Quick: which BRIC nation has the highest consumer loan default rate?
If you said China, India or Russia, you are wrong. Actually, if you said China you are probably right, but since absolutely all economic “data” in China is worthless, manipulated propaganda, only a retrospective post-mortem after the Chinese credit, housing, commodity, consumption bubbles have all burst will we know the answer. So excluding China, which country’s consumers after a multi-year shopping spree funded entirely on credit, are suddenly suffering the epic hangover of soaring non-performing loans as they suddenly find themselves unable to even pay the interest on the debt? Just ask former billionaire Eike Batista whose OGX oil corporation is days away from filing bankruptcy. The answer, with 5.6% of all loans in default, above Russia, South Africa, Mexico, Turkey and India, is Brazil.
It is this same Brazil, where years of credit-driven expansion have resulted in rampant, 6% inflation, which moments ago forced the central bank to once again hike its key policy rate by another 50 bps to 9.50% in an attempt to halt surging prices and contain the flood of liquidity, both foreign and domestic.
And while it is likely that next month the Brazilian COPOM (central bank) will push interest rates into the double digits for the first time since early 2012, it is unknown how the nation, whose consumers are already burdened with more debt than ever at over 25% of of GDP, will thrive when their interest payments jump by 1% every two months.
So how did Brazil, or rather its middle class, which for years had managed to avoid a debt crisis, suddenly find itself on the edge of one? Simple: ultimately every bill has to be paid (or else defaulted upon) and every credit bubble pops.
In an extended profile of precisely this middle class which now finds itself in a very precarious position, the WSJ traces the key concerns in the Brazilian economy:
Most people think of Brazil—among the world’s biggest producers of iron ore and soybeans—as a poor country that lives or dies on sales of commodities. But aspiring shoppers like Ms. Silva fueled much of the country’s recent boom, as consumer loans more than doubled to around $600 billion in five years.
Now, many of these new shoppers are suffering from credit-card fatigue—or worse. Some are defaulting on Brazilian credit cards that can charge 80% annual interest or more. Facing more defaults, banks are now warier about lending.
As a result, consumption is expanding at its lowest rate since 2004. That is compounding other problems, including weaker exports to China and a manufacturing slump caused by a strong currency, that were already slowing Brazil down. With consumer confidence declining, Brazil’s gross domestic product is expected to post 2.4% growth this year, after reaching 7.5% in 2010.
To be sure, the ascent of Brazil’s middle class was a rapid one and largely problem free:
From Brazil to Indonesia to South Africa, faster growth rates lifted millions from poverty in the last 10 years, bringing more people into the middle class and introducing many of them to credit for the first time. But while economists mostly view such credit expansion as a good thing, the case of Brazil shows how middle-class growth can also be knocked off track by too much debt.
And while Ben Bernanke may have found the “transitory” antidote to mean reversion, for Brazil it is still elusive:
Brazil’s consumer credit troubles stand out among big developing economies. Consumer lending rose at an annual average rate of 25% in the four years after the global financial crisis of 2008. As of June 2013, some 5% of Brazilian consumer loans were 90 days overdue, twice the rate of India and more than Mexico, South Africa and Russia, according to Fitch Ratings.
“All these people have been spending more than they have, creating an illusion of economic growth,” said Vera Remedi, an executive at Procon São Paulo, a Brazilian government agency that advises people like Ms. Silva on how to manage or renegotiate their debts.
Part of the problem, some economists say, is that Brazil focused too heavily on policies designed to increase consumption instead of completing ports and roads to help economic production in the long term. Brazilians bought a lot of flat screens during the boom, but the country’s ports are still so clogged some ships turn away instead of waiting.
“Brazil’s external borrowing was spent on trips to Disneyland, suitcases packed with goods straight from New York or Miami,” said Paulo Leme, who runs Goldman Sachs’ business in Brazil. “That will have consequences in the future.”
To be sure, unlike the US and especially Europe, Brazil’s credit problems are not pervasive and certainly have not permeated the financial system to the extent they have in the developed world. At least not yet.
Brazil’s credit problems aren’t expected to return the country to the kinds of crises that destroyed middle classes of generations past, economists say. Brazil’s total outstanding bank loans, including commercial and consumer debt, are around 55% of GDP, which is low by international standards.
The country’s banks are sitting on large capital reserves, which should help Brazil weather any deeper downturn. The central bank’s reserves of $372 billion are a tenfold jump from a decade ago.
But as noted above, the bulk of debt concerns involve the Brazilian consumer, and not only the quantity of debt, but quality as well, because unlike in the US where the primary debt component is mortgages, in Brazil debt is used to source the purchases of appliances and cars: items that almost immediately amortize to zero unlike houses which at least get to preserve their values absent major systemic crashes.
The profile of Brazilian debt isn’t as healthy as it is in countries like the U.S. A big chunk of U.S. borrowing is home loans, seen as healthier since home prices can rise. But Brazil’s mortgage market is tiny. Brazil’s consumer debt went largely to appliances and cars—items that lose value.
Car sales are an example of how the credit boom played out. Auto loans more than tripled between 2004 and 2010 to around $70 billion a year, as consumers clamored to own a key symbol of middle-class life. Banks were lending with no money down, a previously unthinkable concept in the country.
Last year, there were 2.9 million new cars registered in Brazil, a 130% increase from a decade ago. Economists started pointing to massive traffic jams of entry-level hatchbacks as symbols of development.
But while the numbers can obviously be manipulated, it is the “on the ground” anecdotes that truly capture the severity of the debt crisis:
“At one point, I was selling cars with 80-month financing to people who made $500 a month,” said Adalberto Fava, sales manager of a Hyundai dealership that serves a working-class neighborhood on the outskirts of São Paulo. “I knew there was no way they could afford it,” with monthly payments as high as $200. Many of these cars were repossessed, he said.
For a while, credit financed Mr. Bispo’s climb into the entrepreneurial class. He also borrowed $4,200 to start a small business, a beauty salon. He borrowed more to send his wife to a four-year beauty program.
Within six months, the family was behind on loan payments, largely because it had underestimated how much debt it could afford. Ms. Bispo had to drop her college classes. The bank took their car. The couple is trying to hang on to the salon, but it is bleeding money as neighborhood customers, some grappling with their own debt problems, shy away, Mr. Bispo said. The Bispos are defaulting on some bills.
“Each month, we have to decide which bills we can pay. We’re having a financial crisis,” he said.
But at least Mr. Bispo lived well for a while. And then his debt-fueled dreams all came crashing down.
Political leaders worked hard to expand consumption, hoping to close the historically wide gap between rich and poor in Brazil. Under Luiz Inacio Lula da Silva, a poor union leader elected president in 2002, and his successor, President Dilma Rousseff, Brazil hired tens of thousands of new government workers and expanded its welfare system. It subsidized gasoline and electricity prices and directed government banks to unleash billions in consumer loans. The strategy helped lift living standards and spurred growth. In 2009, Mr. da Silva cited the growing middle class in a successful pitch to hold the 2016 Olympic Games in Rio de Janeiro, an event he said would help correct inequality and inspire a poor continent. But policy makers failed to match their consumer-friendly steps with measures to improve productivity and long-term growth, many economists say.
The result: Consumption kept growing even as the rest of the economy was showing strains from weakening commodity prices and an overvalued currency. Brazilian tourists, many of them flying overseas for the first time, were among the biggest spenders among foreign tourists to New York City last year, city officials said.
The logical next step when central-planning fails: central-planning on overdrive.
“The government insists on trying to get people to consume, but on the other hand, the supply, the industries, the companies, haven’t produced that much,” said Samy Dana, a professor at Fundação Getulio Vargas university in São Paulo.
The result inflation. And even more inflation when plans for more stimulus and to boost purchasing power by rising the minimum wage are implemented:
Ms. Rousseff, who faces elections next year and gets many of her votes from the country’s poor, has signaled plans to keep pushing more consumption. She recently announced a minimum-wage increase and a plan to provide an additional $8 billion in credit to low-income families.
Finally, we leave with the personal narrative of the protagonist of this story: Odete Meria de Silva:
The family doesn’t have a lot of education. Her eldest son went to work in his teens. Her youngest wants to go to college, but Ms. Silva is concerned he won’t get in. The teachers at his public school are often on strike, creating gaps in his learning.
Crime is her biggest concern. They live in a rough neighborhood in a country with one of the highest murder rates in the world. Almost everyone in her family has had cars they financed stolen. Her eldest son recently lost a used $15,000 Volkswagen. He still has to make payments on the car, even though it was stolen.
Ms. Silva is an energetic woman who took advantage of government subsidies and credit to climb up the ladder. Barely getting by as a store clerk a decade ago, she heard that the government was hiring drivers to offer free school busing.
She decided to buy a bus and go into business. She sold her small apartment to raise half the $28,000 she needed. She borrowed the rest through bank loans and credit cards.
She racked up debts on three credit cards, buying household goods and $5,000 worth of building materials. At high interest rates, the debt on the construction materials alone more than doubled to about $11,000.
Now Ms. Silva is digging out from her debt. She cut deals with her lenders who agreed to lower her interest payments, reducing what she owed by several thousand dollars.
But other challenges loom. She must buy a new school van next year to keep her contract as part of a government rule designed to increase vehicle consumption. In Brazil’s tightening lending market, getting a loan this time will be harder.
She says she isn’t worried: “I believe things are getting better.”
Because when everything else is gone, or has been repossessed, hope is the last thing to go. Even for a brand new continent of “middle class” debt slaves.