Is Brazil worth the risk for investors?

By Kim Da-ye

The still-low interest rates and sluggish stock market in Korea have investors turning their eyes to alternative destinations. And Brazil has been garnering particular attention as its government bonds pay interests close to 10 percent of the principal.

But the hype is mixed with concerns over whether Brazil’s economic troubles driven by soaring inflation will prevent investors from getting bang for their buck. The lack of experience and in-depth knowledge in the Brazilian economy is clearly an obstacle for Korean investors, observers say.

“In terms of interest rates, Brazilian bonds are attractive, but the foreign exchange rates are important factors to consider. Emerging countries’ currencies tend to be volatile,” Yun Hang-jin, an analyst at Korea Investment & Securities, said.

Brazil’s current benchmark interest rate is 11.75 percent, compared to Korea’s 3.25 percent. In addition, under the tax convention between Korea and Brazil, interest paid to Korean holders of Brazilian government bonds won’t be taxed.

Such terms have helped recent Brazilian government bond-based products become popular here.

Mirae Asset Securities said on May 31 that the balance of the firm’s Brazilian bond product reached 200 billion won three weeks after the launch.

It makes a monthly payment with the interest rate at around 9 percent when the value of the Brazilian real stays unchanged. Samsung Securities followed suit, beginning to sell three types of Brazilian government bonds on May 31, while Tong Yang Securities sold two of the securities until May 26.

The sellers say that investors could benefit from the rising value of the real in addition to the high interest rate.

That exchange rate, however, could cause losses rather than profits.

“The Brazilian real has continuously appreciated, and it is at the highest value in its history although it is difficult to tell whether or not the currency is overvalued,” said an industry source.

A year ago on June 12, 2010, the value of the real was 1.81 against the U.S. dollar, and it rose to 1.597 Friday.

Moises Naim, a senior associate at the Carnegie Endowment for International Peace, called the real “the most overvalued currency in the world,” in his column for The Financial Times.

Another concern is the reason behind Brazil’s high interest rates. One analyst said that a country keeps the yield for the government bonds high under three conditions: fast growth, high inflation and premium for risks of the investment.

Brazil recorded a 6.55 percent inflation rate in May while the analyst sees no default risk for the government bonds.

Furthermore, investors are likely to have to hold the bonds until they reach maturity.

“The secondary market for Brazilian government bonds wouldn’t be large enough for holders of the securities to freely trade them for capital gains,” a source said.