1

Reactions to the Sub-Prime Turmoil

Carlos Hamilton V. AraújoIADB, May 2008

Reactions to the Sub-Prime Turmoil

Carlos Hamilton V. AraújoIADB, May 2008

2

I. Asset Prices

II. Banking System

III. Macroeconomic Developments

IV. Conclusion

Outline

3

I. Asset Prices

4

Jun

14

2007

=10

0

USD/BRL USD/CNY USD/JPY USD/EUR

78

88

98

108

Jun07

Jul07

Aug07

Sep07

Oct07

Nov07

Dec07

Jan08

Feb08

Mar08

US Dollar Spike

Source: Bloomberg

5

Sovereign Spread and Risk Aversion Index

Sources: JP Morgan Chase and Merrill Lynch

bas

is p

oin

ts

Embi+Br

Risk Aversion Index

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Jun07

Jul07

Sep07

Oct07

Nov07

Dec07

Feb08

Mar08

130

160

190

220

250

280

310

Ago07

Apr08

Jan08

May08

6

75

85

95

105

115

125

Jun07

Jul07

Aug07

Sep07

Oct07

Nov07

Dec07

Jan08

Feb08

Mar08

Mexbol MervalIbovespa IPSA IBVC

Jun

14

2007

=10

0Ibovespa x Latin American Stock Exchanges

Source: Bloomberg

7

Almost all IPOs, even those that had already been announced, were postponed

The cost of the international financing became prohibitive, even in case of well ranked corporations

There are reasons to believe that “this time is different”

Other Comments

8

II. Banking Sector

9

Mainly in the second half of the 90s, the Brazilian banking system passed through a huge clean-up process

In the last couple of years, the Congress approved some laws enhancing the protection of the creditors

The above improvements contributed decisively to strengthen the prospect for the system

Some Previous Developments

10

Ownership% System Assets

0

10

20

30

40

50

2003 2004 2005 2006 2007

Foreign Domestic Government

Assets Distribution

11

Past Due LoansPast Due Loans (90+ days) / Total Loans (%)

0,0%

1,0%

2,0%

3,0%

4,0%

5,0%

6,0%

7,0%

2003 2004 2005 2006 2007

Foreign Domestic Government System

Past Due Loans

12

Profitability

Return on Equity%

0

5

10

15

20

25

30

2003 2004 2005 2006 2007

Foreign Domestic Government System

13

Average Cost Deposits%

0

3

6

9

12

15

18

2003 2004 2005 2006 2007

Foreign Domestic Government System

Cost of Deposits

14

* Registered at the Central Bank Credit Information System

38,5% 43,0%44,8%

46,1% 45,6%

61,5%

57,0%

55,2%

53,9%

54,4%

-

100

200

300

400

500

600

700

800

900

1.000

Jun Jun Jun Jun Nov*

2004 2005 2006 2007

Loans*R$ bi

Individual Borrow ers Corporate Borrow ers

Expansion of the Credit

15

III. Macroeconomic Developments

16

Trade Balance

12-month accumulated

exports

imports

US

$ b

illi

on

12-month surplus:

US$36.4 bi

165.6

129.2

45

55

65

75

85

95

105

115

125

135

145

155

165

175

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Feb

08

17

Net FDIU

S$

bil

lio

n

FDI

-15

-5

5

15

25

35

45

Jan

99

Jul

99

Jan

00

Jul

00

Jan

01

Jul

01

Jan

02

Jul

02

Jan

03

Jul

03

Jan

04

Jul

04

Jan

05

Jul

05

Jan

06

Jul

06

Jan

07

Jul

07

Feb

08

18

International ReservesU

S$

bil

lio

n

Apr 03: 15.9

end-of-2004:27.50

20

40

60

80

100

120

140

160

180

200

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Mar

08

Mar 25: US$194.3 bi

19

Net External DebtU

S$

bil

lio

n

1Q03:165.2

4Q04:135.7

4Q07:-10.8-25

0

25

50

75

100

125

150

175

1Q02

3Q02

1Q03

3Q03

1Q04

3Q04

1Q05

3Q05

1Q06

3Q06

1Q07

4Q07

20

External Sustainability Indicators

* Record low since the start of the series in 1970; 2008 – estimates.

net external debt/GDPnet external debt/exports

de 3.1 para -0.1*

%

de 32.7 para –1.4%*

(Feb)(Feb)

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

00 01 02 03 04 05 06 07 08

-5

0

5

10

15

20

25

30

35

00 01 02 03 04 05 06 07 08

21

Interest Payments/Exports Ratio

* Record low since the start of the series in 1970.

%

from 35.6% to 9.5%*

6

10

14

18

22

26

30

34

38

1999 2000 2001 2002 2003 2004 2005 2006 2007

22

IPCA Expectations and Target

central target

12-month IPCA

expectations

upper limit

lower limit

% p

.a.

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Dec

09

0

3

6

9

12

15

23

IPCA (12-month trailing basis )

market consensus

%%

Feb 08: 4.61% 2008: 4.44%*

0

3

6

9

12

15

18

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

Jan

09

Inflation Convergence to Targets

*March 20

24

Jan 084.15%

avg. 1994-Jun/95 4.77%

avg. Jul/95-1998 -0.08%

avg. 1999-2002 2.91%

avg. 2003-2007 4.13%

Consolidated Public Sector Primary Surplus%

of

GD

P

-2

-1

0

1

2

3

4

5

6

7

Jan

94

Jan

95

Jan

96

Jan

97

Jan

98

Jan

99

Jan

00

Jan

01

Jan

02

Jan

03

Jan

04

Jan

05

Jan

06

Jan

07

Jan

08

25Source: BCB

Debt/GDP%

of

GD

P

35.1

56.0

4Q 0742.8

market expectations (annual data)

1Q 02 – 2Q 07 (quarterly data)

35

37

39

41

43

45

47

49

51

53

55

57

1Q02

1Q03

1Q04

1Q05

1Q06

1Q07

2008 2012

26

US

$ b

illl

ion

Accumulated Reduction in FX-Linked Domestic Debt as of Jan 2003

-10

0

10

20

30

40

50

60

70

80

90

Jan03

Jul03

Jan04

Jul04

Jan05

Jul05

Jan06

Jul06

Jan07

Jan08

80.9

Jul07

27

III. Conclusions

28

Asset Prices Similarly to what was seen in the last two decades or so, the Brazilian

assets depreciated in response to the break out of the sub-prime financial turmoil

However, differently from the old pattern, the depreciation was relatively modest and they fastly recovered and on balance have not been hardly affected so far

Banking Sector The Brazilian bank sector was healthy enough to overcome the problems

caused by the international liquidity crunch without sacrificing the recent cicle of credit expansion

Macroeconomic Developments Afer almost a decade of Inflation Targetting, flotation and generation of

primary surplus (privatisation, bank reform), “this time is different” From my perspective, since there has been a strong enhancement in the

fundamentals, this is largely the best explanation for the fact that so far Brazil has not suffered a lot as a consequence of the sub-prime crisis

Conclusion