Brazil faces tough future, say economists

Rob Dwyer
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Vital reforms unlikely; next president will inherit inflation headache.

Regardless of the outcome of Brazil’s presidential election in October, economists warn that the upper limit of the country’s trend growth is between 2% and 2.5%. 

Despite the volatile reaction of Brazil’s currency and stock index to changes in opinion poll projections of the winner, there is little expectation among economists that either leading candidate will be able to make the structural reforms that are needed to increase potential GDP growth in the lifetime of the next administration.

The election contest became extremely close at the end of September, with incumbent president Dilma Rousseff eliminating the lead that Marina Silva enjoyed in projections for the second and decisive round of voting on October 26.

Volatility on the Ibovespa has increased – with government-affected stocks such as Petrobras, Eletrobras and Banco do Brasil – see-sawing on newly released voting data. The currency has also become more volatile and in two weeks in mid-to-late September declined to R$2.45 to the dollar from R$2.20 (fears of China’s slowdown and the bull-run of the dollar were also strong external factors for this devaluation).

No cue

However, the electorate is unlikely to take its cue from the financial volatility, as one economist notes. “The business-unfriendly tone in this campaign has been impressively horrible,” he says. “Not since 1989, when Lula first ran against Collor in the run-off can I remember an election where the business community has been on the receiving end of such disdain from both leading candidates.”

Euromoney spoke to several São Paulo-based economists in September to survey expectations for post-election economic policies and performance. Following the dismissal of a Santander analyst in July this year who wrote a message to clients that linked the impact of the elections to the financial performance of key metrics, none was willing to speak on the record, but there was considerable consensus that the economy will grow by about 0.5% this year and at best by about 1% next year (although there was one outlier whose prediction for 2015 was closer to 2%).

We don’t think [energy] rationing would be as serious as in 2002 because there is more thermo-generation today,
but the effect would be enough to cause a recession


The next president will inherit a tricky macro-economic situation: inflation will be near the top of its band of 6.5%. Analysis by one economist into the causes of the higher inflation in the period between 2011 and 2013, when compared with 2004 and 2010, found that nearly 70% of this came from higher inflation expectations. Therefore, a key policy initiative for the next administration should be to return to an orthodox inflation-targeting regime, with the accompanying policies of a free-floating exchange rate and fiscal restraint.

Economists say that as Silva is advocating making the central bank independent it would be easier for her – although not easy – to rebuild credibility in inflation fighting and begin to lower expectations.

However, one economist suggested that the target should be re-set, at least in the short-term. “They would have to say they were committed to, say, 5.5% by the end of 2015 and then something like 4.8% by the end of 2016 – anything else wouldn’t be a serious commitment.”

An additional complication will be removing price controls on gasoline and removing energy subsidies, which will add to inflationary pressures. Interest rates would have to remain high – or even go higher – as part of this policy and would hit already low growth.

The real will almost certainly devalue to try to reignite Brazilian industry’s competitiveness – with most predicting a fair value target of between R$2.80 to R$2.90 to the dollar by the end of 2016.

Economists also say that the labour market is at an inflection point, with a falling participation rate preventing a rise in unemployment in the past 12 months, but which is beginning to rise, which will also subdue growth.

Potential rebound

In the short term, the only positive aspect that economists can predict is a potential rebound in business confidence. “Business confidence is so low right now that if Marina wins you will likely see a big rebound which will help growth for 2015 – and even if Dilma wins and presents herself as ‘version 2.0’ and borrows credibility from new appointments – you will likely still see a significant rebound,” says an economist.

There is pessimism about the likelihood of the structural reforms that are needed to boost long-term growth, which are becoming even more important given that Brazil’s recent demographic driver of growth is dissipating (the working age population is now growing at just 1.2% a year and will be zero by 2030).

Brazil’s tax collection is higher than the OECD average of developed nations and is more than twice the Latin American average but with 85% of spending nondiscretionary it is doubtful whether Silva would have a political base in congress to achieve fiscal reform, or whether Rousseff would have the will.

Even if reform were possible the fiscal cuts would take years to materialize. Instead, economists say taxes will have to go up in the short-term and that will further impact growth. Expectations for structural reforms to boost labour productivity, or health and education reforms are similarly low.

Then there is the wild card of energy rationing. Should rainfall not return in November at historical norms then energy rationing would have to be implemented, knocking between 100 basis points and 150bp off 2015 GDP growth – almost certainly plunging the country into recession.

An economist says: “Energy rationing is a live issue. We don’t think rationing would be as serious as in 2002 – when it lowered GDP growth by 2% – because there is more thermo-generation today but the effect would be enough to cause a recession.”