Wednesday, July 13, 2011

Brazil's Consumer Debt Bubble

While investors' attention is rightfully focused on the European sovereign debt crisis, the escalating property bubble in China, and the tenuous debt ceiling negotiations occurring in the US, the consumer borrowing binge happening in Brazil represents another consequence of the easy monetary policy of the US Federal Reserve and a grave threat to the global economic recovery.

As highlighted in this recent Financial Times article, "Credit To Redeem", the consumer credit bubble occurring in the Brazilian economy is on par with the real estate and credit bubble that led to the US's undoing in the summer of 2007. This paragraph from the article says it all:

"Part of this inflation has come from rapid credit growth, particularly consumer borrowing. Observers such as Paul Marshall and Amit Rajpal at Marshall Wace, a London-based hedge fund, argue that Brazil is at risk of a full-fledged consumer credit crisis. Retail borrowers are on average spending one-quarter of their disposable income on debt servicing, compared with only about 16 per cent in the US. Defaults are rising. Serasa Experian, a credit monitoring agency, this week said its index of consumer delinquencies rose 22 per cent between January and June, the biggest increase in nine years."

While the central bank is forecasting credit growth of 15 per cent this year, no one agrees on how much debt households can bear. “What’s the limit that people can pay in terms of interest charges plus amortisation? When it’s getting to a third of their income, it’s pretty high,” says Mr Volpon.

In another FT artice, "Brazil Risks Tumbling From Boom to Bust," we learn of the remarkable borrowing rates faced by consumers.

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.

While the Brazilian central bank has aggressively tightened monetary policy, including raising interest rates to a global high of 12.25%, the bank's actions to date have had minimal impact on the growth in credit. Further, the raising of interest rates has resulted in a 40% increase in the Brazilian real and attracted significant foreign investment flows, which have only exacerbated the country's challenges.

While always difficult to predict the top of a bubble, its very clear that the credit binge occurring in Brazil is unsustainable and will end in tears. Add this to the list of risks facing investors as we enter the second half of 2011.

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