Feeble investment puts Brazil's BRIC status at risk
The BRICs are in danger of becoming the RICs. Brazil is losing ground to its major emerging market rivals Russia, India and China, and could slip further if it doesn’t get to grips with chronic under-investment, says Flavia Cattan-Naslausky, Director of Latin America FX Strategy at RBS.
Latin America’s largest economy is forecast to have grown just 1 per cent in 2012 – its slowest rate in a decade – and 2013 threatens to be another disappointing year. President Dilma Rousseff is not dithering. Throughout 2012, her centre-left administration eased credit limits, raised import duties, spent billions of reals on buses, trucks and other home-made goods and cut payroll taxes and energy prices to encourage business.
Yet third quarter growth figures were startling. Tucked away in data showing growth of just 0.6 per cent in Q3 (a figure that took even the finance minister by surprise) was news that investment spending had tumbled 5.6 per cent since Q3 2011. Given the glut of unsuccessful stimulus measures, it is increasingly difficult to escape the conclusion that the government is running out of ideas.
The risk this poses to Brazil’s medium-term growth prospects cannot be overstated.
Until recently, its free-spending consumers and foreign appetite for its soybeans and iron ore masked the investment deficit.
The government’s defenders would claim that a decade of policies focused at raising ordinary Brazilians’ purchasing power has lifted millions out of poverty. Unfortunately its approach has also shrivelled the savings rate and starved industry of vital financing. Total Chinese investment may look top heavy at a staggering 47 per cent of GDP but investment spending of just 20 per cent in Brazil is woefully inadequate. The consequence has been an economy with insufficient capacity to absorb domestic demand. Growth is being imported away.
Investors are increasingly asking whetherthe hype around Brazil as a major destination for Foreign Direct Investment is warranted. Regional rivals such as Mexico, Chile, Columbia and Peru – all of them investing between 23 and 26 per cent of GDP – are raising their game and increasing the pressure. The recent growth of Mexico’s automotive sector should serve as a wake-up call to a country that produces 2.5 million vehicles a year.
What should Brazil do? On the monetary side, the strong consumer economy and Brazil’stight labour market bar the way to further rate cuts, especially since a further depreciation in an already-weak real could raise the import costs and so stifle high-street spending. At least policymakers have now been stripped of their favourite excuse – the strong real. Brazil’s currency has weakened 38 per cent from peak to trough as rates tumbled 525 points between July 2011 and last October. The country’s failure to sustain investment in such favourable conditions – let alone grow it – leaves little doubt that investor confidence is seriously rattled.
On the fiscal front, a USD900 billion programme to upgrade Brazil’s ramshackle energy, water and power infrastructure as well as road, rail and housing has received plenty of hype.
Improving its physical infrastructure is a vital piece of the puzzle, but a more fundamental change in the state’s approach will be needed to arrest the fall in private investment. Rousseff’s administration is aware of the challenge but it has done little to shake the old image.
Speculation grows that the government will continue to tap its budget surplus to prop up the economy. Confidence is further undermined by the use of ‘fiscal adjustments’ to meet 2012 goals, or manoeuvring over electricity pricing to hit inflation targets. Where tentative progress has been made (for example, cutting payroll taxes for many firms) its poorly-articulated strategy has lessened the impact.
The quality of fiscal policy needs to change, with less government meddling, fewer objectives and a clearer business-friendly agenda.
First, it must tackle the ‘Brazil cost’: rigid labour markets, under-skilled workers, corruption, complicated taxes, arcane regulations and an ineffective legislature. These bottlenecks have already neutered the impact of Brazil’s second growth acceleration programme – known as PAC II – and seen the country relegated to 126th place in a World Bank survey of where to do business.
The legal framework must be overhauled, bureaucracy slashed, labour relations reset and anti-corruption efforts redoubled. It must also ensure that, in fixing one problem, it does not cause another elsewhere. Its decision to tackle the country’s high electricity tariffs, for example, is an important measure in helping reduce industry’s costs; but it also threatens investment by power companies who suggest government-controlled concessions no longer offer attractive returns.
Instead of trying to tightly manage the economy, the government should play a more modest role. Rather than burning the state’s resources on consumer tax breaks to try and sustain spending, it should cut overall government expenditure and instead ease the burden on business. Extending last year’s payroll tax cut right across the economy would be a good start and begin to encourage the extra investment so urgently needed.
The price of such a policy would be weaker consumer spending in the short term – a difficult pill to swallow as the government approaches elections in 2014. The payoff would be more sustainable, and ultimately higher, growth over the long term. In truth, the failure of the current monetary and fiscal approach shows Brazil has little alternative if it wants to retain its membership of that exclusive BRIC club.
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