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Brazil and elections aftermath: what next?

Economic Comment


Yesterday, president Dilma Rousseff won a second term in office in a tight race. Her victory does not bode well for the highly-needed structural reforms in the country. While Brazil is in need of reforms on the supply side of the economy, during her first time in office Dilma focused on boosting demand. A U-turn on economic policy is – unfortunately – not expected.

In Brazil: It’s not the economy, stupid

The Brazilian economy is in the doldrums. After three years of poor performance, it fell into a technical recession in the first half of 2014 (see fig. 1). Monetary and fiscal stimulus and a renewed increase of commodity prices allowed Brazil to recover rapidly from the 2008/2009 global financial crisis. However, as the economic structure of Brazil did not allow for supply to keep up with demand, inflation has increased (6.75% in September) and the current account deficit has widened. Meanwhile, investment decreased on the back of deteriorating business confidence, which has recently reached a 5 year low (see fig. 2). Restoring it will be crucial for changing the tide. Monetary policy cannot be used to boost demand, as inflation is above the target range of the central bank.

Figure 1: Economic growth is weak
Figure 1: Economic growth is weakSource: EIU
Figure 2: Confidence at 5 year lows
Figure 2: Confidence at 5 year lowsSource: Getulio Vargas Foundation, National Confederation of Industry

Dilma’s share of the blame

The poor economic performance of recent years can to a large extent be attributed to the economic policies of Dilma’s administration. The problem with these policies is twofold. First, the policies focused on stimulating the demand side of the economy. However, structural problems were found on the supply side, which is reflected in the fact that inflation has been sticking to the upper side of the inflation target range in recent years, that unemployment has remained very low and that the current account deficit has increased, despite the low and sometimes negative GDP growth. Poor education, a large infrastructure deficit, an onerous tax system and bureaucracy have limited productivity improvements and have hurt Brazil’s competitiveness. Second, the policies were erratic, which increased uncertainty and hurt investor sentiment. Dilma’s macroeconomic policy mix consisted of unorthodox measures such as price caps on energy prices, the erratic implementation of capital controls and FX interventions in order to contain appreciation and depreciation of the real and less independence for the central bank. Policy has also been inconsistent. For example, expansionary fiscal policy thwarted attempts by the central bank to contain inflation through monetary tightening. All this has damaged credibility and business confidence. 

Election results mean Brazil will be muddling through

Moving forward, given an environment of low growth and high inflation, the task of the new president is huge. The crucial word is confidence, and bold reforms are needed to restore that. Dilma is not expected to deliver. She has a four-year record of not delivering progress on much needed structural reforms, and in spite of awareness of the need to increase investment, there is no indication that any spectacular progress will be made. Furthermore, the 5 October parliamentary elections have led to a parliament that is more fragmented than before. But even with quick progress on reforms, it will take time for the economy to pick up steam. In the meantime, any fiscal stimulus would lead to more inflation and countermeasures by the central bank. In effect, to less investment. As a result, the Brazilian economy will continue to muddle through. We expect growth to reach 0.4% in 2014 and 1-1.5% in 2015. Without structural reforms, Brazil will remain stuck in the mud.

Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60441

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