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Thursday, March 21, 2019

The Awakening

by Fabio Scacciavillani

© Shutterstock : The world at its feet; Rio de Janeiro

Brazil’s economy has gone from boom to near bust; from growth of 7.5 per cent two years ago to zero. Despite the odds, the outlook is looking bright for Latin America’s largest economy, as Fabio Scacciavillani explains in the second part of our series on BRIC economies…

Brazil’s economy has gone from boom to near bust; from growth of 7.5 per cent two years ago to zero. Despite the odds, the outlook is looking bright for Latin America’s largest economy, as Fabio Scacciavillani explains in the second part of our series on BRIC economies…

Since the late 1960s for three decades Latin America evoked dysfunctional economies, social conflict, destitution, guerrilla warfare, military rule and with few exceptions (Costa Rica, Chile) a general sense of hopelessness. The virulent debt crisis of the 1980s (fuelled by petrodollars deposits piling up in international banks) seemed to exacerbate the problems beyond the point of no return. It was only in the mid-1990s that a new generation of political and business leaders, climbed up the ladder of power and ignited a painstaking reversal in attitude and policies.

MARKET-FRIENDLY REFORMS
The epicenter of this process was Brazil, by far the largest economy in Latin America. After the end of military rule, it spent several years to redefine its institutional framework but ultimately it passed a new Constitution and under the Presidency of Fernando Henrique Cardoso. Between 1995 and 2002 it embarked on a series of market-friendly reforms (which started to bear fruit at the end of the 1990s).

When the long-standing champion of the left, Luiz Ignazio Da Silva (known as Lula), won the Presidency many feared a plunge into populism and demagoguery. On the contrary, the steady course on economic matter nurtured by his predecessors and their technocratic milieu proved resilient and was broadly maintained. Lula’s leftist tinges were most visible in some social programs, foremost the Bolsa Familia (family allowance), which lifted millions of families out of destitution by providing cash transfers in exchange for keeping their children in school and abiding to mandatory vaccination requirements.

The two terms of Lula’s Presidency coincided with a period of exuberant growth not matched since the 1930s when Brazil (and the rest of South America) was the destination for millions of European and Asian migrants. The commodities boom fueled by a seemingly inexhaustible demand from China and other emerging countries played a major role, but the monetary stability achieved after several International Monetary Fund (IMF) programs and the fiscal discipline made possible that the windfall did not get wasted to support parasitism and patronage.

A NEW ERA
Lula’s popularity paved the way for the Presidency of his protégé Dilma Rousseff – the 36th and current President of Brazil (and the first woman to hold the post). She took office in the midst of the global crisis. Brazil’s economy ground to a halt in the middle of 2011 due to the sharp appreciation of its currency, the ‘real’. Two factors, both exogenous, were behind such an outcome: the favorable terms of trade especially towards China and the repercussions of aggressively expansionary monetary policies in the US and other mature economies.

As a result, while the commodity producers thrived, the manufacturing sector profitability was thwarted by the strong ‘real’, which led to an outcry over de-industrialisation. To address the slowdown, the authorities lowered interest rates (despite high inflation), tightened controls on capital inflow and intervened in the foreign exchange market in an attempt to bring the currency down. In addition they granted support to the manufacturing sector through targeted fiscal benefits.

The modest rebound will probably lead to a meager growth rate this year of between 2 to 2.5 per cent (compared to the 4.5 per cent the government is forecasting). Given the current global environment it is no small feat - but it is below both what Brazil needs - and what its potential could be. The road ahead will be undoubtedly uphill: Brazil’s labour force growth will abate while the pension outlays will mount. Domestic credit, which supports a consumption boom (Brazilians are much less thrifty than Chinese or Indians) cannot continue at today’s rate as households are starting to feel the burden of interests on their accumulated debt.

In essence, the current weakness stems from the structural reforms that Lula and his successor have shied away from. The government must start to confront the stagnating productivity growth. It should enact some fiscal reforms to increase public savings and simplify the tax code given that Brazil scores 150 among 183 countries in the World Bank ranking when it comes to the complication of the tax code.

The list of productivity-enhancing measures is not dissimilar from those invoked by free marketers in other emerging countries: improvements in infrastructure and education, reduction of red tape, labour market flexibility and a stronger dose of competition in product markets. On the fiscal front the key challenge is fiscal consolidation which should abide by three principles:

  • reducing the almost 90 per cent of total revenue which are earmarked
  • curbing current primary spending growth (the bulk of expenditure)
  • lowering the tax burden given that Brazil’s tax rate climbed from 27 per cent of GDP in 1998 to 34 per cent in 2010, becoming a drag on growth.

THE ROAD AHEAD
Will the country live up to the challenge? A lot depends on the political skills of President Rousseff who is enjoying an extraordinary level of approval for a President in her second year in office. Senior policymakers display awareness of the task they face, and indeed they pushed for a significant social security reform for new public sector workers from highly productive and in perspective its vast new oilfields constitute a hinge for future resilience.

Furthermore Brazil differs from the other three countries in the BRIC acronym in two respects: a rather established rule of law and the welfare system that attenuates abysmal inequalities. Above all, Brazil’s strength is a democracy that has been strengthened over 25 years and has achieved a stability unscathed by the transition of power from the right to the left.

So despite the challenges, Brazil’s prospects are moderately positive – barring a collapse of Chinese expansion in 2013 or a breakdown of the euro currency – with a return to growth rates above four per cent in 2013.

Fabio Scacciavillani is an economist with the Oman Investment Fund. In this article he expressed his views.

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