Friday, October 31, 2014

Belly-Up Brazil?

SAO PAULO – After years of impressive growth, Brazil’s economic prospects appear increasingly dim. Since the World Cup ended in July, economic activity has plummeted, inflationary pressures have intensified, and consumer and business confidence have collapsed, leading many economists to slash their growth forecasts for this year. So just how sick is Brazil’s economy, and how will its malaise affect the outcome of the presidential election in October?

At first glance, Brazil’s weak growth appears ephemeral, and President Dilma Rousseff should be well positioned to win a second term. Over the last 12 years, her Worker’s Party (PT) has delivered the country’s strongest per capita GDP growth in more than three decades; reduced income inequality with an extensive system of social transfers that reaches one-third of Brazilian households; and reduced formal unemployment to a record-low 4.5%.

But even a cursory look at recent economic data reveals that Brazil’s growth model may well be hitting a stagflationary wall. In fact, Brazil most likely experienced a technical recession during the first half of this year. And annual growth during Rousseff’s presidency has probably averaged less than 2% – the slowest for any Brazilian president since the 1980s, when the country began its transition from hyperinflationary basket case and serial defaulter to stable and increasingly prosperous middle-income economy.

Moreover, had the government not cut taxes and delayed much-needed increases in gasoline and electricity prices, average annual inflation would stand at 7.5% – a level not reached in decades. In services, where the government has taken no measures to suppress inflation, the rate exceeds 9%.

Dig deeper, and one finds that the economy’s foundations are plagued with fragilities and imbalances. Though overall economic activity is weak, the current-account deficit has reached a 12-year high of 3.5% of GDP. Industrial production is 7% below its pre-crisis peak in 2008. This, together with the decline in manufactured goods as a share of total exports, from 54% a decade ago to 37% today, points to a substantial loss of competitiveness.

Even the economy’s apparent strengths – a thriving service sector and low unemployment – rest on unsustainable credit policies. Of course, rapid credit growth is a natural consequence of declining real interest rates. But, in Brazil, lending by state-owned banks has outpaced that of private banks significantly since 2008, meaning that lending at deeply subsidized rates has largely driven the increase in bank credit, to 58% of GDP (roughly double the rate eight years ago).

Against this background, Brazil is preparing for its most important presidential election since its transition from dictatorship to democracy in 1985 – and the polls do not bode well for Rousseff. Despite higher incomes and lower inequality, 70% of Brazilians have expressed a desire for change. This is not surprising, in view of the street protests that erupted last year over the poor quality of public services and rising prices. But is Rousseff’s government entirely to blame?

The short answer is no. While Rousseff’s government is largely responsible for the recent bout of cyclical weakness and social upheaval, Brazil’s problems are rooted in a broader unwillingness to shake off the yoke of policies adopted during more than two decades of military rule.

The 1994 Plano Real, a macroeconomic stabilization program, together with subsequent structural reforms, enabled Brazil finally to quash inflation and ride a wave of cheap global liquidity and surging Chinese demand for commodities. As the government attempted to direct these gains toward wealth redistribution, public expenditure rose and the social-benefits system – underpinned by so-called “acquired rights” – became increasingly rigid.

Brazil needs a new growth model, based on four key elements: tighter fiscal policy, looser monetary policy, a reduced role for state-owned banks in credit provision, and measures to lower Brazil’s astronomical private lending costs. The next government, whether of the left or the right, will also face the unenviable task of reforming the acquired-rights system to make social benefits more flexible and affordable. Its approach will determine whether Brazil goes the way of Venezuela, which is currently mired in stagflation, or Chile, widely regarded as Latin America’s best-run economy.

Given the protections afforded to acquired rights, the process of rooting out economic distortions and restoring Brazil’s finances to a stable equilibrium will require a lengthy process of constitutional reform. And, though the transition will undoubtedly be painful, it is essential to Brazil’s future economic growth and development.

Whether or not the next government can do what is needed will depend on its ability to unify the electorate and a disparate group of regionally focused political parties. But, first, it must reject the temptingly easy – but ultimately damaging – route of raising taxes and doubling down on redistributive policies. That path leads to Venezuela – and to a far less stable and prosperous Latin America.

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  1. Commentedbrasil 61

    nonsense - brasil probs begin w their childlike belief in che ..and more specifically..jurassic labor laws, extreme meddling in cap market flows, corruption as a way of life, ease of doing business, toilet level productivity - Brasil does compete well with 3rd world contries and other complete basket cases but has nothing to do with PT and everything to do with Cardoso and world credit expansion - Brazil business policies shot themselves in the foot and kept on shooting - the real was 1.65 a a while back ..and they thought that a bad thing w a 25% export GDP

  2. CommentedAndres Castillo

    Dude!! maybe I missed something to be read between line, so you should be explicit about it: OPEN BRAZIL'S ECONOMY TO THE WORLD AND LET IT FACE COMPETITION.
    That should cause some pain but if done progressively and rationally this can be minimized. It would also kip inflation at bay and increase competitiveness (particularly in manufacturing)

  3. CommentedVicente Campelo

    There is some lack of understanding in relation to the profiling of the Brazilian entrepreneur. The importance of credit policies through development banks is exceptionally important in the potential recovery of the Brazilian economy. The small and micro firms have an immense difficulty in obtaining the so called easy credit, due to (in a majority of the cases) their weaknesses in technical manners, as in doing economic viability studies for projects and accounting management. Witch results in a middle class that just simply is unable to increase its production capacity.
    Brazil's slow improvement/investment in it's production capability is also the real villain behind rising inflation, so a reduction public banks credit would not contribute in any way to solving this problem.
    At the same time, a looser monetary policy would imply in taking a risk, regarding inertial inflation, that remains an extremely fresh memory in the Brazilian population, something I believe, no candidate is willing to risk bringing back.
    Nevertheless, it is a fact that Brazil's due a huge progressive fiscal reform, witch will allow the country so star solving its deficit problems. Today there is a $250 billion dollars flux that is compromised paying off the interest for the country's debt. Meanwhile, one of the most popular government programs, Bolsa Família, cost only $25 billion dollars.
    The importance of this year's presidential election is the real highlight here. Whether Brazil becomes an economic example for Latin America countries and the big B among the BRICS, is going to be decided on witch path it takes.

  4. CommentedFrancesco Scornavacca

    This is a short-sighted view on Brazil's economic outlook. It is true that inflation is expected to hit 6.3% over this year, but lowering that through increased sovereign bonds interest rates won't accomplish its objective in the short run and will also prejudice GDP output - therefore leading to a stagflation. The proposed loose monetary policy fails to see the main macroeconomic problem Brazil will face over the next years: the lack of investment due to both low expectations and overloaded infrastructure.
    For the first one current government tries to increase wages and promote income transfers to foster consumption. This, unfortunately, is increasing inflation since the markets are still holding back investments.
    The latter has been addressed by a series of state funded infrastructure on roadways, railways, ports and airports which accounts for US$ 200 B.
    The current scenario will keep pushing inflation to its level of 6% in the short run, though the actions on infrastructure may be enough to boost demand expectations and lower prices in the coming years to some extent.
    Apart from that, the mentioned government actions do not target one of the biggest problems in Brazilian economy: taxation. It's not high as this article suggests - it hits an average number when compared to OECD - it's instead, highly regressive. Worse than that, it seems there is no political background to back up such bold move. Tighten the fiscal policy will not relieve the stressed GDP, in fact it will only harm the poor fraction of that society.
    The suggestions on the credit part of this article does not state that Brazil is a champion in interest rate in private banking which conflicts directly to his last proposal. Changing our lending matrix to a private one will hurt Brazil’s much needed investments.
    Of course there are a number of others factors – such as microeconomic policy - that add up in this outlook, but these are the ones I see as the most relevant in this context.

  5. CommentedNathan Weatherdon

    This could be easily predicted AFTER a world cup, despite the stimulus of lots of cash, because there is a sudden shock to employment and lots of people will rather set aside gains rather than invest stimulated/shocked dollars/reals into real activities. That is consistent with stagflation, but actually, I have no idea about the numbers.

    The reason is that small business operators will not look at monetary stimulus of cash proceeds of the World Cup and forecast higher demand, rather, they will observe that the World Cup is over, and instead hold onto their cash and wait for investment opportunities to arise. This is a double whammy on employment. Meanwhile, people have cash chasing goods -> stagflation, maybe.

    I don't see why this would have to be more than a blip from the long term perspective, however.

  6. CommentedBrian Warby

    It certainly doesn't look good for Brazil right now, but I think Mr. Frieda overstate's his case somewhat. He provides a bunch of figures for the Brazilian economy, which are inarguably bad, but not damning. 7.5% inflation is not all that uncommon for middle-income countries, the current account deficit is growing, but still not as high as the US deficit was just a couple of years ago. Manufacturing has declined somewhat, but, again, that's not abnormal.

    Mr. Frieda's policy advice is good general advice, but tighter fiscal policy at the cost of shoring up the tremendous gains made in poverty reduction is not a recipe for long-term success. China has shown that a loose monetary policy is not a prerequisite for a strong economy.
    Mr. Frieda's policy recommendations sound a lot like neo-classical, Washington-Consensus era policies that have failed over and over.

    Brazil certainly has an economic mess to deal with, but it's not the disaster Mr Frieda portrays.