Country Report Brazil
Brazil’s economy is in the doldrums and the recent return to sounder macroeconomic policies, though positive in the long term, will weigh heavily on economic activity in 2015.
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
Brazil’s foreign exchange reserves stood at USD 355bn, or around 13 months import cover, at the end of 2014 and thereby provide a cushion against liquidity risks.
(-) Structural issues constrain growth potential and hurt competitiveness
A complicated and high rate tax system, a large infrastructural deficit and an inadequate supply of human capital constrain the competitiveness of Brazilian producers and economic growth potential.
(-) Sizeable current account deficit
Large and increasing current account deficits, no longer covered by FDI since 2013, render Brazil vulnerable to a stop or reversal of capital inflows. Especially as the low level of openness of the Brazilian economy limits the room for balance of payments adjustments.
1. New cabinet up against a challenging political environment
President Dilma Rousseff won a second term in office in a tight race on 26 October 2014. The elections increased the already high fragmentation of Congress. With 18 parties in the Senate and 28 in the Chamber of Deputies, the new cabinet enjoys less political clout, so adopting reforms will be difficult. The tight win at 51.6% of the votes, reveals a divided Brazil. Thus, the social support the president enjoys is also low, so austerity measures or failure to improve public service delivery could lead to bouts of social unrest, without destabilising the government though. On top of this, a corruption scandal concerning Petrobras, the state owned oil company, is taking huge proportions and might further hurt political and social support. Recent investigations indicate large construction companies and politicians are involved, so the scandal is likely to hurt infrastructure development and policy making this year. Besides, as the company failed to properly report on 14Q3, there are concerns about it not being able to meet reporting obligations for 2014 on time, which could trigger a request for accelerated payment by bondholders and lead to a liquidity crisis. The government is expected to provide support, but that could deteriorate fiscal balances significantly and hurt already low investor confidence. Thus, the president will be faced with the difficult task of balancing low support and high popular demands with sounder economic policy.
2. Sounder policies, worse economic prospects… at least in the short term
The Brazilian economy is in the doldrums. It fell into a technical recession in the first half of 2014 and almost came to a standstill in 2014, when economic growth was estimated at a mere 0.1%. Investments contracted and previously buoyant private consumption, one of the main growth drivers in past years, slowed down on the back of higher credit costs, less job creation and lower real wage growth. The latest data, concerning 14Q3, indicates that yoy industrial production has been contracting since 13Q4 and yoy retail sales also fell in 14Q3. Perspectives for 2015 are not brighter. The leading economic indicator, the IBC-Br has been contracting on a yoy basis for most of 2014, while consumer confidence fell to a historic low in January 2015 (fig. 1) and business confidence indicators remain pessimistic. Besides, persistent drought in the South- East already affected electricity supply in January 2015 and could lead to electricity rationing this year. As the region accounts for a large share of the Brazilian economy, particularly industry, that is poised to hurt output. On the external front, prices for Brazil’s commodities are expected to moderate. On the positive side, the president appointed a new economic team with strong credentials, which has made a U-turn towards orthodox macroeconomic policies. This is positive for restoring investor confidence and for reducing imbalances in the longer term, but austerity measures and monetary tightening to contain high inflation will hurt growth in 2015. Consequently, economic growth is expected to be around -0.5% and the risks to this forecast are tilted to the downside.
3. Increasingly vulnerable as fiscal and external balances deteriorate
In 2014, Brazil’s twin deficits were the largest since 2001, which increases the country’s financing needs and its vulnerability to market sentiment and developments in international financial markets. The budget deficit more than doubled to 6.7% of GDP (fig. 2), while the primary balance turned negative for the first time in 20 years, on the back of disappointing revenue and an electoral spending spree. The current account deficit (CAD) increased from 3.6% of GDP in 2013 to 4% in 2014, while the trade balance became negative for the first time in 13 years (fig. 3), on the back of lower commodity prices and lingering competitiveness issues. FDI coverage of the CAD fell further from 83% in 2013 to 67% in 2014, rendering Brazil increasingly vulnerable to capital outflows and to events in international financial markets. Unfortunately, market sentiment has generally worsened, despite some respite after the appointment of the new macroeconomic team (fig. 4).
Thus, improving the fiscal balances will be crucial for Brazil to avoid a rating downgrade to junk grade, which could hurt capital inflows. Besides, while financing should not be a problem, Brazil will be vulnerable to higher volatility on capital markets due to monetary tightening in the US. Fortunately, austerity measures and falling demand should help improve the twin deficits next year.
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 and government support programmes resulted in strong economic growth in the 2000s. Despite sluggish growth and more heterodox policy in recent years, support for anti-inflation remains strong. Due to progress on reducing poverty and inequality Brazil is no longer one of the most unequal countries in the world, but income disparity remains high, even for Latin American standards. 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 a global player in the agriculture sector and is well positioned to benefit from the likely continued rise of global demand for food and agricultural products. Brazil also has the potential to become a major oil producer, but deepwater, pre-salt fields make it a high cost producer and low oil prices could delay the development of the sector. Brazil also has an important manufacturing sector.