C&B Notes

Is Brazil Its Own Worst Enemy?

Plentiful natural resources and strong demographics are useful but not sufficient ingredients for a successful economy.  Even before the idea of the BRICs was introduced, Brazil had been hailed as a cornerstone of future world GDP.  Alas, the country’s natural advantages have been exploited and wasted through corruption, red tape, politically-motivated subsidies, etc. by self-interested leadership (these issues are plaguing all of the BRICs to varying degrees).  The ballooning Petrobas scandal leads to the top of the government, and change will be difficult to accomplish.

Campaigning for a second term as Brazil’s president in an election last October, Dilma Rousseff painted a rosy picture of the world’s seventh-biggest economy. Full employment, rising wages and social benefits were threatened only by the nefarious neoliberal plans of her opponents, she claimed. Just two months into her new term, Brazilians are realizing that they were sold a false prospectus.  Brazil’s economy is in a mess, with far bigger problems than the government will admit or investors seem to register.  The torpid stagnation into which it fell in 2013 is becoming a full-blown — and probably prolonged — recession, as high inflation squeezes wages and consumers’ debt payments rise.  Investment, already down by 8% from a year ago, could fall much further. A vast corruption scandal at Petrobras, the state-controlled oil giant, has ensnared several of the country’s biggest construction firms and paralyzed capital spending in swathes of the economy, at least until the prosecutors and auditors have done their work.  The real has fallen by 30% against the dollar since May 2013: a necessary shift, but one that adds to the burden of the $40 billion in foreign debt owed by Brazilian companies that falls due this year.

Escaping this quagmire would be hard even with strong political leadership. Ms. Rousseff, however, is weak.  She won the election by the narrowest of margins.  Already, her political base is crumbling.  According to Datafolha, a pollster, her approval rating fell from 42% in December to 23% this month.  She has been hurt both by the deteriorating economy and by the Petrobras scandal, which involves allegations of kickbacks of at least $1 billion, funnelled to politicians in her Workers’ Party (PT) and its coalition partners.  For much of the relevant period Ms. Rousseff chaired Petrobras’s board.  If Brazil is to salvage some benefits from her second term, then she needs to take the country in an entirely new direction.

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Brazil’s problems are largely self-inflicted.  In her first term Ms. Rousseff espoused a tropical state-capitalism that involved fiscal laxity, opaque public accounts, competitiveness-sapping industrial policy and presidential meddling in monetary policy.  Last year her re-election campaign saw a doubling of the fiscal deficit, to 6.75% of GDP.

To her credit, Ms. Rousseff has at least recognized that Brazil needs more business-friendly policies if it is to retain its investment-grade credit rating and return to growth. This realization is personified by her new finance minister, Joaquim Levy, a Chicago-trained economist and banker and one of the country’s rare economic liberals.  However, Brazil’s past failure to deal promptly with macroeconomic distortions has left Mr. Levy to grapple with a recessionary trap.  To stabilize gross public debt, he has promised a whopping fiscal squeeze of almost two percentage points of GDP this year.  Part of this is coming from the removal of an electricity subsidy and the reimposition of fuel duty.  Both measures have helped to push inflation to 7.4%. He also plans to curb subsidized lending by public banks to favored sectors and firms.