Belly-up Brazil?

Financial Mirror (Cyprus) - - FRONT PAGE -

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 sta­te­owned banks has out­paced that of pri­vate banks sig­nif­i­cantly since 2008, mean­ing that lend­ing at deeply sub­sidised 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 sta­bil­i­sa­tion pro­gramme, 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 so­cial­ben­e­fits 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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