 2024, however, inflation fears began to rear its head again, accelerating back over 4% and staying there throughout the summer. The Central Bank reversed course and began hiking in September 2024, again the first bank to do so. A factor contributing to their changing course was Brazil’s deteriorating fiscal situation.
Fiscal Deficit
President Lula took office in January 2023. He ran on a platform of raising social spending, hoping that tax revenues on high earners would cover these costs. These increased revenues did not materialize. Without a substantial enough increase in tax revenue, this fiscal stimulus was funded by debt. Brazil’s nominal budget deficit —including interest payments on public debt—has spiked to roughly 9.5% of GDP from 4.6% when Lula took office. Net public debt, as a percentage of GDP, ended November 2024 at 61.2% of GDP versus 55-56% in 2021 and 2022.
Spreads on credit default swaps (generally purchased as insurance against default) widened sharply over concerns about Brazil’s increased debt burden. While these spreads are nowhere near all-time highs, investors are increasingly concerned about the size and trend of the debt and deficit.
In November 2024, a spending containment package was proposed, and in December 2024, it was voted into law. With a focus on limiting increases to social programs, including tightening eligibility, many saw it as not substantial enough, with doubts as to whether the savings would be realized. Throughout 2024, the Brazilian Real fell against the US Dollar and was the worst-performing major currency for the year.
To defend its currency, the central bank hiked the SELIC by a surprising 100bps in December, issuing guidance that it will likely do so two more times in 2025. Today, the SELIC is expected to hit close to 15% by year-end. This is in stark contrast to the sub-9% rate it was expected to approach in 2025, as estimated in 2023.
Since most corporate debt in Brazil is floating rate, the higher SELIC rate had an immediate and adverse impact on cash flow and net income expectations for companies with levered balance sheets. This sent the stock market reeling. Today, Brazil trades at or near all-time large discounts vs the MSCI EM Index.
Looking Forward
I met with companies in various industries. In each of my meetings, one thing was clear—although most were surpassing expectations, their priorities had changed due to the spike in rates. Expansion plans were reduced or deferred as the cost of funding had increased. Companies refocused priorities away from revenue growth and market share gains.
Investor presentations that once discussed store openings, product launches, or fleet expansion now focus on debt repayment, working capital management, and cost-cutting. These are the steps such firms should take in this environment, but they also weigh on revenue growth. Assuming most firms follow this playbook, a national reduction in investment should reduce inflation.
In short, Brazil’s Central Bank’s monetary tightening is having its intended effect.
Over the next few years, I am encouraged by this newly found financial discipline, both at the company and country levels. Strengthening balance sheets will ultimately give way to expansionary opportunities in the future, hopefully with lower costs of capital. Firms should exit this hiking cycle stronger than they entered it.
With valuations near historic lows and the government making efforts to reduce its deficit, Brazilian equities appear to be poised to outperform.
This piece is intended as an editorial review of a survey of risk considerations and does not constitute investment advice, a solicitation, or an offer to buy or sell any security. Past performance does not guarantee future results. All investments involve risk, including the risk of loss of principal.
References to third-party research, publications, and data sources are provided for informational purposes only. Boston Common Asset Management does not warrant the accuracy or completeness of third-party information cited herein. Readers should consult original sources and qualified professional advisors before making any investment decision.