What higher US interest rates will mean for Brazil

There’s been a lot of chatter about how an increase in U.S. interest rates will affect the U.S. economy, but there’s been less talk about what it will do to the Western Hemisphere’s second-biggest economy.

Justin Solomon | CNBC A gas station in Rio De Janeiro, Brazil.

Justin Solomon | CNBC
A gas station in Rio De Janeiro, Brazil.

That’s not Mexico or Canada—that’s Brazil. And the country will likely take an economic hit if (or when) the Federal Reserve decides to tighten U.S. monetary policy, said John Kilduff, founding partner at investment management firm Again Capital. “Brazil is hurting because of [low oil prices] and because of Petrobras,” he said, referring to the state oil giant that on Wednesday reported a staggering quarterly loss of $8.8 billion, much of it on a charge related to a rampant bribery problem.

Petrobras has been the subject of a massive corruption scandal since last November, which has led to its stock price dropping more than 38 percent in the last year and to the possibility of its defaulting on its $170 billion debt.

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“If the Brazilian government has to assume Petrobras’ debt, its deficit would be much higher,” said Shannon O’Neil, senior fellow for Latin American Studies at the Council of Foreign Relations.

Brazil’s deficit equals roughly 66 percent of its gross domestic product, according to data from the International Monetary Fund. Though it’s not clear how much of that debt is denominated in U.S. dollars, any increase in U.S. rates makes dollar-denominated debt harder to repay. And this comes as the price of Brent oil has plummeted 40 percent over a year, which also has hurt Brazil’s commodities-driven economy.

O’Neil added that Brazilian domestic consumption would also take a hit if the Fed raised its interest rates, as higher rates will also make it harder for Brazilians to buy using credit.

Then there’s the currency situation. Tighter U.S. monetary policy typically elevates the dollar and results in higher interest rates on U.S. Treasurys.

“I think the most direct impact will be [felt] in the depreciation of the Brazilian real against the dollar,” said Ricardo Mendes, managing partner at Prospectiva Consulting, a firm based in Sao Paulo. “We will see investors who currently have positions in Brazilian treasury bonds switching to U.S. bonds, and that’s going to impact the exchange rate.”

The U.S. dollar has risen more than 14 percent against the Brazilian real this year.

Nevertheless, Mendes added that some businesses could benefit from higher U.S. rates, including meat exporters and producers of soybeans and other kinds of commodities, which would likely benefit from increased exports to the United States. “The effects will be both positive and negative, given the size of the Brazilian economy,” he said.

What about Mexico?

Another Latin American economy that will be affected by higher U.S. interest rates is Mexico‘s.

“Without a doubt, the Mexican economy would experience financial volatility whenever the Federal Reserve decides to raise interest rates. This is because there will be a return of capital from around the world back to the U.S., considering U.S. interest rates have been near zero for so long,” said Carlos Serrano, chief economist at BBVA Bancomer.

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Nevertheless, Serrano added that he believes the Mexican economy is equipped to handle tighter U.S. monetary policy. “The Mexican economy has very strong fundamentals, especially when you compare it with other emerging-market economies,” he said.

Serrano also said that, because of Mexico’s strong economic fundamentals and low levels of debt, the Mexican central bank would be able to raise its own interest rates in order to maintain similar rate differentials.

Mexico’s current government debt equals roughly 50 percent of its GDP, according to the IMF.

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