Is the Party Over for Brazil?

For most of the decade since Goldman Sachs’ Jim O’Neill first conferred fab-four status on Brazil, Russia, India and China, even giving them the catchy nickname of “the BRICs,” those emerging economies had certainly lived up to expectations. On average they grew faster than the rest of the world — four times faster than the United States, in fact — and became the darlings of overseas investment portfolios, attracting $70 billion in mutual funds alone. Then, in 2011, their growth decelerated dramatically, prompting another Goldman Sachs economist, Dominic Wilson, to report, “We have likely seen the peak in potential growth for the BRICs as a group.”

The sudden downshift was largely the result of Europe’s deepening sovereign debt crisis, which severely reduced demand for the manufactured exports of emerging economies and suppressed prices for their commodities. European banks that had been sluicing capital into the developing world pulled back in the face of uncertainty at home. However, even as the Russian, Indian and Chinese economies slowed, they still grew at 4.3 percent, 7.8 percent and 9.2 percent respectively. Brazil, on the other hand, lagged the pack at 2.7 percent after having reached a peak of 7.5 percent a year earlier.

Until recently, Brazil’s economy boasted large and vibrant agricultural, mining and manufacturing sectors and the largest oil finds in the Americas. Driven by soaring commodity prices and robust Chinese demand for raw materials, it had steadily expanded its presence in world markets. Domestic consumption, spurred by plentiful credit, grew to account for 60 percent of the economy. Then last year, sectors that had been roaring ahead ground nearly to a halt. The manufacturing sector struggled because the overvalued Brazilian currency (the real) opened the floodgates to cheap imports. Automobile output plunged as carmakers idled factories to whittle down high inventories. Steel mills slowed as a glut in the market depressed prices. Job creation slowed sharply. Capital spending fell. Interest rate hikes that had been put into effect during the first half of 2011 in an attempt to cool inflation began to ratchet back consumer spending. “The most shocking aspect was that all the demand components contracted (at once),” said Mauricio Rosal, chief economist at Raymond James & Associates in Sao Paulo.

Under new President Dilma Rousseff, Brazil’s government began to adopt a series of aggressive strategies to try to reverse the trend. The Central Bank began cutting interest rates again — lopping off 450 basis points in one year, down to a record low 8 percent — in an effort to stimulate growth, reduce the value of the real and reignite consumer spending. The government also took measures to protect Brazil’s industries from a growing flood of Asian imports, including raising taxes on foreign cars and trucks. It also instituted $1 billion in tax cuts to further stimulate consumption and pledged to increase government purchases of made-in-Brazil goods. Despite these stimulus packages, however, the economy barely expanded (0.02 percent) in early 2012 and is likely to come in at less than 2 percent growth for the entire year, according to a Central Bank survey of 100 analysts.

According to David Fleischer, a professor at the University of Brasilia, the government is merely “applying patches to an increasingly exhausted growth model.” Many believe, as he does, that, despite the buffeting vagaries of the global economy, Brazil’s problems are locally rooted. They say its economy is weighed down by an inadequate infrastructure, a limited transportation system, an unwieldy tax code, an expensive and underqualified labor force, antiquated labor laws, corruption and a dysfunctional judicial system. All this pushes up the notorious “Custo Brasil” (the “Brazil Cost”), the intrinsic premium paid for doing business in the country.

By employing stimulus measures “the government is exacerbating some of these structural imbalances in the Brazilian economy, which are likely to come to a head at some point over the next few years,” said Richard Hamilton, head Latin America risk analyst at Business Monitor International.

Increasingly, many business leaders are clamoring for reform. “The time has come to prioritize structural reforms that really address the competitive problems of the Brazilian economy,” said Paulo Godoy, president of ABDIB, a Brazilian association of infrastructure and capital goods industries. Sussumu Honda, president of the Brazilian Association of Supermarkets, agreed: “Brazil is not going to grow unless we make the necessary reforms. The country is not competitive. It’s not just a question of this year.”

Still, neither Rousseff nor Brazil’s Congress have shown much political will for reform. Instead, the government adds to the problem by overspending and doing so extremely inefficiently. In fact, since the 1990s, Brazil’s government has doubled its spending as a percentage of GDP, now at 40 percent, incurring huge obligations by subsidizing hand-picked projects and favored companies, effectively crowding out the private sector. “In Brazil, we have this philosophy that the state is the great investor, but it is very inefficient and very slow to make decisions,” said Adriano Pires, head of the Brazilian Infrastructure Center.
 
“It’s not enough to carry out isolated measures, because they don’t take us anywhere,” said Miguel Daoud, a director for Global Financial Advisor. “The government needs a growth plan.” Most agree that any sustainable growth plan for Brazil would focus on increasing its productivity, private savings and investment. Productivity growth for the past decade has been only 0.9 percent annually, investment only 19 percent of GDP, and Brazilians remain chronically averse to saving.

Brazilian consumers are already some of the most highly leveraged in the world, said BMI’s Hamilton, and by further underwriting consumption the government is giving households incentive to take on even more debt, exacerbating the country’s deficits and perpetuating its reliance on high interest rates to attract capital inflows. Add to that a still overvalued currency and you have a formula for chronic non-competitiveness. “In short,” said Hamilton, “Brazil is consuming a lot more than it is producing, and at some point that has to end — or at least slow down. How and when this will play out is hard to call.”

Although some see it playing out with a prolonged period of lackluster growth, disappointing in light of the frothy expectations engendered by the BRIC narrative, others see it as the beginning of a needed correction. Neil Shearing, Capital Economics’ chief emerging markets economist, recently told the Financial Times: “All this hope of the Brazilian decade, of growth of 6 percent a year, was unrealistic. But it can do 3 or 4 percent, which is about par for the (current) stage of development of Brazil’s economy. Perhaps some sanity has come to the debate about Brazil.”