Brazil: Course Correction Needed

Brazil's current woes are due to more state intervention, capital and price controls, leniency with inflation, lavish public spending and a series of protectionist measures, experts say. Here President Dilma Rousseff. (Photo: Roberto Stuckert Filho/PR)

Brazil needs to stop its lax fiscal policies and provide more investor-friendly policies, experts say.


Inter-American Dialogue

Brazil has officially entered a recession after GDP contracted in the year's first two quarters, according to data released recently by IBGE, the government statistics agency. President Dilma Rousseff's administration attributed the economic downturn to worldwide economic conditions and productivity losses linked to fewer working days during the World Cup, while the government's critics blamed the contraction on lower business confidence and falling investment due to the government's economic policies. What are the primary causes of Brazil's recession, and what would it take to get the economy back on track? When will Brazil return to growth, and how fast will it expand in the period ahead?


Gabrielle Trebat, director for Brazil and the Southern Cone at McLarty Associates: Economists have once again reduced their growth forecasts for Brazil this year--to 0.5 percent--after Brazil slipped into a technical recession in the second quarter. There are a number of theories to explain the recession, including the continued slowdown in the global economy, poor export performance, lower productivity due to the numerous public holidays surrounding the World Cup and a continued decline in industrial production, among other factors. While the answer likely lies in a combination of the above, most agree that high on the list for reviving growth needs to be boosting Brazil's investment-to-GDP levels, among the lowest of major emerging markets. According to IBGE, investment fell 5.3 percent in the second quarter of 2014 and more than 11 percent year-on-year amid flagging investor sentiment and uncertainty surrounding the election. Unfortunately, there is little room for growth-boosting fiscal policies as additional increases in government investment are unlikely after two years of missed fiscal policy targets and lower tax revenue. Many believe that Brazil's consumer-focused economic model has run its course and a correction to a more investor-oriented approach is due with implications for a loosening of regulations and removal of price controls including costly fuel subsidies-certainly a challenge given the potential impact on inflation. Despite the economic picture, Brazil remains a very attractive investment opportunity across a number of sectors-energy, infrastructure, and real estate to name a few-which will require private financing as well as public-private partnerships. The good news is that a consensus is emerging among all the presidential candidates that any incoming administration will have to undertake policy adjustments to revive investor confidence and boost investment, which should offer Brazil a positive foundation for renewed growth and investment in 2015 and beyond.


Shelly Shetty, member of the Advisor board and head of Latin America sovereigns at Fitch Ratings: Brazil is experiencing an extended slowdown. Average growth from 2011 through 2013 was 2.1 percent, less than half the 4.5 percent average from 2006 to 2010. A difficult external backdrop has brought structural growth constraints to the fore. China's economic slowdown, greater economic difficulties in neighboring Argentina and softer terms of trade have adversely affected Brazil. The spillovers from these factors combined with slower credit growth and slackening job creation have dampened domestic demand. Structural limitations to growth including low savings and investment rates, human capital and infrastructure constraints, competitiveness challenges stemming from increased unit labor costs, a high tax burden and difficult business environment have persisted. The significant slide in confidence indicators in recent months appears to have weighed heavily on economic growth. Brazil's economy contracted by 0.6 percent in the second quarter from the previous one, and the fall in investment (5.3 percent quarter-over-quarter) was the main driver of this contraction, further eroding the country's already modest investment rate. The subdued business confidence partly reflects the perceived erosion of policy making, pre-election uncertainty and concerns regarding the persistent low growth and elevated inflation environment. Moreover, the lagged impact of monetary tightening and the potential for fiscal tightening next year point to a likely gradual recovery next year. The positive impact from the infrastructure concessions program to ease supply-side bottlenecks could be felt over the medium term. Falling confidence indicators suggest that economic agents want to see additional policy adjustments in addition to those already undertaken, which include monetary tightening, some exchange-rate flexibility and attempts to boost private investment in infrastructure. Medium-term economic prospects will depend greatly on the next administration's capacity to restore confidence, strengthen the credibility of fiscal and economic policies, reduce the cost of doing business and facilitate a faster transition toward investment-led growth.


Beatrice Rangel, member of the Advisor board and director of AMLA Consulting in Miami Beach: Accuracy is not an abundant virtue during election times. Thus, neither the government nor the opposition is telling the truth to Brazilians. Yes, the world economy has yet to recover from the great recession of 2008, and, yes, the World Cup party was unending. But the real explanation for Brazil's lackluster economic performance is to be found in the urgent need for the country to engage in second-generation economic reforms. These include reduction of bureaucracy and its ancillary red tape, granting total independence to the central bank, revamping the tax system, curbing corruption, vanquishing crony capitalism, transforming education and finding a way to promote infrastructure development. Brazil's economic performance today is a far cry from its emerging-market peers China and India, which are still growing strongly despite their slowdowns, but in terms of employment and return on labor it is a good bet. Consumer demand in spite of recent deceleration remains strong, and foreign demand for Brazilian exports is stable. But the house needs a spring cleaning in order to continue on its development path. Unfortunately, this does not seem to be the objective of the three front-runners in the presidential race. So far, none has had the courage to spell in clear terms how pressing the need for a cleanup is.


Marcos Casarin, economist in the macroeconomic forecasting team at Oxford Economics in London: Brazil's current economic performance is the result of several years of an unorthodox policy experiment. Since 2009, Brazilian authorities gradually abandoned the macro framework in place since 1999, which was based on three pillars--fiscal austerity, inflation targeting and a floating exchange rate--to pursue the so-called 'new economic matrix.' Such policies involve more state intervention, capital and price controls, leniency with inflation, lavish public spending, subsidies for the acquisition of durable goods and a series of protectionist measures to protect chosen sectors from international competition. The results are not only poor economic growth, but have damaging effects on the overall economy. For instance, politicians undermined the credibility of the central bank by intervening in its decision to set interest rates. The decision to deduct cash transfers to state-owned firms from the primary surplus made public finances more opaque, reducing the credibility of Brazil's data reporting process. By freezing fuel and electricity prices, the government left Petrobras and Eletrobras short of cash to pursue their investment plans, culminating in a substantial loss of their market value. Inflation remains elevated, reducing households' purchasing power. And by conceding subsidies to consumption in the form of tax breaks or cheap credit via public banks, the government helped to fuel a housing-price bubble based on household leveraging. It is not surprising that business and consumer confidence have reached their lowest levels since 2009. We at Oxford Economics believe that the current disappointing performance is much more related to bad policy management and to the exhaustion of a growth model based on subsidized consumption than on the factors suggested by the government. In terms of the outlook, we forecast flat growth for 2014 as a whole (which implies a very weak recovery in the second half of the year) and growth of just 0.9 percent in 2015. Looking further ahead, we expect Brazil to remain trapped in a bad equilibrium of low growth and high inflation for several years unless the current policy framework is reoriented.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor


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