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Brazil: Time for a religious revival

Brazil’s consumption-led economy is starting to run aground.

Poor Brazil. First the new pope is Argentine and then it is accused of blasphemy – of going against the holy trinity of economic policy (floating exchange rates, inflation targeting and fiscal restraint) that was credited with producing the Brazilian economic miracle of the past couple of decades. It’s hard to argue that in recent years Brazil has failed to adhere to this trinity. Brazil saw a flood of liquidity of biblical proportions driven by quantitative easing heading its way and it heard a voice telling it to build an ark of capital controls and interventionist policies. Rafts of policies were introduced – tax cuts on the car industries to boost sales, price controls on utilities and oil to lower inflation. Fighting desperately against the tide of money became a constant short-term preoccupation with continual adjustments and tweaks, and the dollar exchange rate became the government’s water mark.

But now the flood is slowing and the economy is running aground. Economists expect growth to recover to around 3% this year, but if that comes to pass it will have been created by some serious priming of consumption. That consumption-led story hasn’t got much further to go. The long-term growth trend for Brazil is now thought to be somewhere under 3% – just two years ago bankers in the country thought that trend growth was somewhere between 4% and 5%.

The problem is that Brazil got what it wanted. Private investment has gone elsewhere. Other countries in Latin America are now the story: Peru is growing at above 6%, Mexico is being hailed by so many people as the region’s powerhouse – even before the reforms are introduced – that the optimism already feels a little overwhelming; Chile continues to be the perfect example of orderly macroeconomic management and Colombia shows large potential.

Just when Brazil needs to move the engine of economic growth away from the consumer-led consumption model, something strange is happening with investment. For the first time in two decades, investment is falling for reasons that are not short-term-crisis-related. Investment has always been relatively low, but as BTG Pactual’s chief economist, Eduardo Loyo, points out, at least it was growing (apart from brief dips in 2001 and 2009). Last year, however, investment fell by 5% when it was expected to grow by the same amount. Loyo’s back-of-the-envelope calculation is that this shortfall alone accounted for two percentage points of missing GDP growth.

In the short term, policy looks challenging. With persistent inflation even with low growth conventional demand-management policies would choke off the sole driver of growth, which – especially in an election next year – is unpalatable. The real answer remains productivity of course, which will enable growth and limit currency appreciation. Between 2000 and 2010 productivity in Brazil grew annually by 1.3%. Peru achieved exactly double that, driven by large increases in investment – much of it foreign.

Brazil needs to compete for these international investment flows again. And to do so its faith in its holy trinity needs to be born again – as well as finally tackling the demonically difficult task of public sector reform; tax reforms and easing the regulatory burden on business.

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