Mixed Bag for Brazil

Slowing growth elicits misguided policy responses from Brazilian government.

Milton Ezrati of Lord AbbettFor the last 80-plus years, Brazil has been perpetually on the verge of becoming the next economic powerhouse but never quite made it. It is easy to see the potential. The nation is large and rich in natural resources and arable land. It has a sizable, active, some might say hyperactive, population and well-developed trade relations in the Americas and with Europe and Africa. Brazil has failed to realize its potential less for economic reasons than because of misguided government policies. So too today, after great expectations built up over the last decade, Brazil seems to be disappointing again, and for much the same reasons. Not everything is negative and policy is nowhere near as misguided as in the past. It would be a mistake to count Brazil out. But the picture is worrying nonetheless.

During the last decade, Brazil very much looked as though it would at last fulfill its promise. Both the real economy and industrial production grew at a vigorous 4% a year. Even after the global recession of 2008-2009, Brazil seemed to sustain its promise. The year 2010 saw the country’s real gross domestic product (GDP) expand 7.5%. But then things stalled. Real GDP expanded only 2.7% in 2011. During the first half of this year, the most recent period for which complete data are available, real GDP barely registered positive, expanding a mere 0.25% compared with the same period in 2011. Business investment, critical to an emerging economy, actually dropped 0.7%. Brazil’s central bank now forecasts a disappointing 1.6% overall growth rate for this year as a whole.

Yet despite the economic weakness, inflation threatens. Overall inflation has run 5.3% during the past year. Prices of manufacturing goods have risen 8%. Food prices jumped at an annual rate of 16% in September alone. The central bank has raised its overall inflation forecast for the current year to 5.2% from 4.7% previously. It is far from an encouraging picture.

It is especially distressing that this recent weakness casts doubt on the nature of past gains. Whereas there was once talk of broad-based development, it is now apparent that earlier growth strides depended mostly on an unsustainably hyped consumer sector and exports of raw materials, especially to China. Certainly, the crumbling state of the country’s economic infrastructure speaks to how little fundamental investment Brazil made during the boom years.

Although raw materials exports are a legitimate growth source, they are, for good reason, associated with the dependence of the underdeveloped on developed nations. Now that dependence is apparent. With exports to China down 1.7% over the past year, industrial production has gone into a steep slide, falling 5.5% over the 12 months to this past June. Meanwhile, it has become clear how much of Brazil’s past consumer gains depended on expensive government transfers, in particular the “family allowance program” instituted by the former president, Luiz Inácio Lula da Silva. Though the program is reported to have reduced Brazil’s poverty rate by 40%, these expensive transfers were never sustainable. Now that they weigh heavy on the public purse, the current president, Dilma Rousseff, has begun cuts of up to 50% so far. These, combined with the debt hangover built on past support, have pushed the default rate on consumer loans up to 7.9%, a 30-year high. This level of failure has rendered largely ineffective recent interest rate reductions engineered by the central bank.

Questions about past success are not the only source of worry. Even more troubling are the policies Brazil has instituted in response to the country’s current economic troubles. Instead of a coherent program for recovery and long-term development, the government, as so often in the past, has settled on a mélange of ad hoc measures. The Rousseff administration, suddenly awakening to the need for economic infrastructure, has, it seems, set out to catch up all at once for past neglect with the equivalent of $66 billion in new building programs for everything from soccer stadiums to support the 2014 World Cup games and hydroelectric plants in the Amazon, to miles of new toll roads and rail links. While infrastructure investment is usually a good idea, especially in an emerging economy, the government has piled so much on so fast that it is having trouble spending money at all, much less effectively. Meanwhile, the massive size of these projects, almost pharaonic in the words of one journalist, all but guarantees delays and waste, though the government has tried to avoid past inefficiencies by privatizing recent efforts.

The disappointing nature of the policy response isn’t limited to the infrastructure effort. In rapid succession, the government has announced payroll tax cuts; lower taxes on electricity; sector-specific tax breaks for politically connected industries, autos and appliances among them; subsidized loans, also for politically connected industries; and, despite rising inflationary pressures, dramatic interest rate reductions, from a 12.5% benchmark rate a little over a year ago to less than 8% at present.

Perhaps even more troubling, the authorities have also taken an ominous turn toward protectionism. Complaining loudly that monetary policy in the United States aims to weaken the dollar, Brazil’s central bank has moved aggressively, as during the country’s troubled past, to drive down the foreign exchange value of its currency, the real. Indeed, the recent, radical interest rate cuts might be aimed less at reviving Brazilian consumer and business spending than at forcing the real down against the dollar. In other protectionist moves, local content rules have been attached to much government spending, while most recently the government announced heavy tariffs on 100 items, including chemicals, paper and steel.

While all of this is understandable, given the economic slowdown, it all looks too much like the country’s failed past for comfort. Every aspect of these policies injects government deeper than ever in economic decision making, long a problem for Brazil. Meanwhile none of the new policies address Brazil’s longstanding, growth-inhibiting problems, such as its famously complex and convoluted regulatory and tax structures or the systemic corruption of which all complain, especially in business circles. Neither has the government addressed the country’s immediate and clear need for educational reform, widely acknowledged as essential to address Brazil’s dire shortage of trained, even literate, workers. Making matters worse, all the measures that the government has taken have a temporary character, leaving people and businesses with little basis on which to plan. Certainly nothing in the government’s response improves Brazil’s competitiveness or relieves the high cost of doing business there, what the locals call “custo Brasil.”

Even against this backdrop, it would be a mistake to dismiss Brazil out of hand. The country retains immense natural advantages, and it did turn in an impressive economic performance during the past decade. Still, the suddenness of the slowdown and the seeming embrace of past policy mistakes raises serious questions and gives investors and business people a clear reason to hesitate where Brazil is concerned.

 

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