Country Report Brazil
With GDP growing by only 1%, 2012 has been a disappointing year for Brazil. In particular investment and the industrial sector have performed poorly. Meanwhile, consumption has remained relatively strong, to a large extent thanks to the tightness of the labor market, with unemployment remaining at record lows. Brazil’s monetary and fiscal policies seem to have become less orthodox, and the Brazilian real is now a strongly managed currency. The low unemployment rate and the low level of investment will constrain the growth of the economy in the coming years. Improving productivity has therefore become even more important. In this respect, it is a welcome development that the government has become somewhat more willing to address Brazil’s important structural issues and has launched new initiatives to improve the low quality of Brazil’s infrastructure.
Economic structure and growth
For the Brazilian economy, 2012 has been a disappointing year. In the first part of the year, the economy stayed in the state of almost stagnation it had entered in the middle of 2011. In the last two quarters of 2011 and the first 2 quarters of 2012 GDP grew only between 0.05% and 0.24% quarter-on-quarter (qoq). The economy recovered in the third quarter of 2012, but with a qoq growth of 0.6%, the recovery was much more modest than expected. As a result, GDP growth for 2012 is likely to have fallen to roughly 1%, after the already low 2.7% growth of 2011, which followed the impressive 7.5% growth of 2010.
In particular investment was weak in 2012, as gross fixed investment fell by an estimated 4%. This was partially the result of the strong monetary tightening in early 2011, but also of the competitiveness problems the industrial sector is facing. Value added in the industrial sector is estimated to have fallen by 0.5%, while value added in the manufacturing sector is estimated to have fallen even by 2%. The agricultural sector, with an estimated growth of 1%, and the services sector, with an estimated growth of 1.6%, performed better. The services sector benefitted from the fact that consumption growth stayed rather decent, as consumption is estimated to have grown by 3.5% in 2012. That private consumption has continued to do well is related to the tightness of Brazil’s labor market, with unemployment falling to a low 4.9% in November 2012.
In het longer run, Brazil is well positioned to benefit from high demand for agricultural goods and commodities. The country is a leading producer of many agricultural goods, such as sugar, soy, coffee, beef and chicken, and Brazil’s agricultural industry has been very successful at boosting its production and productivity. As the intensity of the agricultural production on current land in use is often low, the country can thereby easily boost its agricultural production further, which is a huge asset given that global demand for food is likely to continue to grow due to the expected continuation of population and income growth in the developing world. Brazil also is an important exporter of iron ore. Besides, the country is already a mid-sized oil producer, while oil production has the potential to grow strongly over the medium term thanks to the discoveries of large oil reserves in the so called pre-salt basin. However, the exploitation of these fields will require a lot of investment and advanced technology. The ability of Petrobras, Brazil’s oil giant which has a leading role in the exploitation of these new fields, to invest in these new fields is hampered by the government’s freeze on the price of local oil products. As pre-salt fields are not likely to come into production before 2014, oil production is likely to be stable at best in 2013. Compared to many other commodity producers, Brazil has a relatively developed industrial sector. However, as we already mentioned, this sector has performed weakly recently.
The weak performance of this sector is to a large extent related to a number of structural issues that limit the competitiveness of the Brazilian economy. In fact, the growth of the Brazilian economy is not held back by lack of demand, but by supply constraints. Also, as the unemployment rate is already low, improving Brazil’s productivity is key to boosting the growth of the economy. One of the most important of these structural issues that limit productivity is the tax system. Brazil’s tax system is extremely complicated. What is more, tax rates are also high, while the level of public service provision is rather low. This low level of public sector delivery is very much visible in the field of infrastructure. As a result of decades of underinvestment, the quality of roads, railroads, ports and airports in Brazil is low, although it seems that the government is now more willing to address this issue. In fact, investment in general is very low in Brazil, which constrains the rate at which the economy can grow. Gross fixed investment was equal to 18.2% in 2012, an extremely low rate. Meanwhile, there is also a lot of red tape. In fact, Brazil ranks 130th out of 185 countries (with the number 1 being the best scoring country) on the Ease of Doing Business index of the World Bank. Another challenge for the Brazilian economy is the availability of labor. As we already mentioned, the labor market is extremely tight. Although the performance of Brazil’s educational system has improved markedly in the past decades, with the country finally achieving full basic education, compared to other countries, the quality of the educational system remains mediocre.
Although there have been some problems at smaller banks, the risk profile of the overall banking system is decent. Bank regulation and supervision are strong and the banking system is well capitalized and liquid. The amount of credit extended to the private sector has continued to grow from 40.3% of GDP in 2006 to 61.4% of GDP in 2011. The latest data suggest that this trend has continued in 2012, but that almost all the credit growth has been realized by Brazil’s public banks. This is probably related to the efforts of the government to reduce borrowing costs in Brazil through a reduction of the interest rate on loans extended by public sector banks. In the past decade, an increase in household credit has boosted consumption. However, as the debt service burden of consumers has increased, the room for further growth seems limited, although the recent monetary easing may help to reduce the debt service.
As confidence seems to have grown in the final months of 2012 and the strong monetary easing is starting to have an impact, the economy is likely to grow more vigorously in 2013, with growth forecast to come in between 2% and 4%. However, the growth in 2013 might be affected by problems in the energy sector. Brazil relies to a large extent on hydropower energy, but a drought has resulted in very low reservoirs. As a result, Brazil may have to generate more electricity at oil and gas-fired plants, which produce electricity much more expensively, or, if the drought would be become really severe may even face energy shortages. This may derail the attempts of the government to boost the economy through a reduction of the electricity price. Furthermore, the tightness of the labor market and the extremely low investment rate limit the growth rate of the Brazilian economy in the medium term. Furthermore, it remains to be seen whether credit and consumption growth can continue to drive the economy. However, at the same time, the coming into production of the oil reserves in the so called pre-salt basin is likely to boost growth in the medium term.
Political and social situation
President Dilma Rousseff, who has ruled Brazil since early 2012, is very popular. In December 2012, her approval rating was 78%, while the approval rating of her center-left government was 62%. This is partially the result of the low unemployment rate. Just like her predecessor Lula da Silva, Dilma Rousseff is a member of the Workers Party (PT) and is leading a coalition that includes the Partido do Movimento Democratico Brasileiro (PMDB). The coalition has a majority in both the upper and the lower house. However, the coalition consists of a large number of parties and decision making requires broad consensus. This limits the speed at which reforms can be implemented, but also supports political stability.
The so-called Mensalão corruption scandal, in which senior members of the government of ex-president Lula da Silva were convicted of implementing a vote-buying scheme in Congress, has led to a lot of attention for corruption in Brazil. The fact that high politicians have been sent to prison by the Supreme Court marks progress, as the rich and powerful did not have to fear prison until recently. However, the strong fragmentation of the Brazilian political system makes it hard to deal with corruption effectively. By emerging market standards, corruption does not seem a particularly big problem for Brazil, as the country is ranked 69th out of 176 countries of the Corruption Perceptions Index. At the same time, the country only scores 43 points on this index (Denmark, Finland and New Zealand are the best performing countries with a score of 90, while Afghanistan, North Korea and Somalia the worst with a score of 8), which suggests corruption is nevertheless a serious issue in Brazil. Meanwhile, crime is relatively high in Brazil. Recently, there have been particularly violent confrontations between the policy and gangs in Sao Paulo.
A very important social trend of the past decade is the fall in poverty and inequality. While 37.5% of the population was poor and 13.2% extremely poor in 2001, this had fallen to 20.9% and 6.1% in 2011. Meanwhile, the Gini coefficient fell from 60.1 in 2001 to 51.9 in 2012. The fall in inequality has been the result of strong demand for labor, an increase of the minimum wage (in real terms the minimum wage has increased by more than 505% since 2003) and social transfers. About a quarter of Brazil’s population now gets the Bolsa Familia, a famous conditional cash transfer mechanism, which provides poor households cash as long as children are being sent to school. Meanwhile, the middle class has grown quickly, which has strongly boosted consumption and has turned Brazil into an attractive market for many companies. Inequality is still high in Brazil though. According to a recent study by the World Bank which covered 40 countries, a third of the income inequality in Brazil can be explained by factors on which people have no control such as race, gender, and the educational and occupational status of parents. Improving the quality of education will be key to realizing a further reduction of inequality in Brazil.
As Brazil has a relatively high debt service, realizing a high primary surplus is an important part of government policy. In 2012, the government managed to achieve the targeted 3.1% of GDP, but this was only possible by applying some creative accounting, such as omitting some infrastructure investment from the sums. What is more, there are some plans to weaken the fiscal responsibility law implemented in 2000. The total fiscal deficit in 2012 is expected to equal 2.9% of GDP.
Partially thanks to the strong tightening of monetary policy in early 2011, year-on-year inflation fell from 6.8% in August 2011 to 4.1% in August 2012. Afterwards, inflation has increased to 5.1% in December 2012. The central bank has reduced its main policy rate aggressively by 550 points from 12.75% in the summer of 2011 to 7.25 % late 2012 (see figure 4). Partially as a result of this easing, inflation is expected to remain above the 4.5% inflation target, although below the 6.5% upper bound of the inflation target range. However, inflation would have been higher had the government not used some price controls, such as a cap on petrol prices. In practice, it seems that the central bank is now aiming to keep the inflation rate between 4.5% and 6.5%, even as the central bank officially maintains the 4.5% inflation target. Brazil’s monetary policy has thus become less orthodox.
Brazil has a strongly managed exchange rate policy. It seems that the central bank aims for a real US dollar exchange rate between 2 and 2.1. The exchange rate is not only controlled through foreign exchange interventions, but also through capital controls and macro prudential regulations. Especially during the first half of 2012, Brazil implemented taxes on capital inflows. Some of these controls have been eased, but they may be tightened once again if strong upward pressures on the currency return. Furthermore, greater use of macro prudential measures such as increasing reserve requirements allow the central bank to limit credit growth without attracting more capital inflows. Meanwhile, unlike a year ago, when the real was still in the 1.70-1.80 range, manufacturers and exporters are no longer pushing for a currency devaluation.
The focus of the government agenda has shifted somewhat recently. While government efforts until recently focused on boosting demand, the government seems now more willing to address structural issues. It launched an initiative that foresees a greater role of the private sector in the provisioning of road, railroad, airport and port infrastructure. This may help to improve the quality of infrastructure. In 2013 a number of important auctions for private sector involvement is planned. The success of these auctions is an important indicator of the effectiveness of the new approach.
Balance of Payments
In 2012, Brazil’s trade surplus fell, as external demand weakened, in particular for iron ore, one of Brazil’s most important export products, while domestic demand remained relatively strong. As deficits on both the services account and the income account remained more or less at the same level, this resulted in an increase of the current account deficit from 2.1% of GDP in 2011 to 2.8% of GDP in 2012 (see also figure 5). The current account deficit is expected to increase further in 2013. This is a vulnerability. However, considerable inflows of FDI mitigate the balance of payments risk. Despite the low growth rate of the Brazilian economy in 2012, foreign direct investors remained optimistic about Brazil, which resulted in inward FDI inflows equal to 2.7% of GDP, which thus almost fully covered the current account deficit. Meanwhile, Brazil also was a net recipient of other types of private capital inflows. As a result, Brazil’s foreign exchange reserves have continued to increase. The biggest risk to Brazil’s balance of payments position is a prolonged period of low agricultural and commodity prices. However, this risk is mitigated by the fact that Brazil’s exports in terms of products and markets are more diversified than those of most other commodity producers.
Foreign reserves grew from USD 350bn in late 2011 to USD 379bn in November 2012. Thus, Brazil’s foreign reserves almost fully cover its total external debt. In 2012 they were equal to 15.1 months of imports and covered 241% of the debt service. The increase of Brazil’s foreign reserves contributed to an overall increase of Brazil’s total external assets from USD 723bn in late 2011 to USD 796bn in November 2012. Meanwhile, the total external liabilities of Brazil have declined from USD 1,462bn to USD 1,445bn. As a result, the Net International Investment Position (NIIP), which fell rapidly in 2010 to USD -882bn, has improved from USD -738bn in December 2011 to USD -648bn in November 2012. Meanwhile, the risks of the large net negative investment position are not only mitigated by the large holdings of foreign reserves, but also by the fact that almost half of Brazil’s foreign liabilities consists of foreign direct investment.