Country Report Brazil
Economic growth in Brazil is likely to fall below 1% in 2014, as both investment and consumption have been weakening. In the second quarter, the economy officially entered a recession. Meanwhile, the October 2014 presidential elections have become very competitive after Marina Silva’s entry to the race.
Strengths (+) and weaknesses (-)
(+) Relatively diversified economy and a large domestic market
Brazil’s 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 367bn in July 2014 and were thus equal to slightly more than 13 months of Brazil’s 2013 imports of goods and services.
(-) 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.
(-) Sizeable current account deficit
In recent years, Brazil has posted current account deficits. In 2013 the deficit was no longer fully covered by FDI inflows. The low level of openness of the Brazilian economy thereby limits the room for balance of payments adjustments.
1. Economy in recession
Economic growth in 2014 in Brazil may fall below the already disappointingly low levels of the past three years. The second quarter data released late-August show a contraction of 0.6% qoq, and added a revision of the Q1 data, which now shows a contraction of 0.2%. The median GDP 2014 growth estimate of roughly 100 financial institutions had already fallen to 0.79% in mid-July (see also figure 1). Low confidence and a monetary tightening cycle, the Banco Central do Brasil increased its SELIC rate from 7.25% to 11% between early 2013 and early 2014, have lowered investment. Meanwhile, higher credit costs, less job creation and lower real wage growth are also resulting in a slowdown in private consumption growth. Retail sales have been very weak recently, as they fell unexpectedly by 0.7% month-on-month in June, while service activity grew by a low nominal 5.7%. Although these data were partially influenced by a higher number of public holidays due to the World Cup, the data nevertheless illustrate that consumption growth, which has driven economic growth in recent years, is losing momentum (see also figure 2). As both business and consumer confidence has almost fallen to the low early 2009 levels, the economy may worsen still going into the third quarter.
The weak performance of the Brazilian economy in recent years can partially be explained by commodity price developments. While commodity prices are still relatively high, they are no longer increasing, unlike in the period 2003-2010. However, the fact that inflation has remained high, it stood at 6.5%, the upper bound of the 2.5%-6.5% inflation target range, in July, and that the current account deficit increased to 3.6% in 2013, illustrate that the low growth of recent years is primarily a result of supply constraints. Higher growth therefore requires higher investment and productivity growth. However, Brazil’s investment-to-GDP ratio has remained very low in recent years and the low business confidence suggests that this is likely to remain so in the near future. Meanwhile, progress on structural reforms has also remained slow. This may change after October 2014, when general elections will take place.
2. Election race likely to become very competitive
The death of presidential candidate Eduardo Campos in a plane crash in mid-August 2014 has dramatically changed Brazil’s October presidential election race. Campos, who was running for the center-left Brazilian Socialist Party (PSB), was the third placed candidate in the polls behind President Dilma Rousseff and centre-right candidate Aecio Neves and therefore did not stand a high chance of reaching a possible second round of the elections. However, his running mate and successor Marina Silva seems to have much more popular appeal. In 2010, she surprisingly got 19% of the vote as the candidate for the Green Party. She has stated that she will give a high priority to political reform, which may allow her to get support from the discontented middle class which has become very vocal in Brazil since last year’s Summer. Meanwhile, a spokesperson of the Brazilian Social Democracy Party (PSDB), the party of centre-right candidate Aecio Neves, signalled that this party would support Silva in a second round. A poll released a few days after the death of Campos showed that Rousseff was supported by 36% of the voters, against 21% for Silva and 20% for Neves. However, in a second round (which will take place if no candidate manages to get more than 50% in the first round) Silva would get 47% of the second round vote, against 43% for Rousseff. If Neves would go to the second round, he would be expected to get less support (39%) than Rousseff (47%). While the election has thus become rather competitive, Rousseff has still significant strengths. Her approval rating has increased recently and she still has a strong core constituency among poor voters. Meanwhile, she also has the most campaign resources.
In economic policy terms, a Silva presidency could imply a gradual return to orthodoxy, as Silva’s economic team favours the fiscal restraint, inflation targeting and exchange rate flexibility of pre-Rousseff administrations. However, Silva’s policy agenda is to a large extent focused on political reform. Political reforms could be very welcome given the clientelism and inefficiency of the existing system. However, her unwillingness to accept the existing wheeling and dealing of the political system, whereby political parties tend to run ministries as their personal fiefdoms, may make it more difficult for her to get support for structural reforms, such as reforms aimed at simplifying Brazil’s extremely complicated tax system. Meanwhile, a Rousseff administration could become more reform minded after the elections, as there will no longer be a need to be re-elected. A Neves administration will be the most business-friendly government. However, as many Silva supporters may prefer a Rousseff win over a Neves win, the likelihood of Neves winning a second round is relatively low.
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 vigorous 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 capitalised 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.