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Analysis: Private equity wary of Brazil currency, prices

12 April 2011

(Reuters) April 12, 2011 – Brazil’s policy stalemate over inflation and the rapid strengthening of its currency are fanning concern among private equity bankers that the government could be forced to take measures that could further undermine the value of their investments.

Policymakers appear trapped between opposing views — those who want the real to weaken to help manufacturing exports and those who want a stronger currency to help tame inflation. Consumer prices are climbing at the fastest pace in six years, while the currency is flirting with a 12-year high.

Instead of pushing for broad economic reforms that could reassert confidence, investors fear the government will place the burden on them through new taxes and capital controls. President Dilma Rousseff has said she will not let her inflation battle choke economic growth — which is running at the fastest pace in 24 years.

“Both inflation and the exchange rate are outside of historical trends, and that’s worrisome,” said Duncan Littlejohn, who oversees about $2 billion in private equity money for Paul Capital Partners in Sao Paulo.

Littlejohn said policy inconsistency has displaced worries about the soaring value of Brazilian assets among industry leaders, who met this week for an annual gathering of the Brazilian Private Equity and Venture Capital Association.

Indeed, lack of clarity over economic policy is making it harder for specialized investors to gauge whether government policies will lead to stable prices, or if the central bank will tolerate more inflation. At stake is the expected decline in Brazilian interest rates to global averages.

Apart from helping unleash consumer power in Brazil, lower interest rates could bolster the value of buyout firms’ assets in the long run.

“The way the government deals with the inflation and the currency problems could impact private equity deals,” said Carlos Asciutti, a private equity industry advisor with Ernst & Young in Sao Paulo.

“In the end what everyone wants to see are interest rates falling toward global levels in the long term,” he added.

In other words, while funds will continue to raise cash to invest in Brazil, many will hold off on spending it until government policy becomes clearer, some bankers said.

The policy inconsistency, says Littlejohn, relates to the real, which Goldman Sachs called the world’s most overvalued major currency. With inflation running high, the obvious thing to follow would be a decline in the real, he said.

As long as the United States continues to flush the world with dollars to spur its economic recovery, the real will likely strengthen. Meanwhile, worries are mounting that the end of that policy will reverse the conditions that caused the surge of capital flows to Brazil in the first place.

While investors wait to see the impact of changes in U.S. monetary policy, the Brazilian government appears undecided whether it will let the real rise or fight to make it fall.

Brazil’s currency has appreciated 50 percent since 2009, and 5 percent in just the last two weeks, making assets more expensive in dollar terms.

Resistance to putting new money in Brazil is growing as investors fret they might be buying assets at the peak value.

“Brazil is not cheap at all,” said Marcelo di Lorenzo, who on Monday was appointed as head of Brazil private equity at UK-based fund 3i. “That is why macroeconomic conditions are so important to make an investment decision. Inflation or the currency are as important as valuations as decision vectors.”

By Guillermo Parra-Bernal and Jeb Blount