Brazil’s “dream team” faces an eco­nomic night­mare

▶ In­vestors are ex­pect­ing mir­a­cles from the act­ing pres­i­dent ▶ “You’re hav­ing to do this ... ex­er­cise with a very weak econ­omy”

Bloomberg Businessweek (North America) - - The Global Tech -

In­vestors are bullish on Brazil. The coun­try’s Bovespa eq­uity in­dex is up al­most 19 per­cent this year, while the real has gained 13 per­cent against the dol­lar. One big rea­son for the rally: Pres­i­dent Dilma Rouss­eff has stepped aside as she awaits an im­peach­ment trial, which has al­lowed Vice Pres­i­dent Michel Te­mer to take over as act­ing pres­i­dent.

The fi­nan­cial com­mu­nity ex­pects Te­mer, a mem­ber of the Brazil­ian Demo­cratic Move­ment, to pur­sue more mar­ket-friendly poli­cies than Rouss­eff, who hails from the Work­ers’ Party. Gold­man Sachs, in a re­search note to clients, dubbed his eco­nomic cabi­net, led by Fi­nance Min­is­ter Hen­rique Meirelles and Eco­nomic Mon­i­tor­ing Sec­re­tary Man­sueto Almeida, the “dream team.” “The po­lit­i­cal trans­for­ma­tion in Brazil is cre­at­ing huge in­vest­ment op­por­tu­ni­ties,” says Jan Dehn, the head of re­search at Ash­more Group, an emerg­ing­mar­kets in­vestor.

Yet the list of prob­lems Te­mer and his team must tackle is daunt­ing. In the first three months of 2016, gross do­mes­tic prod­uct shrank 5.4 per­cent year-on-year, ex­tend­ing a re­ces­sion that be­gan in 2014. The un­em­ploy­ment rate is 11.2 per­cent, its high­est since at least 2012, and the cen­tral bank is strug­gling to tame in­fla­tion, which is run­ning above 9 per­cent this year. “Mar­kets are get­ting ahead of them­selves,” says Des­mond Lach­man, a for­mer deputy di­rec­tor at the In­ter­na­tional Mon­e­tary Fund who’s now at the Amer­i­can En­ter­prise In­sti­tute. “You’re not go­ing to find a sil­ver bul­let.”

The new gov­ern­ment has also al­ready been tarred by scan­dal. Bud­get Min­is­ter Romero Juca was forced to step down in May over al­le­ga­tions he wanted to block a probe into graft and money laun­der­ing. Fabi­ano Sil­veira, the min­is­ter of trans­parency and con­trol, re­signed the same month af­ter lo­cal press pub­lished a record­ing of a con­ver­sa­tion in which he crit­i­cized the graft probe known as Car­wash and of­fered ad­vice to a politi­cian un­der in­ves­ti­ga­tion.

A pri­or­ity for Te­mer and his ad­vis­ers is rein­ing in a bud­get deficit of 603.7 bil­lion reais ($179 bil­lion), which amounts to more than 10 per­cent of GDP. That’s the sec­ond-high­est level in the Group of 20, af­ter Saudi Ara­bia. The ad­min­is­tra­tion has pro­posed putting a cap on fed­eral spend­ing, throt­tling back the costly gov­ern­ment pen­sion sys­tem, and with­draw­ing money from Brazil’s sov­er­eign wealth fund to pay for gov­ern­ment op­er­a­tions.

Mak­ing a sig­nif­i­cant dent in the deficit won’t be easy. Cut dis­cre­tionary spend­ing, and there’s the risk of a back­lash from an al­ready frus­trated elec­torate. Raise taxes, and the re­ces­sion could deepen. Pri­va­tize gov­ern­ment com­pa­nies? Be­ware the wrath of the unions. And any at­tempt to re­form so­cial se­cu­rity will take decades to have an im­pact on the na­tion’s bal­ance sheet.

Lach­man says that to put the econ­omy on a healthy path, Te­mer needs to trim the deficit by at least 5 per­cent­age points of GDP, plus ad­dress such long-term is­sues as so­cial se­cu­rity, all with­out fur­ther de­press­ing growth. “You’re hav­ing to do this whole ex­er­cise with a very weak econ­omy,” he says. “If the pol­i­tics are very dif­fi­cult now, how much more dif­fi­cult are they go­ing to be in a few months’ time if the econ­omy keeps slid­ing?”

Te­mer must also grap­ple with a mount­ing na­tional debt, which climbed to 4 tril­lion reais last year—67 per­cent of GDP. In­ter­est pay­ments hit 464 bil­lion reais in 2015. Debt is on course to top 80 per­cent of GDP within two years, ac­cord­ing to Lach­man.

While Brazil has for­eign cur­rency re­serves of $376 bil­lion, such high debt lev­els are wor­ri­some for a coun­try that missed for­eign debt pay­ments in the 1980s and re­ceived an IMF bailout in 2002. “Economies re­ally suf­fer” when emerg­ing-mar­ket gov­ern­ments ac­cu­mu­late too much debt, says Koon Chow, a Lon­don-based strate­gist at Union Ban­caire Privée. “They tend to have more tur­moil,” he says, “and as­set prices are more volatile.” �Jonathan Levin and Ye Xie The bot­tom line The act­ing pres­i­dent has lit­tle room to ma­neu­ver as he tries to re­vive the Brazil­ian econ­omy.

“Mar­kets are get­ting ahead of them­selves. You’re not go­ing to find a sil­ver bul­let.” ——Des­mond Lach­man, Amer­i­can En­ter­prise In­sti­tute

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