Goldfajn’s great but gradual restoration

Brazil’s central bank governor Ilan Goldfajn says the end of deleveraging may lead to a stronger recovery but that reforms are crucial to sustaining the country’s economic rehabilitation

  • By Thierry Ogier
  • 11 Oct 2017
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Central Bank governor Ilan Goldfajn in August 2017 as he launches a campaign to stimulate the circulation of coins. Some rights reserved by Agência Brasil/José Cruz/flickr
Brazil’s longest recession on record is officially over but the scars it has left behind are all too visible.


Unemployment is still high, at the rate of 13%, while a quarter of the economically active population is officially “underemployed”.

In Rio, the expected post-Olympics boom never materialised and over 40% of office space was still vacant in the first half of the year, according to Colliers, a real estate consultancy. In São Paulo, the vacancy rate (24%) was also much higher than the Latin American average (18%).

The symptoms of the crisis may now start to dissipate as Brazil’s economic fortunes have started to revive of late. But the question is: how long will they last?

The recovery is finally underway after two consecutive quarters of growth, although it will be a “gradual” one, according to a cautious Ilan Goldfajn, president of the country’s central bank. “People are seeing that the economy is finally recovering, that interest rates are coming down,” he says. “There is a perception that profits may go up in the future, the stock market goes up. It is a logical consequence of what we are living. However, it is true that for a sustainable recovery and for a sustainable disinflation we do need to stick to the reforms.”

While the central bank governor was speaking to GlobalMarkets in mid-September, financial markets were experiencing a sense of near euphoria thanks to the implementation of a sound economic policy amid a supportive environment in global capital markets. The São Paulo stock exchange was breaking records day after day, bond yields were coming down while the CDS premium was falling below 200bp. But Goldfajn admits that this is not enough.

“The recession has passed. What we are having now is a consumption-led recovery coming from real income gains that were achieved through surprise disinflation. This means that people have enjoyed a permanent gain in income. We don’t see inflation coming back, not to the level it was before. Which means that this has boosted consumption, it has boosted sales and we have already seen some employment gains,” he says.

Goldfajn says the end of deleveraging may lead to a stronger recovery. He now expects a 2% quarter-on-quarter growth at the end of this year against a background of low inflation (around 3%), and 2%-3% GDP growth next year. The central bank has slashed the benchmark Selic points by six percentage points within a year, while inflation was falling below target (2.7% in August over 12 months), and Goldfajn has indicated that more will be done. “We will probably continue the cycle. We have signalled it is possible to do so if conditions remain the same. Depending on the extension of the cycle, of where we are in the cycle, we will reduce the pace because we are getting closer to the full cycle,” Goldfajn says.

Moreover, he believes that conditions have now been met for a rebound of investment. “Given the output gap, when consumption starts recovering it will help investment too. It is an essential second step in the recovery. First you have consumption. Then as the output gap narrows you will see investment increasing,” he says.

But investor confidence is also required. This may now depend on the completion of the reform agenda and the ability of the government to address Brazil’s fiscal weaknesses.

Reform offensive

Much progress has already been made on the reform front in spite of an explosive political crisis and a seemingly never-ending series of corruption scandals, some of them involving the president of the country, Michel Temer. The budget spending cap, the labour reform, the creation of a new long-term interest rate that will help cut subsidies in BNDES government loans, the change in the rules of the oil and gas sector, education reform… All these are already in the bag and have been praised by investors. “The reform agenda has regained momentum,” says Martin Castellano, deputy chief Latin America analyst at the International Institute of Finance (IIF) in Washington DC. “We are talking about high quality reforms that we have not seen in decades — not only those that need Congress approval but also many other changes in regulations to provide more room for the private sector to operate and increase productivity,” he says.

Yet the big reform is still pending. Indeed, the much-expected pension reform, which could have a long-term positive fiscal impact, has yet to be approved by a 60% majority in Congress. The reform, which introduces a minimum age of retirement (65 for men and 62 for women), is widely unpopular, especially among those civil servants who will lose some of their privileges. But as Brazil is now just a year before its next general elections, its chances of approval are diminishing.

“I will not get into politics but it is always important to have the least uncertainty possible in all type of areas in order to have higher investment,” Goldfajn says. “The boost in revenues, lower interest rates, lower inflation, all these will help future fiscal deficit,” says Goldfajn. “Notwithstanding, we will need social security reform. This is the one that you need… If it does not happen now, it will need to happen next year so it is a matter of time.”

While finance minister Henrique Meirelles has been battling away in Congress to get the reform approved, economists have confirmed the need to overhaul the pension system for the benefit of the country’s public finances. “If nothing is done, the share of social security expenditure will increase from almost 50% of the overall federal budget at present to 80% of overall expenditure in 10 years. It is totally unviable,” says Marcelo Carvalho, chief Latin America economist at BNP Paribas in São Paolo. 

Meanwhile, the fiscal situation has continued to deteriorate and the government had to revise its primary deficit downwards for this year and 2018 to around 2.5% of GDP. “The fiscal adjustment has been slow and of poor quality,” says Alberto Ramos, head of Latin America economics at Goldman Sachs in New York. “The fiscal performance has actually got worse. If this is not addressed, many of the gains we have seen so far, including in financial markets, could be compromised. And this would leave a very complex legacy for the next administration.”

The outcome of the 2018 presidential election is also a big question mark as the traditional political establishment has been decimated by the Lava Jato anti-corruption investigation. In the short term, however, current Brazilian economic policymakers inspire enough confidence. “There may now be a decoupling — not between politics and the economy — but between politics and economic policy,” says Carvalho. “As long as economic policy remains in place investors feel more comfortable in spite of all the political noise. We currently have an economic team that is respected and is backed by politicians, including by the president, to continue to do what has to be done in spite of day-to-day uncertainties.”

Brazil’s recovery has also been supported by a positive external backdrop. While global tailwinds have been relatively strong the risk of market complacency may have increased too. “We should be a bit more mindful of these fiscal issues, but in this external environment that is very favourable with abundant global liquidity, the market focus is not necessarily on the fiscal dynamics,” says Ramos.

The gross debt-to-GDP ratio already amounted to 73% in June, up from 51% at the end of 2013. This should be a cause for concern. “It is important not to get carried away and think all will be great forever and forget to do the homework,” says Carvalho. “It is exactly when the sun is shining that you need to go up and repair the roof. Rain will come, sooner or later, and we need to be prepared.”

If Brazil takes too long before grasping the fiscal nettle, Ramos argues that the gross debt ratio may reach 90%, which would be “too high for a country like Brazil. Ninety percent is a very unstable equilibrium. It is not that things will unravel in the very short term but if you do not address the issues you will be incubating vulnerabilities that will make you weaker down the road.”

Goldfajn agrees that now is a good time to reduce Brazil’s potential weaknesses. “We should not be vulnerable,” he says. “We need to stick to the reforms, we need to try to pass the pension reform while the international environment is stable. It pays to do it while the external environment is benign.”

  • By Thierry Ogier
  • 11 Oct 2017

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