Country Report Brazil
The recent mass protests show that Brazil's middle class has become more vocal in its demands for better public services. Meanwhile, economic growth has continued to disappoint.
Strengths and weaknesses
Relatively diversified economy and a large domestic market
Its exports are relatively diversified, both in terms of export products and markets. Together with the large domestic market, this reduces the vulnerability to external shocks.
Large stock of foreign reserves
Foreign reserves stood at USD 373bn in late 2012 and were equal to almost 15 months of imports.
Structural issues reduce or limit Brazil’s growth potential and competitiveness
A complicated and high rate tax system and inadequate supply of infrastructure and human capital constrain the competitiveness of Brazilian producers and the growth potential of the economy.
Current account deficit
Brazil’s current account deficit has been growing and is no longer fully covered by FDI inflows. At 2.4% of GDP, the deficit was not extremely high in 2012, but the low level of openness of the Brazilian economy limits the room for balance of payments adjustments.
1. Middle class protests
In late June 2013, Brazil experienced mass protests that were unprecedented in its recent history. The direct cause of the demonstrations was an increase of bus fares, but they soon turned into protests against corruption, the low quality of public services in general and the authoritarian way in which the police reacted to the protests. While taxation in Brazil is relatively high by emerging market standards, the quality of public service provision is rather low. The protests showed that in particular the middle class wants the government to be more effective and more responsive to the demands of its citizens. President Rousseff reacted to the protests by announcing a number of political reforms. However, the response from Congress was not very enthusiastic. Nevertheless, Congress recently approved a bill that designates all royalties from newly found oil fields to health and education. While the protests were not directed in particular against President Rousseff, they nevertheless had a big impact on her popularity. The percentage of Brazilians polled who found her good or great dropped from 57% before the protest to 30% directly afterwards. However, recently her popularity has recovered to 36% and she remains the favorite to win the 2014 presidential elections. Nonetheless, Marina Silva of a newly founded Green Party could as a possible contender to benefit from protest votes.
2. Economic growth continues to disappoint
Economic growth continued to disappoint in the first quarter of 2013, after disappointingly low growth in 2011 and 2012, when GDP grew by 2.7% and 0.9%. The economy grew by only 0.55% quarter-on-quarter (qoq) in the first quarter of 2013. Growth would have been worse, had the agricultural sector not grown very rapidly. Thanks to a record harvest, agricultural GDP grew by 9.7% qoq (seasonally adjusted). The good news from the first quarter was that investment, which was very weak in 2011 and 2012, finally recovered, as investment went up a strong 4.6% qoq. The pick-up in investment seems good news, especially as Brazil has a very low investment ratio and the economy is suffering from supply constraints. However, we are not convinced that investment growth will remain this strong. At first sight, recent industrial production data give reason for optimism, as capital goods production increased by 13.8% yoy in the first 6 months of 2013. However, we note that on the demand side, inventory growth contributed a strong 140 basis points to growth in 1Q, which bodes not well for growth in the rest of the year. Meanwhile, the HSBC manufacturing PMI has fallen in recent months and reached contraction levels in July.
Meanwhile, consumption, which has driven growth in recent years, seems to have weakened in the beginning of this year. In July, consumer confidence fell to the lowest level since 2009, according to the Getulio Vargas Foundation. As inflation breached the upper bound of the 2.5-6.5% inflation target range, the central bank tightened its monetary policy between April and July in three steps by 125 basis points to 8.50%. The central bank has also intervened to stem the fall of the real. Just like the currencies of other emerging markets with current account and budget deficits, the real has come under downward pressure now that financial markets expect the US Federal Reserve to start tapering its special assistance programs (see also figure 2). Overall, we expect the economy to grow by only roughly 2% in 2013, as confidence remains relatively weak.
3. Moment of truth for new infrastructure initiatives is near
Last year, the Brazilian government launched a number of infrastructure initiatives that were warmly welcomed. The level of development of infrastructure in Brazil is relatively low, which became even more apparent this year, when the relatively big 2013 agricultural crop overloaded the infrastructure system, which resulted in long traffic jams and even higher transportation costs. It was hoped that the initiatives launched last year, which foresaw an increased role for the private sector, would be able to partially deal with these problems. However, in late July 2013, the auction of the concession to build and operate a new metro line in Sao Paulo failed. Furthermore, the auction of the concession to build and operate a high speed railway line between Sao Paulo and Rio de Janeiro was postponed. Later this year, the government hopes to auction the concession for 9 road projects and 10 railway projects. The success of these auctions will determine to what extent Brazil will be able to deal with its huge infrastructural challenges.
Brazil has a turbulent macroeconomic and political history. After a long period of military rule, democracy was (re)established in the 1980s. Brazil had to reschedule its public debt in the late 1980s and experienced hyperinflation in the late 1980s and early 1990s. Since the launch of the Plano Real in 1994, Brazil has been able to make its macro economy much more stable, in spite of a number of crises in the first decade after the launch of the Plano. Rising commodity demand and booming domestic demand on the back of strong wage and credit growth resulted in strong economic growth in the 2000s. Although growth has disappointed lately, and Brazil’s policy mix has become somewhat more heterodox in recent years, support for anti-inflation policies remains strong. Brazil used to be one of the most unequal countries in the world, but inequality and poverty have fallen rapidly in the past decade, though inequality remains high. Several structural issues limit the growth potential of the economy. First, the savings and investments ratios are extremely low. Second, tax rates are high and the tax system is extremely complicated. Third, the quality of infrastructure, education and health is quite low. However, Brazil’s banking sector is well capitalized and supervised. Brazil’s exports are relatively diversified, both in terms of markets and products, even as the reliance on commodity exports has increased in the past decade. Brazil is well positioned to benefit from the likely continued rise of global demand for food and agricultural products. Meanwhile, oil production is expected to increase strongly this decade, which will turn Brazil into a major hydrocarbon producer. Brazil also has an important manufacturing sector, although this sector has struggled in recent years.