Brazil: No Longer in Intensive Care

Under President Michel Temer, Brazil has been able to reduce inflation, improve exports and now attempt to improve the country's fiscal imbalances, the author argues. Here business hub Sao Paulo. (Photo: Brazil Foreign Ministry)

The best news is that Brazil’s government is committed to solving its fiscal situation.


Brazil has come a long way since the impeachment of Dilma Rousseff. The currency has stabilized. The equity market has rallied and corporate sector has gone a long way to putting its house in order. The economy has definitely turned the corner and is moving in the right direction.

However, like a car crash victim who has been in intensive care for a prolonged period of time, they are not released until they go through a lengthy convalesce. The same goes with an economy. After two years of deep recession, the Brazilian economy still needs to heal more before it obtains a clean bill of health. Unemployment lingers at an all-time high, remaining north of 10 percent. The Brazilian economy will be lucky to grow more than 1 percent y/y in 2017, despite the low base. The economy is battling important headwinds. The biggest obstacle is the immense deleveraging process. Households and corporates continue to pay down the debt that was accumulated during the financial orgy of the Lula era.

The fiscal accounts are also in disarray. The operational fiscal deficit will be close to 8 percent of GDP, and the primary shortfall will be about 2.5 percent of GDP this year. Yet, the seeds for a turnaround have been sown. The central bank’s draconian monetary approach lowered the inflation rate to about 4 percent, slightly below the target of 4.5 percent. This has allowed the monetary authorities to lower rates. Many analysts believe the process will accelerate later this year. Refusing to let up, there is talk that the central bank may even lower the inflation target to 4.25 percent. Clearly, Brazil’s monetary authorities have been the unsung hero of the economy’s stabilization. However, the export sector is the unsung hero of the economic recovery.


Although the Brazilian Real (BRL) has appreciated from the lows, the export sector has benefited from a tremendous improvement in competitiveness. This is something that has eluded its southern neighbor. Argentina also underwent a large devaluation, but saw most of the gains eroded by a corresponding rise in the inflation rate. In contrast, Brazil has been able to reduce its inflation rate, despite the large devaluation.

This has led to an impressive terms of trade shock, which has led to a significant improvement in the external accounts. Brazil’s trade surplus was just short of $50 billion in 2016, allowing the current account shortfall to narrow to 1 percent of GDP.

At the same time, Foreign Direct Investment (FDI) continues to pour into the economy, posting inflows of $11.5 billion just in the month of January 2017. The recovery in commodity prices and the large change in relative prices will ensure more FDI inflows. There are also signs that portfolio capital inflows are coming back to life. New corporate issuers are making the rounds, and there are indications that a wave of equity offerings are on the horizon.


However, the best news is that the government is committed to solving its fiscal situation. The congress approved a constitutional amendment that will cap government expenditures at 2016 real levels for the next 20 years. The measure is the first of a multi-year, multi-government process. President Temer introduced subsequent legislation to reform the social security system. The package has three major components. It will set the retirement age at 65. It will unify the various pension schemes, and it will eliminate overlaps, loopholes and distortions. Other pending reforms include education, labor and tax. These changes will radically overhaul the Brazilian economy.

In most countries, such reforms would be taboo. They would be akin to political suicide. However, Brazil’s political class is fighting for survival. Having endured the drama of Rouseff’s impeachment, the scandals of the World Cup stadiums and the unending saga of Lava Jato, the Brazilian electorate is ready to vote the entire political class out of office. This is a trend that has been sweeping the planet, given recent events in the U.S. and Europe. The incumbents realize that their only chance for survival will be to restore economic growth. That will require the restoration of investor confidence. However, the only way that confidence can be restored is by enacting the structural reforms that have eluded the country since it emerged from military rule in the 1980s. Elections are scheduled for the end of 2018. Polls show President Temer’s support plunging below 14 percent. Indeed, he has no chance of winning the presidency in 2018. The sense of desperation among the political parties is so high, that there are rumors that the major parties may field a unified national candidate. Nevertheless, these are the changes that Brazil needs to undertake to complete its convalescence and obtain a clean bill of health.

Walter Molano is head of research at BCP Securities and the author of In the Land of Silver: 200 Years of Argentine Political-Economic Development. 


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