Brazil's economic growth: A test of credibility

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Despite Roussef’s protestations, only structural reform will put Brazil back on a growth path.

In an interview with Euromoney this month, Gerardo Rodriguez, former undersecretary of finance and public credit for the Republic of Mexico, says the markets will force policy change in countries such as Brazil. For Rodriguez, now senior investment strategist of BlackRock’s emerging markets team, the markets punish policy weakness, driving corrective responses towards orthodox macroeconomic management.

Unfortunately, the signs of this happening in Brazil are not encouraging. In early September, first finance minister Guido Mantega and then president Dilma Rousseff declared to the national media that "the worst is over" with regards to the country’s struggling economy. Second-quarter GDP growth of 1.5% had surprised on the upside and a $60 billion package of support for the real had halted its dramatic decline. Seemingly these two combined to give the government the cover to call the bottom of disappointing growth figures.

There are, however, good reasons to think that Rousseff has been dangerously rash in predicting a continuing return to strength in the Brazilian economy. True, the second-quarter GDP figures took the markets by surprise, but a decent performance had been expected and the consensus is for a return to a more anaemic third-quarter performance.

The stop in the slide in the real is also likely to be a short-term – and potentially costly – treatment of the symptoms of FX weakness rather than the disease of underinvestment, fiscal expansionism and an uncompetitive and overly bureaucratic manufacturing base. Worse, the intervention has probably validated the government’s belief in the effectiveness of its natural inclination to interventionism.

The one bright spot is that the central bank has – belatedly – realized that the government’s commitment to the fiscal side of inflation control isn’t likely to materialize any time soon. Raising the Selic rate signals its attempt to regain credibility. But that will take time to rebuild and now Brazil faces sharp monetary tightening in the face of stubbornly high inflation at the same time as weak growth. Perhaps significantly, in the latest Copom (central bank monetary policy committee) minutes the previous meeting’s minutes’ description of the government’s fiscal policy as being "expansionary" has been removed.

Rousseff identified the "oscillation" of the dollar as the principal cause of the country’s recent slowdown. Fed policies had hit all emerging currencies and countries, she claimed, without exception. Well, yes, but not equally. Since May, Brazil’s five-year swaps have widened by 362 basis points and the real has depreciated by about 15%. In Chile, the peso depreciated by about 6%. Mexico and Colombia lay somewhere in between.

By identifying the main problems for Brazil’s economy as external, the policy response of internal reform is taken off the table. In contrast, Mexico, which has much stronger financial and economic fundamentals and institutions, is embarking on an ambitious programme of reforms – including labour, fiscal and energy initiatives that economists and bankers predict will boost investment and long-term GDP growth.

Rousseff, a former student of economics, must surely recognize the gamble she is taking by predicting resurgent growth in the second half of 2013 and beyond. Facing intense domestic political pressure and an election next year, it may be intended to boost confidence. But for a government with dwindling credibility across the board the dangers of such a policy backfiring are self-evident.