As the country sinks into what threatens to be its worst recession since the 1930s, rattled by political turmoil and in the midst of severe stagflation, Brazil is playing with fire.
The immediate causes of its woes are external shocks from the commodities market, China and the US Federal Reserve – all of which have stalled Brazil’s economic growth engine. However, much of the country’s pain is self-inflicted. Today, Brazil is suffering the consequences of a lack of reform during its golden age.
Urgent measures are now needed to reduce the country’s fiscal deficit, as well as key structural reforms to reduce the size of the government. However, a shaky political situation emanating from corruption scandals and political ties to state-owned enterprises has delayed the action needed for economic recovery.
Regressive utopia
Fernando Henrique Cardoso, who became finance minister in 1993 before going on to become president less than two years later, made great efforts to overhaul the country’s economy by privatising state enterprises and opening up to foreign trade and investment. His aim was to equip Brazil to flourish in an era of globalisation through innovation, technology and competitiveness.
After his departure from office, however, the new government under Luiz Inacio “Lula” da Silva reverted to a regressive utopia of statist protectionism – and missed an opportunity that may not come again. Lula’s successor and today’s president Dilma Rousseff could have used the commodity windfall that Brazil enjoyed between 2011 and 2014 to trim the bloated state, but instead she splurged on handouts, subsidised loans and costly tax breaks for favoured industries.
What’s more, there are a number of structural issues that place the country in an especially difficult position. First, after successful macroeconomic stabilisation in the second half of the 1990s, Brazil is back to square one with a mismanaged macroeconomic environment. Since its peak rate of growth in 2010, the Brazilian economy has done nothing but decelerate, entering negative territory in 2014.
While most countries are enjoying falling energy prices, the normalisation of regulated prices in Brazil has raised inflation way beyond the official target of between 3% and 6%. The central bank has responded by raising interest rates to 14.25%, despite the economic recession. Furthermore, the fiscal deficit has deteriorated rapidly to 9% of GDP, pushing public debt up further – from 62.5% of GDP four years ago to 72.6% today.
One of the key reasons for Brazil’s growing budget deficit and sovereign debt load is its over-generous pension system. Failure to reform pensions has led to lower productivity as people are discouraged from joining the workforce, forcing others to pay higher taxes in order to compensate for the deficit. This poses the risk of defaults in sovereign and corporate debt, which could lead to further downgrading and higher borrowing costs.
Secondly, Brazil’s structural problems are acute and difficult to solve. The opportunity of the good years was not used, and the so-called Dutch disease generated by the commodity boom has become one of Brazil’s key areas for economic development.
There are also other more deeply-rooted problems such as poor educational levels. Indeed, the share of the population who attain tertiary education remains low at 13%, compared with the G20 average of 27%. The quality of education ranks very low even when compared with other emerging economies meaning effective education is crucial for Brazil to improve its economic prospects.
As if this were not enough, the government is also facing a multibillion-dollar corruption scandal and the possible impeachment of President Rousseff.
What next?
To solve these problems, Brazil must take control its fiscal deficit and inflation in the short term, undertake structural reforms in the economy and regain its regional influence.
First, its fiscal condition needs to be improved to prevent further sovereign credit-rating downgrades. An additional increase in borrowing costs from downgrading would be detrimental to Brazilian corporations. Monetary policy tools should be used to bring down inflation, even at the cost of an even greater recession in the short term.
Secondly, an unremitting effort to push through structural reforms is necessary to bring the economy back on track. The role of state-owned enterprises in the economy should be reduced to increase transparency – privatisation of both these and state-owned banks is also essential. What’s more, attracting foreign capital to upgrade infrastructure is vital, as is the reform of the educational system.
Finally, Brazil needs to find a new leading role in the region. Locked out of the promising Pacific Alliance between Mexico, Peru, Colombia and Chile, Brazil is becoming isolated from the best-performing economies of Latin America. An association agreement with the Pacific Alliance is long overdue.
Political stability
Over and above the very weak economic situation, it is political instability that is paralysing the Brazilian economy. While the boom years have not been used to support reform, Brazil is currently experiencing resistance to economic reform, especially with regards to its austerity measures and political ties with SOEs. Though it is clear that President Rousseff is moving towards tightening policies, the road to reform is not easy in the current political climate.
The question of whether Roussef’s impeachment might result in a better outcome for Brazil remains doubtful. All things considered, it can be expected that Brazil will remain subject to economic and political turmoil for quite some time
